Key Records You Need for the R&D Tax Credit

The Research and Development (R&D) Tax Credit is designed to reward taxpayers, of any size and within any industry, that create new or update existing products, processes, techniques, formulas or software. Businesses with qualifying research activities (QRAs) are strongly encouraged to utilize the R&D Tax Credit, as it can help them minimize their tax liabilities, enhance their cash flow and make long-term investments in product and/or process innovation.

To claim the R&D Tax Credit, the Internal Revenue Service (IRS) requires businesses to prove that their research activities qualify. In order to demonstrate their QRAs, businesses must provide thorough and specific documentation along with their R&D claims.

Documents Required for R&D Tax Credits

The IRS requires specific records when reviewing the R&D Tax Credit to ensure a business’ claim is valid. Beginning in tax year 2025, mostly all taxpayers will be required to adopt additional level of details when filing the R&D tax credit. This will include the list of wages, supplies, contract research expenses and the cloud computing expense for each business component (research and development activity). Having the following essential primary documents on hand, will be helpful when businesses will be asked to provide required documentation to the IRS:

• Business Components
  • List of all business components that the business engaged in during the current tax year they are filing by breaking out the actual name and unique identifier of those business components.
• Employee wage documentation – Wage documentation will need to be provided for all employees who were involved in R&D activities, including:
  • W-2 forms
  • Timesheets
  • Payroll registers
• Contractor expense documentation – If a business hired third party contractors to perform or in any way assist with research activities, those contractor expenses will need to be documented, including:
  • Invoices
  • 1099 forms
  • Contracts
• Supplies and materials documentation – Any materials or supplies that were used in QRAs must be properly documented, including:
  • Receipts and invoices
  • General ledger entries
• Lease or rental agreements for research equipment – If a business has leased or rented equipment for research purposes, the IRS requires documentation to show those expenses were necessary for the business’ R&D activities, including:
  • Lease agreements or rental contracts
  • Usage logs

For 2024 tax filing year, the IRS is requiring taxpayers to answer two new questions on Form 6765. These questions are:

• Did the taxpayer include any new categories of expenses for the current year that they are including as qualified research expenditures (QREs)?
• Did the taxpayer determine any of the QREs following ASC 730 Directive method? The Directive method is a method certain large business taxpayers can use when identifying QREs based on financial statement R&D amounts.

Effective Strategies for Organizing R&D Documentation

Rather than waiting until the study process to address documentation, businesses should maintain up-to-date R&D Tax Credit records as expenses arise to ensure compliance with IRS requirements. Here are a few strategies that businesses can use to organize their R&D documentation:

• Organize by project – The best way for businesses to handle documentation is to break it down by individual research projects. Each project should have records on the project objectives, the activities performed and the associated costs.

• Link expenses to research activities – Make sure that all expenses can link back to QRAs. This means showing a clear connection between the costs and the specific tasks they support. For example, invoices for materials should indicate which research project they were used for, and employee timesheets should show the time spent on specific R&D tasks. Making the connection between the cost and the QRA is critical for meeting IRS requirements.

• Provide clear and detailed descriptions – It is important that businesses make their descriptions clear and detailed when writing project summaries, timesheets, expense reports, etc. General descriptions that are vague can raise suspicion with the IRS and lead to a claim being rejected.

• Backup documentation – In addition to primary records stated previously, it is advisable to also maintain backup documentation that can help support the business’ claim in more detail. This can include emails to provide context on how QRAs progressed over time and meeting notes to show how decisions were made during the research process.

• Work with a R&D Tax Credit professional – Working with a tax professional who understands the specific requirements and regulations of different jurisdictions can help businesses navigate the complexities of R&D Tax Credit documentation. The Brown Plus R&D Tax Practice can help organizations identify their QRAs, document their expenses and ensure their compliance with all IRS regulations.

By following these strategies, businesses should be able to clearly demonstrate to the IRS that their R&D expenses are valid and that their claim is well-supported. If you have any questions on R&D Tax Credits or compiling the necessary R&D documentation, please contact Patrick Rogers, EA, MST, Tax Principal and R&D Director at Brown Plus.

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