Add the Cheese, Improve Your Credit

The R&D credit regulations contain an example many refer to as the “cheese” example. The example discusses a taxpayer with a “large-shred” product that wants to add a “fine-shred” version of a product. It concludes that adding a “fine-shred” product includes qualified R&D.

Fun fact, 74% of Americans add cheese to their hamburgers (see survey).

What does cheese have to do with the R&D tax credit? You may be surprised.

The R&D credit regulations contain an example many refer to as the “cheese” example. The example discusses a taxpayer with a “large-shred” product that wants to add a “fine-shred” version of a product. It concludes that adding a “fine-shred” product includes qualified R&D.

Perhaps you are one of the millions of consumers that purchase shredded cheese at the grocery store. As you decide between the large-shred or fine-shred cheese, do you ever consider the research and development that are involved in shredding cheese?

This is an important example because most of us understand the process of shredding cheese. Think of the last time you shredded cheese in the kitchen. You probably used a cheese shredder with large holes on one side and small holes on the other side. Changing between large shreds and fine shreds is not an overly complex process.

If shredding cheese can result in qualified R&D activities, what qualified activities are you missing? The truth is many qualified activities are not included in credit computations because people don’t understand, or over complicate the tax regulations.

The Cheese Example

The following example is included in the R&D credit regulations.

Example 3. (i) Facts, X is engaged in the business of manufacturing food products and currently manufactures a large-shred version of a product. X seeks to modify its current production line to permit it to manufacture both a large-shred version and a fine-shred version of one of its food products.

A smaller, thinner shredding blade capable of producing a fine-shred version of the food product, however, is not commercially available. Thus, X must develop a new shredding blade that can be fitted onto its current production line.

X is uncertain concerning the design of the new shredding blade, because the material used in its existing blade breaks when machined into smaller, thinner blades.

X engages in a systematic trial and error process of analyzing various blade designs and materials to determine whether the new shredding blade must be constructed of a different material from that of its existing shredding blade and, if so, what material will best meet X’s functional requirements.

(ii) Conclusion. X’s activities to modify its current production line by developing a new shredding blade meet the requirements of qualified research.

Qualified Research is Not Difficult

The basic test for qualified research is resolving uncertainty. In the cheese example the uncertainty was whether X needed a new blade material. You can almost hear the discussion in the boardroom.

“We need to make a fine-shred version of our product”.

“We will need to add a new shredding blade”.

“Can we make the blade out of the same material”?

“I don’t know, let me look into that”.

And just like that, qualified research begins.

There is no “difficulty” test. Research doesn’t need to be especially difficult to qualify. The resulting product does not have to push the frontiers of the market.

Qualified research can be as simple as finding a new blade to make fine-shred cheese.

Don’t Over Complicate Matters

Many who prepare R&D credits over complicate matters. There are several reasons why, 1) professionals get paid for their expertise and some think that they look more expert by over complicating rules, 2) many professionals simply have not taken the time to study the regulations, and 3) professionals who lose technical discussions with the IRS lose confidence and under claim credits.

Whatever the reason, over complicating matters results in smaller credits. The cheese example sets a low bar for qualified activities. Don’t overlook the seemingly simple activities when exploring qualified research.

Find the Cheese

Where does your company hide the cheese? Where can you find qualified research buried in seemingly simple process changes or new product variations?

A.I. technology can help you find hidden research. A.I. models can be trained from the broad experience of thousands of professionals. This gives A.I. the advantage of millions of decisions. No single professional can replicate the experience that A.I. can gather from a large data set.

A.I. finds the hidden research by reviewing your products, people, departments, and industry experience. The A.I. then predicts where research may be located based on applying vast learned experiences. As you validate these predictions you uncover hidden qualified research (a.k.a. the cheese).