If your company claims the research credit (aka R&D credit), now is the time to dig deeper, especially into how you’re documenting your process of experimentation.
The IRS has rolled out major updates to Form 6765. Some of the new reporting requirements are optional for 2024, but they will soon be mandatory. One thing is clear: businesses that cannot demonstrate a systematic process of experimentation (POE) could be leaving credits on the table.
Here is what is changing, what POE really means, and how to document your innovation in a way that holds up.
Quick Recap: What Is the R&D Credit?
The research credit has been around since 1981. It is designed to reward companies that invest in innovation by developing or improving products, software, processes, or technologies.
Until recently, claiming the credit was fairly straightforward. You would report your total wages, supplies, and research costs, and that was usually enough.
Not anymore. The IRS now wants to see how those numbers tie to actual research activity. Most importantly, they want to know whether your work followed a legitimate process of experimentation.
So, What Does “Process of Experimentation” Really Mean?
Process of experimentation is not just a nice-sounding term. It is one of the four core requirements you must meet to claim the R&D credit:
- Permitted Purpose
- Technological in Nature
- Elimination of Uncertainty
- Process of Experimentation
Courts and the IRS have made it clear. Simply building or designing something new is not enough. There needs to be a structured, iterative effort to resolve technical uncertainty. That means systematic testing, evaluating, and refining your hypothesis or approach instead of guessing and hoping for the best. Rather than just stating that uncertainty existed and emphasize the end results, companies must outline the development process and decisions made that lead to the end results.
A qualifying POE involves identifying potential solutions, testing them through modeling, simulation, or systematic trial and error, and analyzing the results to determine what works. Then repeating the process as needed until successful. Ironically, failure is often viewed as more indicative of uncertainty and experimentation.
In court cases, such as the recent Phoenix Design Group, companies that fail to document this testing or could not prove how they overcame technical uncertainties often lost their credits. Some even faced penalties.
Why the New Form 6765 Emphasizes POE
The updated Form 6765 does not just ask for numbers. It asks you to “Describe the information sought to be discovered. Use the space provided” for each business component. Comically, the space provided is about 50 characters long and you can be sure that won’t be sufficient to substantiate a claim on audit. That is where POE becomes critical.
Section G has you describe up to 50 of your most significant business components. For each one, you will need to explain the project’s name, type, and as noted above, the information sought to be discovered, and the amount and type of expenses incurred.
Think of Section G as the storytelling section. It is where you show how your work qualifies, not just how much you spent.
How to Know If Your Project Qualifies
Ask yourself:
- Was there a clear technical uncertainty at the start?
- Did you identify more than one possible solution? If so, what were they?
- Did you test or prototype, including initial proof(s) of concept, before landing on an answer?
- Did you document what worked and what did not?
If you can answer “yes” to all of these, you likely have a qualifying POE. If not, it might be time to rethink how you’re tracking and organizing your R&D activities.
So, What Exactly Is a Business Component?
A business component is any product, process, software, technique, formula, or invention that you’re developing or improving. These are the building blocks of your R&D credit, and each one must be tied to a qualifying uncertainty and process of experimentation.
Under the new guidance, you will need to document how each component meets that POE requirement, especially for the 50 that represent 80 percent or more of your qualified research expenses.
What this Means for You
The bar is getting higher, but that is not a bad thing. When your R&D documentation is strong, your credit claim is stronger too. You will also gain better visibility into your innovation pipeline and how your team is spending time on technical problem-solving.
Here is how to get started:
1. Track Activities, Not Just Costs
Do not stop at wages and materials. Capture what your team is actually doing. Who is experimenting? What is being tested? What decisions are being made?
2. Build POE Into Your Workflow
Use project management or time-tracking tools that allow you to log iterations, A/B tests, prototypes, or technical trials. A well-documented trial-and-error process is gold during an audit.
3. Rethink How You Define Components
If you have been treating an entire product line as a single business component, consider breaking it into smaller, more focused components. Each one might have its own POE and could increase your credit.
4. Do Not Wait to Document
Try running a mock Form 6765 every quarter. Use it as a litmus test. Are your write-ups clearly describing a POE? Would they make sense to someone outside your company?
Why This Level of Detail Pays Off
We have seen it time and again. Companies that start tracking POE early not only strengthen their audit defense, they often uncover missed credits. The process also gives leadership better insight into where their innovation efforts are delivering the most value.
Courts have backed this up. In Union Carbide Corp. v. Commissioner, the Tax Court upheld the credit because the company provided detailed documentation of its experimentation, including test logs, design alternatives, and analysis. On the other hand, in Siemer Milling Co. v. Commissioner, the court denied the credit because the company failed to show any structured testing or evaluation. The work was deemed routine, not experimental.
The difference came down to proof of process.
As Partner Shawn Marchant puts it, “If you are doing real R&D, there is almost always a process of experimentation. The challenge is having the documentation to prove it.”
How We Help
At Tanner, we help you build systems that bring structure to your experimentation and credibility to your R&D credit. That includes:
- Defining business components that align with IRS guidelines
- Embedding POE into your documentation and workflow
- Coordinating across state, federal, and international rules
Whether you are just getting started or looking to elevate your credit strategy, we are here to make sure your process holds up.
Your Next Step
The 2024 tax year gives you time to refine your approach before the new requirements become mandatory. Use it. Tighten your tracking. Strengthen your documentation. The more clearly you show your process now, the more confidently you can claim your credit later.
Want help mapping it out? Let’s talk. We will help turn your innovation into an asset that pays off long after tax season.