Will an R&D credit automatically trigger an IRS exam?
Perhaps you’ve asked this question. While the official answer is, “no one knows exactly”, there are things you should know if you file an R&D credit.
SPRX R&D Credit Tip – Expect an exam. While we are not sure how R&D credits factor into the IRS formula for exam selection, we do know that if your R&D credit is selected for exam you need to be ready for it right from the start.
Your DIF score
Do you know your DIF score?
Don’t worry, no one knows their DIF score. It’s an IRS secret.
The IRS selects tax returns for exam based on a variety of methods. One of those methods is computer scoring. The IRS has a secret algorithm that scans your return, analyzes various characteristics, and scores your return based on how likely an exam will result in adjustments. The higher the likelihood for adjustment, the higher your DIF score. IRS examiners select the highest-scoring returns for exam.
But DIF score is not the only method used. The IRS examines many large corporations tax returns annually. Area offices may select your tax returns for exam based on local compliance projects. Additionally, participants in potentially abusive tax avoidance transactions may have their tax returns selected.
The R&D credit is a lightning rod
The R&D credit has been a hot button for the IRS for 30+ years. R&D credit exams can be contentious and last several years. There are a lot of subjective decisions that are made when computing the R&D credit. These subjective decisions make the IRS suspicious of how you computed your credit.
Over the years the IRS has demonstrated their suspicion of the R&D credit.
- The IRS has formed teams of specialists to audit the R&D credit
- IRS leaders have mentioned that almost one half of exam resources are focused on R&D credit issues.
- The IRS has included the R&D credit on the list of top ten potential fraud areas more than once
- The IRS has ranked the R&D credit as a Tier 1 focus area
- IRS internal guidance instructs agents to be suspicious
- IRS internal guidance gives agents the words to use when disallowing your credit
- The IRS requires all amended tax returns with an R&D credit to be filed with the Ogden Service Center and marked “Amended for Research Credit” on the top of the return so it can be quickly identified
The IRS has been very public about its suspicions of the credit. It is not certain how this suspicion factors into the decision to examine your tax return.
Expect an exam
If you expect an exam you’ll be prepared. The IRS has provided you with a road map to a successful R&D credit exam. The IRS wants to see a list of all research projects, all qualified costs by project, and documentation that shows how each project meets the qualification tests.
Preparing such a detailed report may have been a challenge in the past. Manually reading every document or creating spreadsheets to present costs can be cost prohibitive. Many CPAs will even suggest that you just wait and see if you will be audited before preparing. We call this “audit roulette”. Losing at roulette is devastating.
With today’s technologies, you can quickly and effectively prepare for a potential R&D credit exam. Artificial intelligence can help read, analyze, and score all research documents. You can quickly find the documents that will be useful in supporting your tax decisions. Automations quickly prepare memo, supporting schedules, document indexes and reports.
If you are going to file an R&D credit, it is wise to prepare now and expect to be examined.
SPRX.tax builds the automation tools that save you time and money.