Practical strategies for using sampling for the research tax credit.

• Author: Rotz, Wendy

For nearly two decades, taxpayers have filed original returns and refund claims for the research tax credit using estimates based on statistical samples. Sampling is versatile and flexible. It may be used for the research tax credit on an originally filed return or to submit a refund claim. Some taxpayers use sampling for base period determinations; others already have these figures, so they only estimate the current year.

The regular research credit equals 20% of a taxpayer's current-year qualified research expenditures (QREs) that exceed a base amount, determined by applying the taxpayer's historical percentage of gross receipts spent on QREs (the fixed-base percentage) to the four most recent years' average gross receipts. In general, the historical base period for determining the fixed base percentage is 1984 to 1988. However, for a startup company, which is defined as a company that did not have both gross receipts and QREs in at least three of the base period years, or the first tax year in which there were both QREs and gross receipts began after Dec. 31, 1983, a different, more complicated set of rules applies. To avoid the inherent difficulties in determining the fixed-base percentage based on what may be long past years, taxpayers can elect an alternative simplified credit (ASC). The ASC is 14% of the QREs for the tax year that exceed 50% of the average QREs for the three tax years preceding the credit determination year.

Sampling may be used whether a taxpayer is using the ASC or the regular method. Sampling can be applied whether or not the credit is base-sensitive. Samples may be organized by employee, project, department, supervisor, or any other convenient means of listing, grouping, and analyzing the costs that potentially may qualify.

In statistical sampling, cases are randomly selected from a listing. The QREs are determined on the sampled items rather than the entire listing. Statisticians use these determinations to extrapolate total QREs for the entire listing. This approach saves both the taxpayer and the IRS time and money.

Sampling for the research tax credit is becoming ever more popular as the IRS pushes for more documentation and establishment of the nexus between projects and qualifying activities performed by employees on those projects. Sampling allows the taxpayer to allocate precious resources to gather robust documentation for the sampled projects. Without a sample, either the taxpayer needs to allocate more resources to gather robust documentation for each project, or the taxpayer is limited to gathering cursory documentation for each project. (When a taxpayer draws a valid statistical random sample to estimate QREs, the IRS audits the taxpayer's sample rather than drawing its own selections. Thus, a taxpayer may better prepare for its audit--indeed, control it--with the knowledge that if it is audited, the IRS will be reviewing the sampled records with QRE-supporting documentation already collected and...