WHY AUTOMATED R&D TAX CREDIT
SOLUTIONS WORK ONLY FOR A FEW

By: Alex Pak | Director, Los Angeles

For decades, companies have been trying to design software that could accurately and
completely capture a company’s R&D tax credits. The main reason that companies have been unsuccessful over the years is because the R&D tax credit rules are interpretive and guided by a 4-Part Test for R&D qualification. There is no decision tree that can accurately capture the full extent of R&D due to the interpretive and unique nature of each companies’ R&D efforts. So software solutions often fall short.

For decades, companies have been trying to design software that could accurately and completely capture a company’s R&D tax credits. The main reason that companies have been unsuccessful over the years is because the R&D tax credit rules are interpretive and guided by a 4-Part Test for R&D qualification. There is no decision tree that can accurately capture the full extent of R&D due to the interpretive and unique nature of each companies’ R&D efforts. So software solutions often fall short.

The biggest flaw of automated software options is that it is in fact, not automated. These systems all require individuals within organizations, many of whom have no tax experience, let alone experience with the R&D tax credit, to make determinations about qualification. This not only leads to the inevitable reduction of credits, but also adds an additional layer of responsibility to employees who are not accustomed to making tax determinations. This impact increases in industries where multiple types of Qualified Research Expenses (QREs) need to be identified such as in manufacturing,where supplies comprise a large portion of a company’s qualified QRE pool.

What You Should Know About Automated R&D Tax Credit Software

  • Understanding the Credit – Understanding the rules for qualification and how to appropriately reflect time and costs within a software system is critical to the success of any R&D tax credit study. This means that each person who inputs data into the system needs to have experience and knowledge with the credit, this is generally not feasible and a major weakness.
  • Non-Compliance – Human nature is to limit the discussion/documentation of failure and boast about success.But the opposite is what is helpful in identifying R&D activities and costs. Time tracking is subjective and often leads to understatement.
  • Security – Any automated R&D tax credit software would have to breach security firewalls for any analysis to be possible. Exposure would only increase should you use contractors to perform qualified activities as they would need access to the system to capture their time.
  • Federal & State Credit Calculations – The actual calculation of federal and state credits are generally not included in the software as it only captures Qualified Research Activities (QRAs), which leaves the determination of QREs and the actual calculation still outside the system.
  • Support QREs – If project managers and others working on the R&D are outside the development umbrella,automated systems will not include them in the scope and those individuals will need to be identified and included outside the software system.
  • Code Variances – Some software systems have algorithms that are designed to identify and pick up certain words to determine qualification. If a company is not diligent in tracking specific tasks, the reading of those tasks via algorithm will be flawed. As an example, if software developers code an activity to a ‘general’ code, it will be hard for the algorithm to identify it as R&D.
  • Audit – While tracking platforms can play a role, where they all fall short is in the audit process. Unlike a consulting team with experience dealing with both the IRS and state agencies, it will fall on the taxpayer to defend the results of their claim.

Ultimately, software platforms do have value, but require informed input from a wide range of employees who almost always have little to no experience with corporate tax compliance. Where software really works well is in identifying clearly obvious R&D activity while falling significantly short in capturing ancillary expenses. Should your company have the personnel with the necessary experience to perform an analysis, the software solutions out there may be a perfect fit. But for the vast majority of companies, especially in the small to mid-sized business space, software solutions only add to the complexity of your operations and put additional responsibilities on your employees. Then, add to this the threat of having to defend the results in audit, the proposition becomes more of a risk than a benefit.