Statistical sampling makes it easier to claim a research tax credit than ever before.

• Author: Rotz, Wendy

Not just large but also medium-size and even smaller companies can more easily and cost-effectively take a research tax credit (RTC) now that the IRS allows multiple tax years under one statistical sample study.

For decades, taxpayers (especially larger companies) have used estimates based on statistical samples to file original returns and refund claims for the federal RTC as well as state research and development (R&D) credits. Statistical sampling, which the IRS accepts broadly, also applies to the domestic manufacturing deduction, tangible property, repairs, and cost-segregation studies, to name a few other tax applications that rely heavily on sampling for estimating values of deductions and credits on tax returns. With statistical sampling, only a portion of a company's records require review and documentation to support qualifying expenses.

That sample is used to extrapolate the credit for the entire company.

Even with a sample, the documentation the IRS requires for an R&D study can be onerous, as it requires rigorous support of a four-part test (described below) to claim that an expenditure qualifies for the credit, as well as clearly documenting the nexus (also described below) between qualified research activity (QRA) and the expenses claimed for the credit; the nitty-gritty details can be tedious. Traditionally, only larger companies have found the RTC worth their effort, even with the use of statistical sampling. Until now, many smaller companies and even some larger ones have either forgone the credit or claimed an RTC without thorough documentation--leading to more exposure in audit, as well as time and effort defending an RTC.

The IRS has long said that because the RTC is incremental in nature, it must be estimated annually--and the Service has not wavered from that position.

What has changed is how precise the estimates must be. The accuracy of the estimates is now assessed over the cumulative study rather than individually for each credit year. This greatly reduces the required sample size and, therefore, the amount of effort spent documenting and supporting the credit. That, in turn, lowers the cost of a study while achieving the same benefit. With the ability to stack as many open tax years as desired into a single study, the cost-benefit ratio of claiming the RTC is now more favorable than ever before.

Increasing R&D

The RTC is a credit for increasing R&D expenditures over a historic base amount. Taxpayers may elect one...