How to Use Time-tracking Data to Capture and Substantiate the R&D Tax Credit

We often see companies in software development, architectural and engineering services, aerospace, and other industries utilize sophisticated time-tracking systems for employees to accurately log time spent on projects. For a business with qualified Research & Development (R&D) projects, this data can become the backbone of an R&D Tax Credit study and claim. If the appropriate data is being captured and a knowledgeable technical analysis is performed, there are many benefits to basing an R&D claim on this information.

For a company’s time-tracking data to be useful for an R&D credit claim, a few elements must be present. The data must be able to accurately identify each employee’s time, the projects worked on, and the type of task the employee was performing. Additional details can also provide substantial context, but even relatively simple systems can be useful if this data is present.

The goal of utilizing time-tracking data for calculating an R&D credit claim is to determine the amount of time that each employee is performing qualified R&D activities on projects qualified under Section 41. The most critical aspect of this evaluation is determining which projects qualify for the credit. Each project must pass a four-part test and pass any applicable exclusions, such as the funded research exclusion. Our experienced team at McGuire Sponsel works with clients to efficiently stratify projects into groups that are likely or unlikely to qualify, and then performs a thorough review of those projects to ensure all parties are confident in the final qualified project list.

Once the qualified project list is determined, an examination of the time within each project must be performed to ensure that only qualified research and development activities are quantified. As each organization approaches projects differently, we work closely with clients to understand the phases of their development cycle. Our team applies tenured experience partnering with businesses within the industry to determine which and how much certain phases or tasks are considered qualified R&D time. Qualifying activities typically revolve around the preliminary conceptualization of an innovative solution, the iterative design or development procedure to evaluate and revise the solution, and the final verification that an appropriate and effective solution was developed and can be implemented.

While the data should be relied upon, it is also essential to review the conclusions drawn from the data and determine if there are any potential inaccuracies. By balancing the minute details of the data with a high-level review of qualified employees, we can determine if each individual’s contributions is included at a reasonable and appropriate level.

It is common for highly technical management-level leaders to attribute much of their time to “overhead,” and the portion of time that can be applied to the R&D credit may need to be estimated. For instance, a software firm’s chief technology officer may spend significant time brainstorming solutions or working on platform architecture designs with the team. However, this may not be accurately reflected in the data, so another approach to quantifying his or her time should be considered.

Using time-tracking systems as a foundation for an R&D Tax Credit calculation and claim provides many benefits. First and foremost, it provides strong documentation, creating a nexus between employees and projects, along with specifics on the activities performed by those employees. It also contributes to accurately determining qualified research expenditures for each business component. These are both common requests in any audit situation examining R&D Tax Credit claims.

If you have any questions regarding qualified research expenditures or our R&D Tax Credit practice‘s approach to claims, please do not hesitate to reach out.