The R&D Tax Credit & Experimentation

Recently, a webinar commentator posed the question about the R&D tax credit and whether healthcare professionals engage in research in their daily practices. The question was based on the commentator’s interpretation of experimentation as the discovery of something new.

As with all things legal and tax-related, language is everything. So how does the language of the tax credit address experimentation? The Audit Techniques Guide (“Guide”)[1], the document created by the IRS to assist field investigators during R&D tax credit evaluations, states that qualifying research “constitutes elements of a process of experimentation for a qualified purpose (also known as the process of experimentation test).”[2]

Is experimentation the discovery of something new?

In short, no.

The Guide states the following:

There is no “discovery” requirement under section 41 separate and apart from that already required under Treasury Regulation section 1.174-2(a)(1) (i.e., was the research undertaken to eliminate uncertainty concerning the development or improvement of a business component).[3]

A “business component” is any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or used in a trade or business of the taxpayer.[4] Clinicians generally use processes or techniques in their businesses. (As a quick aside, the commentator in this webinar also mistakenly indicated that the research activity had to be held out for sale to other clinicians to qualify. However, the Guide clearly indicates that the development may be utilized within the taxpayer’s own business.)

So, with regard to experimentation, it is a question of uncertainty and whether you are developing your techniques to reduce uncertainty. To put a finer point on it:

The final regulations, like the proposed regulations, abandon the requirement that the research activities be undertaken to obtain knowledge that exceeds, expands or refines the common knowledge of skilled professionals in a particular field of science or engineering.[5]

What is uncertainty?

Is there uncertainty in the care you deliver as a clinician? Statute tells us that “[u]ncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product.”[6] Uncertainty in the capability refers to the capacity of the taxpayer to achieve a result. Uncertainty in the method refers to whether the plan of attack will result in the desired outcomes. “[S]long as the appropriate design of the desired result is uncertain as of the beginning of the taxpayer's research activities”[7] there is uncertainty in the activity.

How do you demonstrate uncertainty in healthcare?

A search on Google Scholar will show you whether the issue is an active area of research rather quickly. Is the activity in question an area of current CE? Are there multiple ways to treat the same condition which require differential decisions on medications, materials, and/or equipment utilization? If so, there is uncertainty in the method.

Uncertainty with regard to capability is often a question of whether the clinical team has the appropriate training, the facility is appropriate, and the business model is prepared to meet additional time or other requirements.

Other Requirements

The R&D tax credit does require substantiation of your activities and there are definitely areas where specifics are a necessity. Identifying the uncertainty is only the first step, next is a process for evaluating your approach to development. Uniquely, Dr. Tax Credit utilizes a recognized clinical trial process as we assist our clients as they frame their qualifying activities in the appropriate format. Working with our clinicians, we have also developed a series of active clinical trials to evaluate some common questions in the field. When our clinicians join these ongoing trials, not only are they working to achieve a tax credit for their business, but the results they share may ultimately “expand the common knowledge” in their respective fields.

We think that’s pretty exciting. Please reach out if you have any additional questions.

[1] https://www.irs.gov/businesses/audit-techniques-guide-credit-for-increasing-research-activities-i-e-research-tax-credit-irc-41-qualified-research-activities [2] Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities, 5.a.4 [3] Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities, 5.a(2) [4] Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities, 5.a(3) [5] Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities, 5.a(2) [6] Sec. 1.174-2(a)(1), Income Tax Regs. [7] Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities, 5.a(4)