Most times, the exercise of an IRS audit falls solely on the Tax Department. Whereas this is typical and normal for financial audits, this should not be the case for specific R&D Tax Credit audits. Although familiar with the operations, the tax department is not able to speak to the nature of the qualified activities with respect to the specifics of the 4-Part Test. This is why it is often to the Taxpayers’ benefit to have a strong technical (R&D or Engineering) representative champion the process, including audits.
R&D tax credit audits are specifically aimed to evaluate the nature of the qualified activities as they relate to the definition of “research and development” under the tax code. This is a very narrow scope, and should be treated with some appreciation of the technical nature of the conversation.
IRS Auditors are usually pleased to interact with a technical representative. Agents need to assess the qualification of claimed activities against the 4 Part Test, most importantly the Technical Uncertainty and Process of Experimentation, and the specifics of the underlying principles of science or engineering. They need to be able to understand the nature of the qualifying activities, and review specific technical documents / corroborative records in order determine the level of the qualification. This is best done by sitting down with an R&D champion who can generally speak to the nature of the research and development activities for the company, and explain how development efforts extend into and are supported by manufacturing operations.
Identifying a good technical representative at the beginning of the tax credit study process is critical for a number of reasons;
- To aid in the navigation of the R&D life-cycle to help direct BGI to the areas of research activities.
- This individual often understands the drivers for development efforts (i.e., blue sky, market-driven, customer requests for improved functionality, quality issues, manufacturing constraints, etc.).
- A good R&D Champion also understands the R&D life-cycle from ideation through commercial viability, and can identify the groups, departments or teams who are involved during various steps.
- Ensures alignment with BGI framework approach to the company’s nature of operations.
- BGI has a unique approach, which is tailored to the specifics of every Taxpayer.
- The R&D Champion offers valuable input to allow for the customization of BGI’s framework to ensure that it is aligned with the development efforts conducted by the company. This further supports that compliance is achieved during the process as a result of the efficiencies developed.
- Encourages cooperation from all levels of staff.
- Showing that this project is on the radar from Senior Management demonstrates the need for compliance from all levels of the organization.
- Offers key unbiased testimony in the event of an audit.
- The R&D Champion often helps with the IRS to hear about the company’s qualified activities directly – without any filter or consideration of financial aspects.
- If an activity is under debate, the Champion is able to speak directly to its nature as it pertains to the process of experimentation or uncertainty challenged.
- The Champion can also provide first-hand information as to the types of corroborative records that exist, and what technical aspect they attest to.
There are a number of benefits from ensuring a good R&D Champion is part of the entire process. Overall, it helps to ensure an efficient study is put together through alignment with BGI framework methodologies. It encourages compliance with other departments or groups, by focusing efforts and interviews with individuals in key areas with eligible activities.
But most of all, comprehension is increased on all fronts – from BGI interaction, internal communication and subsequent IRS audits.
BGI further bridges the technical gap and supports the process by also bringing in Engineers / Scientists in at the beginning stages. Again, having a strong technical background allows for the language of science of engineering to be spoken between individuals. This allows past experiences to be utilized so that conversations occur more efficiently, and technical documentation is more readily understood and interpreted.
BGI technical professionals have intimate experiences with audits, and can help direct or interpret questions or requests from the IRS to streamline the answers provided.
It just makes sense – the IRS sends in specialized Engineers to review claims, so why wouldn’t the Taxpayer have an Engineer involved in the process?