Many companies in the U.S. work in the life sciences industry, including firms working in the fields of pharmaceuticals, biomedical, biotechnology and medical devices. For the bulk of companies in life sciences, developing new or improved products involves a complex interaction between the development process, manufacturing process, and regulatory approval and commercialization.Many life sciences activities and related expenditures are eligible costs for the R&D tax credit, which allows companies that invest in research and experimental activities to offset income tax liability at the federal and, in most cases, state level.
New drug discovery and development, and related activities, are expensive and time-consuming. Every year, life sciences firms increase investments in new drug and medical technologies discovery. To maximize your tax credits and incentives in life sciences research and development, your firm must properly analyze and effectively evaluate R&D activities.
The following are three segments within life sciences research and development that typically qualify for R&D tax credits:
1. Project Accounting Data
Many life sciences firms track their research and experimental expenses using formal project accounting systems. Employees’ time and other R&D project expenses are recorded and summarized on a regular basis.
Knowledgeable taxpayers will use these project accounting reports to identify potentially qualified research expenditures. One area of opportunity under R&D tax credit regulations is when calculating employees’ qualified R&D wages. Taxpayers are allowed to back out of the calculation, any non-working time such as vacation, holiday, sick time, etc., that will yield a larger amount of qualified time and wages for the tax credit.
However, potential problems exist when there are insufficient records to establish the nexus between the “business component” (e.g., new drug) being researched and developed and the employees conducting research activities on those projects. Even companies relying on their project accounting systems to identify qualified employees need to qualify the research activities under the §41 statutory requirements.
Taxpayers using project accounting should consider what tasks are eligible activities and whether or not the research projects are eligible for the R&D tax credit. Just because an employee is performing a research task doesn’t necessarily mean the development of the business component is a qualified activity.
2. Research Departments
In the life sciences industry, the research and development process is a massive ongoing effort that requires involvement from each department within the organization, with many departments dependent on one another to succeed in its development.
Furthermore, it’s not possible for one department to perform all of the development on its own, and the R&D process frequently requires the help of many different departments and divisions of labor. Some of the life sciences departments involving qualified activities include biology, chemistry, pharmacology, toxicology, analytical, biostatistics and pharmaceutical technology development teams.
3. Contemporaneous Documentation
In addition to reviewing and analyzing department activities and expenses, maintaining R&D contemporaneous documentation – management meeting minutes, technical emails, lab notes, engineering progress reports and other documents showing qualified time – is critical to meeting the R&D tax credit substantiation requirements.
For example, one recent taxpayer under IRS audit claimed some qualified employees as having attended technical meetings and performed technical design reviews on a research project. However, the taxpayer could not produce any books or records that showed the employees actually attended these meetings or were involved in technical design reviews.
The result: The IRS disallowed all the wage expenditures related to these two activities. Had the taxpayer maintained good books and records showing employees performing research activities in these areas, it would have sustained more R&D tax credits.
While only a few types of qualified life sciences expenditures are eligible for the R&D tax credit, many rules and regulations help determine what activities are qualified and how to properly document these expenses.
As you evaluate these potentially qualified expenditures, consider what types of documentation you have to support the claim: Is it sufficient, or are some areas lacking and in need of more substantiation?
The more information and support you have to justify your R&D tax credits, the more success you will have if these claims come under examination.
Ready to capture R&D tax credits for your qualifying life sciences research expenses? Download your complimentary, educational guide below.
