No one enjoys being audited. But with the Research and Experimentation Tax Credit being named one of 2019’s Dirty Dozen again, IRS audits for the R&E Credit are not an unusual occurrence.

While it’s easy to feel like getting audited is a sign you’ve screwed up, audits are a normal, healthy part of the tax system – and are pretty likely if you claim certain credits. So, don’t panic! You’re not in trouble, you just need to show your work.

Paying attention to a few details pre-emptively can take the stress out of your audit and help it resolve more quickly.

  1. Attitude is Key – Going into an audit geared up for battle is a quick way to get a fight. Instead, approach audits as a conversation, and seek to work with the auditor to demonstrate that the credit claim is eligible. These credits were designed to benefit companies doing R&D; auditors just want to make sure they go to the right people, and not the scammers.
  2. Triple check for simple mistakes; they’re a huge red flag– From improper use of the fixed base percentage to ignoring that for the 50% limitation to using the wrong percentage for the Alternative Simplified Method: errors in completing the forms are possible. Auditors are looking for reasons to deny some or all of the claim, and this is a quick error.
  3. Fixed Base Percentage should not change year-on-year– The traditional rules fixed base percentage is intended to stabilize 11 years after the company’s start of qualified expenditures and revenue, and the 1984-1988 base percentage has been (mostly) stable for decades. While adjustments to base period methodology are not unusual, yearly changes to the base percentage are another red flag for an audit.
  4. Using engineers and conducting interviews is key– The IRS uses engineers to evaluate and test the credit claim against the requirements; therefore, so should whoeveris compiling your credit. In-depth interviews with the included personnel enable our team to quickly determine what is eligible and not, and prepare the entire claim knowing what questions would typically be asked in an audit.
  5. Reports and substantiation documentation help make the case– Auditors often have a list of standard questions they ask, but many can be directly addressed by a well-written report and accompanying documentation. Often, submission of these items is enough to confirm for the agent that the credit claim is valid.
  6. Taking blanket percentages of personnel is another no-go– Individually evaluating personnel against the credit requirements rather than applying a blanket percentage to employees or even departments is critical. The interviews enable this detailed approach.
  7. Entire General Ledger Accounts are rarely fully qualified– Even in cases when a company has done an excellent job segregating costs, often supplies end up in the contract research accounts and vice versa. Additionally, a number of items may be reasonably allocated to a cost center, but not all will be eligible for the R&E credit.

While audits on Research and Experimentation Tax Credits are not uncommon, that doesn’t need to send you into a panic. Many of the pieces that create an easy and smooth audit are handled before the tax form is even completed.

Partner with an expert who understands the research tax credit. Hull & Knarr has successfully defended 98% of every dollar claimed across hundreds of audits because we believe in filing right the first time. We use engineers to drive your credit, using the same methods the IRS does, to make sure your claim is airtight.

Getting expert help is easy, even if you are already under audit. You can contact us to chat about the R&D Credits. The conversation is free, and the advice is free.

By Ariane Woods

About: Ariane, Engineering Director, is a degreed electrical engineer and has been with Hull & Knarr since 2006. She lives in Columbus, Indiana, with her husband, 2 kids, and a cat.

Pulled from the website: https://www.hullandknarr.com/why-we-are-different/