Date: July 7th, 2022
Re: Qualification of Chiropractic Activities, Quantification of Costs, and Documentation of Projects and Activities
What “Business Components” are qualified under I.R.C. § 41(d) within the chiropractic industry?
Generally, chiropractic development in practice (as opposed to in a university basic research setting) involves improving specific chiropractic techniques for use on new patient classes, such as evaluating the combination of spinal decompression and cold laser therapy for treating patients with scoliosis and sports injuries. The purpose of the development is generally to improve patient outcomes, including improving recovery time and reducing the likelihood of re-injury. If successful, the techniques developed are sold, as services used in the trade or business of chiropractors.
What research activities are “qualified research” under I.R.C. § 41 within the chiropractic industry?
The common chiropractic activities that constitute a process of experimentation include the following: 1) conceptualizing new techniques and processes, 2) developing variations (or alternatives) to existing techniques or processes, such as new modalities or process templates for “care plans” 3) evaluating new and existing patients as ideal candidates for evaluation of new techniques or processes and recording an initial “baseline” for post-treatment comparison, 4) re-evaluating patients and recording results, 5) analyzing results across the patient population to identify trends, and 6) using trend analysis to refine and improve technique and process concepts from #1.
How can research activities be quantified for the chiropractic industry?
Qualified time for the chiropractic industry can be quantified by estimating the time spent in three categories of time. First, the chiropractors themselves must estimate the non-patient/non-administrative time they set aside weekly for 1) conceptualizing new techniques and processes, 2) developing variations to these new techniques/processes, 3) analyzing patient data for trends, and 4) using patient files/results to continue to improve upon techniques and processes. Second, the number of new patients can be multiplied by the time spent evaluating each new patient (and reviewing these evaluations) to determine the total time required to identify ideal patient candidates and record a “baseline” for each one. This total time can then be split (or spread, depending on the data) across all persons performing initial evaluations. Third, when re-evaluating patients, the number of patient re-evaluations can be multiplied by the time spent on each re-evaluation.
How can research activities be documented for the chiropractic industry?
Most chiropractors maintain records that include communications with other persons within the practice about new techniques and protocols, as well as notes describing modalities performed on each patient (sometimes referred to as a “treatment plan”), the patient’s initial baseline, and patient outcomes/measurements recorded over the time they received treatment.
Law & Analysis
Research activities are “qualified research” under I.R.C. § 41 if they satisfy the four-part test: the business component test, the I.R.C. § 174 test, the technological information test, and the process of experimentation test. I.R.C. § 41(d)(1). However, the activity is not qualified research if it is excluded under any one of eight exclusions. I.R.C. § 41(d)(4). To answer the four questions presented above, the following walks through the four-part test, answering each question via one or more of the elements of the four-part test.
1. The Business Component Test
The business component test requires that the application of the information discovered as a result of the research activity is “intended to be useful in the development of a new or improved business component of the taxpayer.” I.R.C. § 41(d)(1)(B)(ii). A business component is defined as any product, process, computer software, technique, formula, or invention to be held for sale, lease, or license or to be used by the taxpayer in its trade or business. I.R.C. § 41(d)(2)(B).
Generally, chiropractic development in practice (as opposed to in a university basic research setting) involves improving specific chiropractic techniques for use on specific patient classes, such as evaluating the combination of spinal decompression and cold laser therapy for treating patients with scoliosis and sports injuries. The purpose of the development is generally to improve patient outcomes, including improving recovery time and reducing the likelihood of re-injury. If successful, the techniques developed are sold, as services used in the trade or business of chiropractors. Thus, the techniques developed by chiropractors will satisfy the business component test so long as they are new to the chiropractor or improved by the chiropractor, as opposed to techniques they may learn from a conference or other educational material and apply within their practice, without further development by the chiropractor.
2. The I.R.C. § 174 test
To satisfy the I.R.C. § 174 test, a taxpayer must show that the expenditures connected to the research activities were “incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense.” Treas. Reg. § 1.174-2(a)(1). Section 1.174-2(a)(1) of the Treasury Regulations defines “research and development costs in the experimental or laboratory sense” as “[expenses] for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product.” This Treasury Regulation further explains, “Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the technique (or process) or the appropriate design of the technique (or process).”
In the chiropractic profession, we have identified uncertainties as to the optimal design of chiropractic techniques, such as the optimal combination of chiropractic modalities to perform decompression for a patient presenting symptoms of sciatica who is also suffering from obesity (or diabetes, or is a geriatric patient, or any number of other factors). In addition, chiropractors may also be uncertain as to whether a particular modality or alternative sets of modalities comprising a technique is capable of improving a patient outcome.
3. The Technological Information Test
The technological information test requires the research be undertaken to discover information that is “technological in nature.” I.R.C. § 41(d)(1)(B)(i). Information is technological in nature if it “fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.” Union Carbide, T.C. Memo. 2009-50 at *79 (citing to H.R. Rep. No. 99–841, at II-71 – II-72 (1986) (Conf. Rep.)). The information discovered does not need to be new to the world, only new to the individual chiropractor.
Chiropractors undertake to discover medical information rooted in the application of the biological sciences to symptoms including chronic pain and sciatica. Medical information discovered may include the optimal set of alternate modalities forming a technique for performing spinal decompression on a particular patient class, such as patients who are obese or present a sports-related injury.
Some chiropractors have been known to evaluate modalities that are counter to the prevailing scientific opinion in peer-reviewed medical journals. The reasons for such an opinion may be from a unique perspective on the natural world, or they may be a result of a greater willingness within the profession to re-consider modalities of care previously rejected by the scientific community. Regardless of the reason for such a position to be taken by the chiropractor, the technological in nature requirement requires that the research be undertaken to discover information that relies upon the principles of the physical or biological sciences. I.R.C. § 41(d)(1)(B)(i). See also Union Carbide, T.C. Memo. 2009-50 at *79 (citing to H.R. Rep. No. 99–841, at II-71 – II-72 (1986) (Conf. Rep.)). Thus, the assumptions or “basis” of the research must be based on facts derived from the scientific community.
For an example reductio ad absurdum, assume multiple peer-reviewed medical journals have studied the effectiveness of shoulder massages to treat broken legs (an absurd claim) and have concluded that shoulder massages are ineffective in doing so. If a chiropractor were to reject this scientific research by presuming a shoulder massage could cure a broken leg and then set out to identify the optimal shoulder massage technique for treating broken legs, then this would not satisfy the technological in nature requirement because the basis of the research has been scientifically disproven (shoulder massages cannot cure broken legs). However, if a chiropractor was uncertain as to whether some new type of shoulder massage could be used to treat broken legs, again fully knowing the prevailing peer reviewed journals reject this position, and set out to evaluate the veracity of this position through a double-blind trial where some patients received the new shoulder massage technique and others did not, then this would satisfy the technological in nature requirement. This is because the research is not based on a rejection of science but rather is intended to prove (or disprove) a published scientific opinion while relying upon the scientific method to do so.
4. The Process of Experimentation Test
The process of experimentation test requires that substantially all of the research activities must constitute elements of a process of experimentation that relates to a new or improved function, performance, reliability, or quality of the business component. I.R.C. § 41(d)(1)(C), (d)(3)(A); Treas. Reg. § 1.41-4(a)(5). A process of experimentation “is a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities.” Treas. Reg. § 1.41-4(a)(5)(i). Section 1.41-4(a)(5)(i) of the Treasury Regulations further explains that a process of experimentation must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science and involves the identification of uncertainty concerning the development or improvement of a business component, the identification of one or more alternatives intended to eliminate that uncertainty, and the identification and the conduct of a process of evaluating the alternatives (through, for example, modeling, simulation, or a systematic trial and error methodology). A process of experimentation must be an evaluative process and should be capable of evaluating more than one alternative.
Summarizing the above, there are three requirements to satisfy the process of experimentation requirement:
Substantially all (defined as 80% or more) of the process of experimentation must be related to the development of new or improved function, performance, reliability or quality of the business component. I.R.C. § 41(d)(1)(C), (d)(3)(A); Treas. Reg. § 1.41-4(a)(5).
The process of experimentation must be capable of evaluating one or more alternatives to overcome technical uncertainty, through, for example, modeling, simulation, or a systematic trial and error methodology. Treas. Reg. § 1.41-4(a)(5)(i).
The process of experimentation must be technological in nature fundamentally relying on the principles of the physical or biological sciences, engineering, or computer science. Section 1.41-4(a)(5)(i).
“In order for activities to constitute qualified research under section 41(d)(1), substantially all of the activities must constitute elements of a process of experimentation that relates to a qualified purpose.” Treas. Reg. § 1.41-4(a)(6). Thus, to qualify activities and quantify the time spent on qualified activities, taxpayers must determine whether the activities constitute elements of a process of experimentation. Multiple courts have described “development processes” of taxpayers that form a process of experimentation for the taxpayer, including the Norwest and Suder Courts.
Norwest Corp. v. Commissioner, 110 T.C. 454, 458 (1998), described a nine-phase software development process used by the taxpayer (a bank). The development process began with an initial request for development, followed by initial definitions of scope/cost/approach, and ended with a post-implementation phase involving debugging, updating, and enhancing the software.
Suder v. Commissioner, Nos. 14435-09, 14460-09, 6183-10, 6210010, 2014 Tax Ct. Memo LEXIS 196 (T.C. Oct. 1, 2014), described a three-phase development process, beginning with initial concepting, then leading into rounds of software and hardware development, and ending with multiple rounds of testing. In Suder, the taxpayer developed telephone systems.
B. What activities qualify for chiropractors and how can they be quantified?
Thus, the “bookends” of a qualified development process may stretch from initial concepting of the new or improved business component through design, development, evaluation, and concluding with the final test when uncertainty has been eliminated. And, qualified research expenses will include the cost of the time spent by employees on the activities that constitute this development process.
For chiropractors, the process begins with conceptualizing new techniques (or improvements to existing techniques) for a patient population, involving new and/or existing modalities used within their practice. Then, the chiropractors identify patients who may be good candidates to attempt using the new/improved technique with them. This “new patient” step may involve running a number of tests on new patients, noting results, and possibly discussing the patient internally to determine the optimal technique or plan of care for them. After a number of visits executing the new/improved technique, most chiropractors will perform a re-evaluation where they evaluate the effectiveness of the technique performed on the patient. Based on these results across the patient population (often also reviewed in each isolated case as well), the chiropractor will continue to evaluate alternatives to the new technique to better treat their patients.
The time spent in each of these steps can be estimated using new patient visit numbers, re-evaluation numbers, and reactivated patient numbers, all of which are commonly tracked by chiropractors. By multiplying these by the time spent in each type of visit, an estimated number of hours weekly (or annually) can be derived. Added to this, will be time spent developing new concepts of techniques and performing internal analysis of patient results to continue improving these techniques.
C. How can chiropractors document qualified activities?
Documentation requirements for the I.R.C. § 41 research and Development Credit are subject to the general requirements within I.R.C. § 6001. I.R.C. § 6001 requires taxpayers to “keep such records . . . as the Secretary deems sufficient to show whether or not such person is liable for tax under this title.” Thus, there is no specific documentation requirement under § 6001 and the records kept by taxpayers in the normal course of their operations should be retained.
For the chiropractic industry, documentation of claims may vary significantly from chiropractor to chiropractor depending on what records they retain contemporaneously. For some chiropractors, only patient notes and patient care plans may be available, with some test results over time also tracked to the patient’s file. Other chiropractors employ more complex systems for analyzing patient data across unique classes of patients and/or across the variety of modalities and techniques they employ to analyze patient outcomes. And yet others may keep journals, blogs, YouTube videos, notebooks, meeting notes, emails, or other internal communications outlining areas of technique development undertaken by the chiropractic office. So long as the available data can show the following (albeit with some explanation in the form of a memorandum), then it will be sufficient to support the credit, if requested within an exam.
Does the documentation show the chiropractor spent some time improving the functionality, performance, reliability, or quality of chiropractic techniques and/or developed new chiropractic techniques for this purpose? Note that a “technique” in this context may be an entirely new modality or it may be a combination of modalities applied to a new patient class, such as all persons over 70 with diabetes, a BMI over 30, and lower back pain. Also note that demonstrating success is not a requirement, only an intention to achieve improved patient outcomes.
In the pursuit of #1, does the chiropractor’s documentation show within their documentation that they evaluated more than one alternative technique via a process capable of evaluating multiple techniques?
In the evaluation of #2, does the chiropractor’s documentation show that the evaluation of alternatives relied upon the hard sciences (physical or biological sciences, engineering, or computer science), and not the soft sciences or anti-scientific principles (principles that are not supported by peer-reviewed medical research)?
For most chiropractors, this level of documentation is possible via their notes and care plans alone (with redactions for patient confidentiality, and other requirements that may be applicable, such as HIPAA). However, to fully connect such notes and care plans to the three requirements above, they often will need to be supported by a memorandum with additional facts provided through statements from the chiropractor themselves. In cases where the documentation from the chiropractor includes systematic patient analysis (such as via a software system), journals, notebooks, meeting notes, emails, or other internal communications, such a memorandum may not be necessary beyond merely familiarizing any reviewer with how to interpret the data provided.
In addition to § 6001, the Office of Chief Counsel of the IRS issued a memorandum, Field Attorney Advice (“FAA”) 20214101F, outlining specific requirements for research credit claims for refund. FAA 20214101F does not require any contemporaneous documentation to be submitted. Rather, taxpayers must respond to five standardized questions in writing. This attestation is then reviewed within 6 months by the IRS. If rejected, the taxpayer is provided 45 days to amend their attestation in order to perfect their claim for refund. The good news with this process is that taxpayers can have some certainty prior to perfecting their claim that the IRS has accepted their research credit claim for refund and will process the amount claimed. Unfortunately, the IRS still retains the ability to initiate an exam to gather additional documentation regarding the taxpayers claim. However, the stated goal of FAA 20214101F is to drastically reduce the number of research credit exams overall by rejecting claims prior to the claim being perfected.