Will Claiming the R&D Credit Result in an Audit?

At a glance

• The main takeaway: Claiming the R&D credit on a timely-filed return will not automatically trigger an audit, but any company benefitting from the credit should be prepared for the possibility. Thorough documentation and support from a skilled tax advisor can help.
• Impact on your business: An unsuccessful audit could result in the IRS fully disallowing your credit and even levying additional penalties.
• Next steps: Be proactive about audit readiness while maximizing your credit value by working with an R&D credit expert. Schedule a consultation with Aprio’s R&D Tax Credit team today.

The full story:

One of the top concerns we hear from business owners is whether benefitting from the Research and Development (R&D) Tax Credit means they will get audited by the IRS. Rest assured, claiming the R&D credit will not automatically trigger an audit. In our experience, the rate of audits among R&D clients is no larger than the rate of clients whose income tax returns are audited.

However, the recent passage of the Inflation Reduction Act with the provision to hire 87,000 new IRS agents will likely trigger additional audits for all companies and could mean increased attention on tax incentives. Additionally, new laws around amended R&D claims may bring even more scrutiny to companies that claim R&D credit refunds.

Should this prevent your company from claiming and R&D tax credit? In short, no. The R&D credit exists to incentivize companies for performing R&D activities in the United States – so long as you qualify for the credit and appropriately document your activities, you should continue to benefit from this incentive.

Nonetheless, this changing landscape does make it more important than ever to be prepared for an audit. To help, we’ve put together answers to the three most frequently asked questions we receive on the topic.

1. What triggers an audit?

Again, claiming an R&D credit does not automatically trigger an audit. Many audits are a result of random selection or statistical-based screenings. Other causes may include:

• If another area of your company’s tax return comes under scrutiny
• If a related entity or taxpayer you transacted with is audited
• If your company falls under an industry the IRS is currently focused on
• If your credit amounts are exceptionally high
• If you are starting to utilize R&D credits after a period of generating NOLs
• If you claim an R&D credit refund on an amended return (especially after the IRS announced new procedures for claiming R&D credit refunds).

While some red flags may draw more attention to your company’s R&D credit, sometimes an audit truly is random and unpredictable. Therefore, all companies claiming the credit should be proactive in preparing for a potential audit.

2. What can I expect if my R&D credits are audited?

Whether you’ve been through an audit before or not, the process can be overwhelming when you don’t have the added support of a CPA or tax credit advisor on your side. If your R&D credit is selected for audit, an IRS auditor will thoroughly investigate your credit claim to evaluate compliance with applicable regulations. An audit of your R&D credit may be unlikely, but sometimes it’s more advantageous to expect the best while preparing for the worst.

Involving a skilled advisor from the outset of an audit can help expedite the process and minimize potential credit disallowance from the IRS. Experienced tax advisors can help you manage an IRS audit, even if that advisor didn’t help in the preparation of your R&D credit.

3. How can I best protect my credits?

While there is no way to entirely “audit-proof” an R&D credit claim, two factors can dramatically improve your chances of a successful audit (especially when prioritized from the outset of calculating your credit): choosing the right R&D tax credit advisor and preparing thorough documentation.

• Choosing the right advisor: Companies who prepare R&D credits without the help of a skilled advisor are at a higher risk of making mistakes and typically have a more difficult time defending those credits if audited. Instead, partner with an R&D credit expert who knows what auditors commonly look for, who will adhere to the appropriate regulations when calculating your credit, and who will prioritize best practices when helping you document your credits. And in the unlikely event that you do get audited, you’ll already have a friendly face (and knowledgeable party) to help you navigate the process.
• Preparing thorough documentation: It’s always best to gather supporting qualitative documentation early—preferably at the same time you gather quantitative support for the credit computation.  The passage of time can create significant barriers to collecting contemporaneous documentation, whether that’s due to changing systems of record, acquisitions/dispositions, or employee turnover. 

The bottom line

The chances of your company’s R&D credit being audited are low; however, failing to be prepared for the worst-case scenario could result in the IRS disallowing your credits – or even levying penalties for inaccurate credit claims.

Put your mind at ease by partnering with a skilled advisor, like those on Aprio’s R&D Tax Credit team. We can help you maximize your credit value and prepare top-tier documentation from the beginning, so you’re better protected against a potential audit. We can also help businesses navigate and manage IRS audits even if we didn’t calculate the original credit. Whether from the beginning of an R&D credit study or the beginning of an IRS audit, involving an expert as early as possible will increase your chances of success.

Related resources

• Raising the Stakes for R&D Tax Credit Refunds
• It’s Official: Software Development Included in Tax Definition of R&D
• How Changes to R&D Deductions will Impact your Tax Burden