For the research credit, Nexus is defined as the process of providing documentation between Qualified Research Activities (QRAs), also known as a R&D Business Components and their Qualified Research Expenses (QREs), also known as the paid wages, supplies and third-party contractors associated with your QRAs.
Nexus is one of the most important factors to check off when a business goes through the process of claiming the R&D Tax Credit. It’s all about documentation, documentation, documentation.
In order to prove Nexus during an audit, the IRS will want to see the documentation for each employee and how their time on the job was spent working on QRAs. Without Nexus, the chances of disallowance greatly increase.
It is common for businesses to build Nexus for credit through different cost accounting methodologies. They are as follows:
- Project Accounting – this is the only method for establishing Nexus, it’s as simple as that. Project accounting entails tracking all financial components of QRA. As it sounds, this method is more granular thus leaving a better audit trail. If in audit, providing proof of project accounting, will significantly decrease the risk of disallowance. Project accounting is especially helpful when claiming the credit for large scale projects.
- Cost Center Accounting – unlike project accounting, cost center accounting is considered a “higher level” form of tracking project expenses. A cost center is like an ongoing activity, or a bucket of a lot of little business components. The risk in utilizing this method is that it is more difficult to tie in specific projects to expenses. This method does not build nexus. There’s more work and more risk when in the exam.
If a company is already tracking time towards projects, then they typically have Nexus for purposes of the research credit. However, they’re still required to qualify their projects against the 4-Part Test to prove that it’s qualified research.
For companies that don’t track time, they can create Nexus after the fact (quarterly, bi-annually, or annually). Alternatively, you can use Armor’s timecard module to track time as you go (also known as “contemporaneously”).
Do you want to be even better? Although nexus can be created after the fact, Contemporaneous Nexus is a more “bullet-proof” tax position. This method is the most accurate way to ensure that your R&D credit is “audit-proof.” With Contemporaneous Nexus, employees complete and record daily time tracking for work that is considered QRA(s). The key is, you have to prove that you tracked your QREs against QRAs in real-time. In other words, you have to show that you didn’t create nexus after the fact.
They key to Contemporaneous Nexus is that projects and expenses must be accounted for in real-time. By the way, Armor is proficient at providing this service. Now, this doesn’t mean that time must be tracked every hour on the hour. For purposes of the research credit, recording your time at the end of every day is sufficient enough to build Contemporaneous Nexus.
As the value of your credit increases, you should highly consider utilizing Contemporaneous Nexus, as your credits are more vulnerable to audit, the larger they get.
As you know, the general rule of thumb when filing taxes is to keep track of all expenses and their related documents in case of an audit. The same goes when filing for the R&D Tax Credit. Being proactive is always better than waiting until the last minute. Better be safe than sorry, right?
With that said, if you’re interested in claiming the R&D Tax Credit, it is important to know what Nexus is and how your business can properly and efficiently create it. The key to tracking Nexus is to know which business components qualify and how much-qualified expenses are being paid towards those components.
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