Is your manufacturing company preparing your R&D Tax Credit (RTC) claim internally or hoping to do so in the near future?
Companies of all sizes are being faced with tough decisions in regard to tax breaks and tax planning. With budget cuts and company wide layoffs, completing an in-depth R&D tax credit claim with an outside firm may no longer be an option.
The trend now is for manufacturing companies to take their entire RTC claim preparation in-house. While this might be an economically sound decision at the moment, a later IRS audit may make them wish they had sought outside help.
RTC claims are now considered a Tier I audit risk. The IRS is expanding the number of claims subject to examination, and in many cases, are aggressively reducing claim sizes and assessing penalties on the amounts reduced.
In May 2008, new audit guidelines were released by the IRS which specifically addresses the RTC and the documentation required to support a claim. The IRS is focusing its examination efforts on the Qualified Research Activities (QRAs) claimed, the Qualified Research Expenditures (QREs) associated with the QRAs, and the connection or “nexus” between the two. The activities must qualify, and even if they do qualify, proper documentation must be available to support that the activities actually occurred and that there is an evident relationship between the activities and the expenditures.
This added scrutiny is moving manufacturing company reporting to a mostly project-based model. Unfortunately, project-based reporting is both time consuming and expensive. Also, the company’s information systems in place may not be set up to accurately capture information needed to support an RTC claim. Add that to mounting lay-offs, and the resources may not be available to give attention to this kind of detail.
Without assistance, moving the whole RTC claim preparation in-house could leave a lot of tax dollars on the table and put at risk the dollars being claimed. Under claiming is common as there is a fear of not knowing exactly what the IRS is looking for under the new examination approach.
When moving the RTC claim preparation in-house, it is advisable to have a transition year with a firm that has been successful with post-May 2008 audits. This allows for a period of staff training where the manufacturing company’s personnel work in conjunction with the advisory firm for a smooth transition of responsibility.
If assisted, the manufacturing company won’t have to sacrifice quality control, credit dollars or be placed into a high probability of IRS examination adjustments. The advisory firm can also help with successfully implementing a process to gather and capture QRAs and QREs and the “nexus” between the two.
If a decision is made to have a transitional year to bring the R&D tax credit preparation work in-house, there are a few specific items that should be included in the engagement letter with the service provider. The engagement should address that the work is designed to transition the preparation from outsourcing to in-house. It should also include a detailed transition and training plan that addresses quality control issues.
Legislation Update: The RTC, created in 1981, has been extended by Congress 13 times and will expire again this winter if President Barack Obama does not succeed with his goal of making it permanent. The U.S. needs to have a permanent RTC to become competitive internationally.
Braithwaite Global provides research tax credit services. For more information, visit www.braithwaiteglobal.com