On a dollar-for-dollar basis, the Federal Research Tax Credit is the largest tax incentive provided for in our Tax Code.  The IRS has focused on the research tax credit over the past several decades given the dollars that are involved.  Most of this focus was by the Large Business & International ("LB&I") division within the IRS. 

LB&I is tasked with auditing taxpayers who have more than $10 million in assets.  The Small Business and Self-Employed ("SB/SE") division audits taxpayers with less than $10 million in assets.  While the SB/SE division had occasionally audited research tax credits, it hasn't ever focused on these audits as the LB&I division has.  That recently changed.  

Earlier this year the SB/SE division put together a research tax credit team to handle research tax credit audits.  The team consists of revenue agents who put in for or applied to be on the team.  The IRS had its revenue agents in the SB/SE division reassign any audits involving research tax credits to this new team.  This has caused significant delays for these transferred audits.  These transferred audits are ongoing and, given the timing, we expect to start seeing the new research tax credit group to start to close the audits. 

Given the new team, it is likely that there will be more audits involving research tax credits for SB/SE-sized taxpayers.  But the news isn't all bad.  The focused and trained agents may be able to streamline the audits.  This is likely the impetus behind the SB/SE division forming this new group, as SB/SE division revenue agents who are not trained to work with the research tax credit have historically struggled with the credit--which has led to longer audit timelines and often credits being disallowed when they should not have been disallowed.  Thus, the new research tax credit group may allow legitimate claims to be examined and allowed faster than has been in the past.

The audits do not seem to be following the "deny-deny-deny" path the LB&I division pursued when it had a similar re-organization in the early 1990's and then again the mid 2000's.  This difference is likely due to the level of focus SB/SE can put into examining claims.  The SB/SE division does not have the same budget LB&I does, and the SB/SE division is tasked with auditing substantially more taxpayers than the LB&I division.  The SB/SE division has historically been forced to take a more practical approach to audits given this reality.  If past IRS initiatives are any indication, this focus on the research tax credit will be temporary and lose steam as the IRS finds other issues to focus on.    

For those who are currently under audit by the IRS, the SB/SE division's focus on research tax credits should not factor into whether to continue to take research tax credits.  Congress provided the research tax credit as an incentive.  How the IRS carries out its audit function changes over time.  But one factor has remained constant: The IRS does tend to audit taxpayers who report a tax credit in one year, but not in the prior year or who file amended returns to take a tax credit.  Breaks in taking the credit can often invite additional review by the IRS.  

The better practice is to continue to take credits and, if adjustments are needed given the outcome of audits for earlier years, those changes can be made at that time.  It should also be noted that the IRS will often audit one to three years and not later years, even though those later years have been filed by the time the IRS audit for years one to three are closed.  This is particularly true for SB/SE division audits given its resource constraints.   

About the Author: Dawson L. Fercho is the partner-founder of Corporate Tax Advisors, Inc. (CTA). He brings over 20 years of consulting experience, 14 years exclusively focused on the Federal Research Tax Credit, working with the accounting industry and small to mid-size manufacturing, technology, engineering, architecture and construction clients. In his current role for Corporate Tax Advisors, Dawson is responsible for all areas of client service and overseeing CTA's marketing and business development. Dawson recently past the IRS Special Enrolled Agent Exam, giving him authority to practice before the Internal Revenue Service in all our nation's tax arenas including the Research Tax Credit. He can reached at dawsonf@corporatetaxadvisors.com

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