The Research and Development (R&D) Credit is an often used tax planning tool that could help reduce an entrepreneur’s tax burdens. The problem is that it was abused.
Hundreds of companies showed up almost overnight promoting the credit. Most of those companies were more interested in selling their services than in properly qualifying their new clients for the credit.
Young blonde girls in skirts that were way too short approached every Architect I had telling them that they’d easily qualify which was ridiculous. Just because you design a house and decide to put a kitchen here rather than there, doesn’t mean that you’re creating a brand new technology which would qualify for the credit.
So the IRS did a study of over 900 credits that came in several years ago, and determined that over half of them didn’t begin to qualify. So they radically changed the existing rules to stop the abuse pf the system.
Since those rule changes companies haven’t stopped claiming the credit, but it has become much riskier to do so in the past few years.
There have been fourteen major cases filed in the Federal Tax Court System since 2019 and the Service has only lost one of them. That’s a 93% conviction rate, which is almost unheard of in Federal Taxation Circles.
Of those wins, the case with the largest impact on IRS audits was Little Sandy Coal Co. Inc. v. Commissioner because it led to an enhanced focus on business components and the process of experimentation. This has empowered most IRS auditors.
The Seventh Circuit held in the case that…
1 – The company wasn’t entitled to claim R&D Credits for its shipbuilding subsidiary because it failed to provide a principled way of determining what portion of the employee activities for each vessel constituted elements of a process of experimentation.
2 – The ruling also affirmed that the “substantially all” standard inherent in the credit includes direct research, support, and supervision activities as elements of a process of experimentation.
Identifying individual business components became a major exam focus after Little Sandy Coal. Prior to that, we didn’t need to spend much time defining those individual components.
Let me leave you with this…
OBBBA restored the deductibility of R&D Expenses in the year incurred. Last year we were required to amortize those expenses over a useful life of five years.
This hurt many companies that lost 80% of their R&D Deductions in the first year.
But the Research and Development Credit is still available. We just need to be sure that we qualify before claiming it.
The qualifications for the credit include…
1 – The activity must be related to improving the functionality, quality, or reliability of a business component.
2 – The process must be technological in nature being based on a hard science such as engineering, physics, and chemistry or the life, biological, and computer sciences.
3 – At the beginning of the process, there must have been an uncertainty as to its success in creation or implementation.
4 – There must have been a process of experimentation with multiple design alternatives or a trial and error approach.
Successfully completing these credits is no small feat. It isn’t as simple as filling out one of the usual IRS Forms. It takes time, documentation, education, and talent. If you’d like to know if your company qualifies, you know my number.
One last thing.
It’s November. If you haven’t sent in your work recently and we’re behind on your monthly financial statements, please send in your work today.
Tax Planning is a major focus of our firm. With all of the tax law changes we’ve had this year, it’s become more important than usual.
I won’t be able to do tax planning for you or your company if I don’t have a set of November 2025 financials in place, so please send out your materials today.
We’re all going to get through this. Let’s get through it together.Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
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