This month, we’re continuing our series of why it is beneficial to use an outside R&D tax consulting firm to calculate your R&D credits with an article on Statistical Sampling!
What is Statistical Sampling?
As you may know, a statistical sample is a procedure used to quantify a certain attribute of a large number of items. A subset (sample) of the items are analyzed, and the results of this analysis are extrapolated over the rest of the items (the population). For example, you might use statistical sampling to estimate the average height of an adult male in the United States. Since it is highly unlikely that you could collect height information from every adult male in the United States, you would randomly select some. Then, you would ask them their height, and use that information to estimate the average height of the entire population. As you might expect, the more individuals you interview, the higher the accuracy of the estimate will be.
Why Use Statistical Sampling?
The primary benefit of sampling is that the amount of work required to calculate the desired attribute is substantially reduced. In the example above, rather than trying to contact every adult male in the United States and get them to tell you their height, you could pick about 500 people at random and achieve an accurate estimate. It would be much easier to record 500 heights than 100,000,000!
What Do Statistics Have to Do With the R&D Tax Credit?
Just like statistics can be used to estimate the average height of an American adult male, they can be used to calculate the amount of expenses associated with projects or employees. For example, if your company works on 100 projects in a given tax year, it would be impractical for you to have to provide detailed explanations of each project to calculate the qualified R&D expenses for them. You could review the 25 largest projects and just claim expenses associated with those projects, but that analysis leaves a lot of potential costs on the table. Instead, you can use statistics and randomly draw 25 projects out of the 100, analyze them, and use those projects to estimate the costs associated with all 100 projects. That way, the amount of time required to calculate the R&D expenses is substantially decreased and you don’t unnecessarily discard any of the costs.
Is Statistical Sampling Allowed on a Tax Return?
Yes! Revenue Procedure 2011-42 (the Rev. Proc.) governs the use of statistical sampling to estimate amounts placed on a tax return. The Rev. Proc. outlines when sampling is appropriate, which statistical methods are allowed, the documentation requirements for the sampling procedures, as well as the formulas to be used to calculate sampling error and confidence boundaries. This is where your friendly neighborhood consultant comes in to play! Just make sure that the team you hire includes an expert in statistics who can translate the IRS guidance & save you a ton of time.
Statistical sampling expertise is one of many reasons to consider hiring an outside consultant for your R&D credit calculation.
Unconvinced? Stay tuned to learn more reasons in the coming months! Convinced already? Reach out to us today to request an assessment of your eligibility for the R&D credit and we’ll get back to you within a few hours!