The research credit is an important feature in the tax code to encourage research and experimentation by the private sector.
The IRS continues to see significant misuse of the research credit. Improper claims for this credit generally involve a failure to participate in or substantiate qualified research activities and/or a failure to satisfy the requirements related to qualified research expenses.
To qualify for the credit, a taxpayer’s research activities must, among other things, involve a process of experimentation using science that is intended to improve a product or process the taxpayer holds for sale or lease. However, there are certain activities, including research after commercial production, adaptation of an existing business product or process, foreign research and research that is funded by the customer that are specifically excluded from the credit. Qualified activities also do not include activities where there is no uncertainty about the taxpayer’s method or capability to achieve a desired result.
The IRS often sees expenses from non-qualified activities included in claims for the research credit. In addition, qualified research expenses include only in-house research expenses and contract research. Qualified research expenses do not include expenses without a proven nexus between the claimed expenses and the qualified research activity.