Photo of my dad’s combine during soybean harvest
Background
I have had a few farmers reach out to me to ask whether they qualify for the Research & Development (R&D) credit. They often mention a neighbor who claimed it on their tax return, or a salesman from a tax-credit company promising big returns if the farmer hires them to conduct an R&D tax credit study. This is a hot item as of late, and many farmers are left questioning if it is too good to be true. The tax court recently upheld a poultry producer’s R&D credit in the case of George v. Commissioner. This post will help you understand what qualifies as R&D in the IRS’s eyes and the crucial record-keeping requirements the credit hinges on.
What does the IRS consider “Research & Development”? A Four-Part Test
You may think that R&D is reserved for those working in a laboratory, and not farmers. However, it is much easier than one may think for a farmer to qualify for the R&D credit. Here is the four-part test to qualify:
Permitted Purpose: You are trying to improve the function, performance, reliability, or quality of a product or process (e.g., increasing bushels per acre or optimizing livestock feed rations).
Elimination of Uncertainty: You didn't know the "best way" to do it at the start. There was a technical question about the design or method. You are not using tried and true methods or practices.
Process of Experimentation: You used a systematic and data-driven approach (trial and error, maintaining a control group, independent and dependent variables) to evaluate different alternatives.
Technological in Nature: The research relies on "hard sciences" like agronomy, biology, chemistry, or engineering.
Here are a few examples of common activities that may qualify for your operation:
Note: the IRS specifically mentions under Internal Revenue Code Section 41(d)(3)(B) that “Research will not be treated as conducted for a qualified purpose if it relates to style, taste, cosmetic, or seasonal design factors.”
IRS Scrutiny & Record-Keeping Requirements
This credit is much more than filling out a form on a tax return. It requires you to document your research hypothesis and your findings throughout the year. Most tax credit companies that approach farmers offer to assist with an R&D study for previous years and will put together a generic research study document to substantiate the credit. However, the IRS will need more than a document stating that you had R&D; they will want to see your technical research data and findings.
Claiming a credit can be a tall administrative task. It is worth noting that it does not require your research to be successful. The Tax Court's recent rulings have made one thing clear: the IRS will allow these credits, but only if you have the "paper trail." To claim the credit, you should track:
Trial protocols and hypotheses (what were you trying to prove?).
Specific records of inputs used in test areas vs. control areas.
Labor hours dedicated to monitoring and analyzing results.
The specific expenses allocable to R&D. You cannot consider your entire operation to be R&D.
Bottom Line: Documentation is Everything
Taxpayers claiming a credit need to prove that research was actually done, and did not create a research study after the fact to claim a tax credit. In the George v. Commissioner case, the court relied on the taxpayers’ documents they generated throughout the year to corroborate the claims in their research credit study
This credit has loads of potential and could be very valuable to many farmers. It is likely underutilized in the ag industry, largely due to farmers not viewing their operation as having any research and development. Farmers should do an in-depth analysis of whether they qualify and the recordkeeping requirements with their CPA before pursuing the credit.
Even if you have R&D, everything hinges on the quality and timeliness of your records. You must have detailed data and notes from the time of the research for it to hold up in an IRS inspection.
Thanks for reading!
-Blake
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