Your company may face significant difficulties in determining what expenses associated with pharmaceutical research activities are eligible for R&D tax credits under Internal Revenue Code §41. You must know both what R&D activities are eligible and what documentation is needed to identify and capture these qualified research expenses. Identify Qualifying Wages
A key component of pharmaceutical research spending is the wages paid to in-house chemists, scientists and other technical personnel. Most of these employees perform a variety of activities, some of which are qualified (creating experimental formulations) and some of which aren’t (drug quality control and FDA filing). This makes identifying and qualifying these employees a challenge.
To claim the R&D tax credits, you need to analyze how employees’ activities are tracked throughout the year. Do you have a formal project accounting system that enables employees to document their time? If so, are all company personnel using it consistently?
While you aren’t specifically required to use project accounting to claim the R&D credit, you must retain sufficiently detailed records to substantiate that the expenditures claimed are eligible for the credit. Having a process in place to establish the correct amount of eligible wages is critical to substantiating the R&D costs for your pharmaceutical company.
Depending on the company’s time tracking system, qualified activities such as direct supervision and administrative support often are overlooked. Even if your company doesn’t require employees to track their daily time and activities, at a minimum, employees need to record and allocate their activities into qualified and nonqualified tasks.
Don’t Wait To Document Qualified Research Expenditures
To meet the substantiation requirements, it’s also critical to maintain contemporaneous documentation, such as management meeting minutes, technical emails, lab notes, formulation and chemistry progress reports, and other documents showing qualified time.The IRS and state tax authorities may deny your claim for the tax credit if you lack documentation in key areas. Common problem areas in an audit include lack of project nexus between the qualified activities and the eligible expenses, as well as a lack of sufficient contemporaneous records to prove that R&D activities are in fact taking place.
Make it a priority to track and gather relevant information. Personnel movement is more common than ever, and staff turnover can limit the availability of key information to properly substantiate R&D activities. In addition, many retention policies are now shorter in an attempt to lessen risk, which often limits the availability of key information to properly substantiate credits.
Even if your company isn’t in a position to conduct a full R&D review now, you should lay the groundwork to ensure the necessary information is available when the time comes to do a full study.
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