Misconception: R&D Tax Credits Will Get Denied in an IRS Audit

Misconception: R&D Tax Credits Will Get Denied in an IRS Audit

Posted by Jeffrey Feingold on 12.02.20

Are you afraid to claim the R&D tax credits?

If you are, you are not alone. Many companies in the U.S. are afraid to claim the R&D tax credits that are truly theirs because they don't want the hassle and expense of an audit. According to the IRS, only about 10% of eligible companies claim the R&D tax credits. That's a sad statistic considering how lucrative these tax credits are, and how businesses need cash during these hard economic times. This low number of taxpayers claiming their R&D tax credits falls in two categories -- they don't know about them, or they are afraid they will get denied in an IRS audit. The R&D tax credits are one of the most lucrative credits available to businesses.

The R&D tax credits have been around since 1981 under President Ronald Reagan. They were a temporary measure to encourage American industry to keep up with the Japanese on technology and to create high paying technology jobs in a failing economy. Over the last 30 years, whenever these credits expire, Congress extends them. There is currently a move to make them a permanent part of the tax code. These credits are very popular with businesses and with both parties in Congress. President Obama is asking for them to be permanent as well.

Misconception: It's a risk. R&D Tax Credits will get denied in audit, and the IRS will go after anyone that claims the credit.

It is true that companies claiming the R&D tax credit automatically raise red flags with the IRS and stand a good chance of being audited. This is not as frequent as it used to be. Audits are changing. Thanks to many court cases and new directives, the definitions are much clearer on what can be claimed, and how to do it. Back in April of 2007, the IRS issued a directive that increased its scrutiny of credit claims. This resulted in the R&D credits being one of the most closely watched of all credits. During the two years following, companies filed appeals to the point of overwhelming the IRS. Several court cases in 2009 helped to better define the procedures for claiming these credits in favor of the taxpayer. Companies like TG Missouri, Union Carbide, FedEx Corp, and McFerrin blazed the way to reversing or tempering the restrictive interpretations of the IRS. Other companies have followed. Today, a well-documented credit can be claimed safely on R&D work that meets the qualifications.

Your chances of an audit are lower than they used to be.

The answer is "It depends." There are no statistics on your likelihood of an audit.

It depends on:

  • The dollar value of the credit you are asking for relative to your company size and to the average credit requested in your industry.
  • Original return or amended return. Original returns have lower chances of being picked for audits. Amended tax returns go through the Tier 1 process, increasing your likelihood of an audit.

Under the current administration, audits are largely on the 80% that get the biggest benefit. Small corporations are usually not audited. Factors like the average credit in your industry are considered. If you fall into those guidelines, you may not get picked.

Your tax credits don't have to be denied if you are audited.

It depends on a number of things.

  • The documentation you have to prove you qualify for the credit.
  • The documentation you have for the activities for which you are taking the credit. Usually R&D has a great deal of data regarding experiments and those who did them.
  • The documentation you have for the financial amount of the credit.

The way your documentation is done and the amount of it you have is directly proportional to the chances of success you will have under an IRS audit. An accounting software program that keeps record by project is very helpful. There are companies who are experts on the types and amount of documentation that you need to survive an audit. Tax Point Advisors, for example, helps our clients prepare for the tax credit and prepares high-level detailed documentation on everything in case of an audit. We have never had a credit lost under audit. This industry-leading audit success is a result of lots of work by a team of experts who deal with tax credits every day.

What do you need if you are audited?

Documentation. Documentation. Documentation.  It is critical that the taxpayer maintain an acceptable method to keep documentation, financial information, and project information to prove the credits being claimed. It is very helpful to have an expert tax preparer to defend you in case of an audit as well.

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