Keeping proper documentation of your R&D activities is crucial to ensuring your R&D tax credits will be supported in the case of an audit. The Internal Revenue Service (IRS) and the state Departments of Revenue (DoRs) are intentionally generous with these credits, but also want to ensure accurate credit amounts.

Looking at the R&D documentation process can seem overwhelming at first,  but don’t fret! Taxpayers do not need to track every single task every single employee completes. Our goal is to avoid overwhelming the team, while still compiling strong evidence to support the credit claim in the event of an audit.

R&D Tax Credit Documentation Requirements

Congress has outlined the eligibility requirements for the R&D credit under the Code of Federal Regulations (CFR). Under CFR, taxpayers need to retain records detailing the following:

  • Calculations
  • Personnel Data
    • W-2 forms for employee compensation
    • Included Percentage
    • Personnel Titles
    • Time Tracking (if available)
  • General Ledger Data
  • Patent applications
  • Invoice copies for purchases and included patent costs

Are there alternatives to time tracking?

Many new companies, smaller organizations, and companies that are not doing any sort of consulting work do not elect to track employee time on projects.  When time tracking documentation is not available, the IRS will allow estimation as per Cohan V. Commissioner.  General project data taxpayers have available to link personnel to projects and costs can be used. The IRS calls this linking nexus. Alternative documentation that illustrates the “who did what” of your projects might include:

  • External communications like white papers, press releases, blog articles, or brochures
  • Internal communications like presentations prepared for management or review committees
  • Meeting Minutes from project meetings
  • Design and development documentation including technical drawings, schematics, notes, and test data

Taxpayers should note that while the IRS and DoRs are flexible about the type and format of evidence provided, the existence and provision of documentation to prove nexus as per United States v. McFerrin is mandatory. These guidelines provide the framework for computing and substantiating the R&D tax credit.   In October of 2021, the IRS provided updated guidelines for refund requests, more information is available here.

How to document your R&D activities

When considering the best ways to document your R&D activities,  first analyze what information is already available. Working within existing systems to find documents that already illustrate included activities can eliminate a lot of extra work. Often, the key to eliminating duplication is to store copies of in-process documents in electronic storage. Things like photos of whiteboards can also be utilized: keep it simple and save e-copies before getting rid of any hard copies!

Have more questions?

Get in touch with our R&D Tax Credit Team to get your questions asked and answered. We’re available to you to discuss how we can help you prepare your R&D documentation and substantiate your tax credit.