Can RD Tax Credits Increase Scrutiny from the IRS?
Newly imposed guidelines from the IRS point out that “claims for refund” based on the RD tax credits should be substantiated by extensive reports about the business components to which the claim relates. For business components that performs activities qualifying for the credit, taxpayers must identify:
- All research activities done
- All persons involved in performing each research activity
- All information each individual was working to discover
All information should be presented in a written statement instead of through the production of documents. However, document production is sufficient if the taxpayer identifies “the exact pagest that support a specific fact”.
According to information released together with the new guidelines state that, “The IRS will provide a grace period (until Jan. 10, 2022) before requiring the inclusion of this information with timely filed Section 41 research credit claims for refund.” The release also stated that “further guidance will be forthcoming”. An email address where taxpayers and other stakeholders can send comments was also provided.
Defining “Claim for Refund”
It appears in this context that the IRS refers to claims for refunds of taxes paid with returns filed previously. A claim such as this would normally be made by filing an amended return. But, it’s possible that the IRS could start requiring this level of documentation in case of a dispute with an R&D tax credit.
Breaking down RD tax credits claim by business component
The most significant and potentially troublesome requirement involved here is perhaps that taxpayers claiming a refund based off the R&D tax credit would have to reveal the efforts related to each ‘business component’. The current form on which taxpayers claim the credit from has lines indicating total supply expenses, total contract research expenses, and total wages. However, it is not indicated whether a unit-by-unit breakdown is necessary to support the claim for the credit.
“Business component” is a term that is used to refer to any product, process, technique, formula, invention, or computer software, that is held for lease, for sale, license or used for the taxpayer’s trade or business. Depending on one’s interpretation, some businesses could have hundreds or thousands of “components” where they can perform research activities on. Companies can end up producing written statements thousands of pages long identifying each component, all research activities carried out for each component, and all the persons involved for each research activity and all information each person sought to discover.
Ambiguities
The manner in which the IRS released this guideline has led to some uncertainties about what happens next. This type of change to the process for claiming a refund based on RD tax credits is often published in a proposed form within a certain period for comments from affected stakeholders and taxpayers. In this situation, an internal memo together with an information release has been announced to the public, saying that the service won’t require the disclosures indicated in the memo for several months. It also specified that comments can be emailed to a certain email address. No specific comment period is indicated. This means that additional information will be added, but it does not explain what form that information will take.
As of the moment, taxpayers planning to file an amended tax return claiming R&D tax credit-based refund should know that they may be subject to a more complicated documentation requirement after January 10, 2020. All taxpayers claiming R&D credit on their tax returns should keep an eye out on updates on this issue and keep in touch with their tax advisors with regards to any questions related.
Why Is Getting a Tax and Technical Expert Necessary When Claiming R&D Tax Credit?
One important factor that is necessary to help you get the credit is by choosing the right partner. Your partner should be able to provide you expert advice on both law and technical businesses relying on R&D practices.
You need a partner to help build documentation that protects you in an audit since the IRS frequently audits companies who claim the credit, and they can do this for up to seven years. If you are unable to present enough technical evidence in an audit, you will have to return the money or worse—pay a huge penalty.
Below are things you need to look for in a partner when claiming your credit:
R&D, Engineering and Tech Expertise –The secret to building a sound claim is starts lies in documenting, understanding, and reporting your company’s R&D methods and practices. It’s important that your partner understands technology and engineering companies. They also need to make sure your qualifying R&D expenses comply with the IRS’s four-part test.
Thorough Documentation –In the event of an audit, having the right records help you save time, money, and your sanity. Because of this, find a partner that is able to prepare the following documentation, including:
- Identifying and recording qualifying work based on the IRS’s four-part test
- Backing up the claim, including a breakdown of how each of your projects completely comply with the IRS’s four-part test.
- Time-tracking employees whose wages are included in the claim.
- Filing the R&D Tax form.
- Preparing the payroll offset forms and tracking it on a quarterly basis.
- Defending the credit in case an audit is executed.
Guides You Towards Best Practices –Choose a partner that is able to guide your R&D and internal finance team on building ongoing documentation practices for future audits and claims.
End-to-End service –You normally won’t have to look through their books or coordinate with your payroll provider since you’re running a business. Because of this, you need a partner that takes the lead and supervises the entire process for you—pulling you and your R&D team only when it’s necessary.
Most accountants and tax preparers providing R&D tax claiming services only offer partial solutions: they just ask one or two questions about your expenses, then file the forms based on their calculations. But it would be difficult for them to document, understand, and defend your R&D practices to the IRS if they do not have the engineering expertise.
If you want to get the most out of your tax credits and protect yourself from audits, it would be wise to partner with the right types of experts.