Is your R&D experimental enough?

In the recently decided case of Little Sandy Coal Company, Inc.., Petitioner v. Commissioner of Internal Revenue, Respondent, the U.S. Tax Court denied the Petitioner's claim for research and development tax credits pursuant to I.R.C. 41. Part of the reason for the denial is that the taxpayer could not prove that the process of experimentation requirement was met, and thus his activities did not meet the requirements of I.R.C. 41(d)(1)(C). In order to meet this requirement, the taxpayer had to prove that at least 80% of the research activities constituted a process of experimentation.

Treas. Reg. 1.41-4(a)(5)(i) defines a process of experimentation as:

"a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities. ..." Treas. Reg. 1.41-4(a)(5)(i).

In part because the taxpayer could not prove that they met the 80% criteria, the tax credits were denied. While the research and development tax credit is a helpful tool in allowing companies to recuperate the cost of doing research and development, this is by no means a "no strings attached" tax credit, and careful planning and record-keeping is essential when claiming these credits.