Does Bill Gates use TurboTax? We don’t think so. While automated online platform tax return submission might be a convenient solution for many people, they are often incapable of capturing the complexity of a given person’s detailed financial picture—especially if there are a lot of moving parts.
But an Accounting Today story by editor Dan Hood entitled “Tech News: A new platform for R&D credits” reported that a company called Clarus R+D has launched Version 2.0 of its online R&D tax credit platform, which uses cloud-based software to handle the documentation, reporting, and filing requirements associated with claiming the R&D credit.
Automated Online Platform Pitfalls
While we can understand the appeal of this type of low-overhead, software-based approach, using such a platform could have unintended pitfalls for many taxpayers. The strongest argument against using an online system to submit R&D tax credit claims is the fact that on July 1, 2021, the IRS issued a news release placing business credits—particularly R&D tax credits—on its “Dirty Dozen” list of possible examples of tax fraud:
Improper claims of business credits
Improper claims for the research and experimentation credit generally involve failures to participate in, or substantiate, qualified research activities and/or satisfy the requirements related to qualified research expenses. To claim a research credit, taxpayers must evaluate and appropriately document their research activities over a period of time to establish the amount of qualified research expenses paid for each qualified research activity. Taxpayers should carefully review reports or studies to ensure they accurately reflect the taxpayer's activities.
The IRS has also issued past statements that emphasize the risk taxpayers take if they don’t have a clear understanding of how to file a research credit:
Unsupported claims for the Research Credit may subject taxpayers to penalties. Taxpayers should carefully review any reports or studies prepared by third parties to ensure they accurately reflect their activities. Third parties who are involved in the preparation of improper claims or research credit studies also may be subject to penalties.
The fact is, filing for an R&D credit is complicated, and nuances can have an outsized impact on your filing. When it comes to computer software design, for example, the line between coding for a function (which is a qualified activity) and doing configuration (which is not qualified) is a fine one. The same applies to the end of the research process, which concludes when you have a final product. But when do you have a final product? Third-party software can't determine that.
Services That Automation Can't Replace
Another example is the funded research rule, which requires a legal analysis of the client's contracts. Computers can't do that work.
A major benefit of using a professional to file your claims is that they can help tease out the projects that are missed, such as internal use software (for example, uncovering in-house costs to develop software for a company’s own use), process improvements (for example, identifying manufacturing lines), and projects abandoned due to failure. Software-based solutions could have great difficulty probing through a company’s records to reveal these projects.
Changes in requirements can also complicate matters. Let’s look at the Little Sandy Coal case. This case requires taxpayers to take an extra step in calculating their tax credits. Specifically, taxpayers must identify which employees are performing direct supervision and direct management and compare their qualified time to the qualified time charged by those performing research. After this recent court case added a new requirement for calculating the credit, study providers pivoted instantly and started complying. A computer software company would likely have to push through a major update to be able to do the same. If your software processed your claim before the crucial update, your claim would face unnecessary risk.
If the IRS’s warnings about the need for accuracy in R&D claims isn’t enough, Engineered Tax Services EVP Heidi Henderson shared two more reasons to be hesitant about utilizing an online platform in her December 10, 2021 Accounting Today article “Plan now for two major changes to R&D credits: the IRS has recently introduced two major changes to R&D tax credits.
First, on October 15, 2021, the IRS released IRS Memo: IR-2021-203, stating that as of January 10, 2022, if a taxpayer plans to file retroactively to capture the research credit on an amended return for prior years, they must now include much more detailed supporting documentation and substantiation.
Specifically, every refund claim is now required to identify all business components relating to R&D tax credit claims, along with an amended tax filing. For each component, taxpayers now must:
- identify all research activities performed;
- identify all individuals who performed each research activity;
- identify all information each individual sought to discover;
- provide total employee wage expenses;
- list total qualified supply expenses;
- report qualified contract research expenses.
The IRS added that taxpayers will be offered only 45 days to perfect their refund claim. After that, the IRS will make a final determination—which will not be eligible for appeals, an extraordinary dead end to impose on taxpayers.
Second, effective January 1, 2022, R&D tax credit amortization rules drastically changed. Formerly, taxpayers granted the R&D credit were allowed to claim R&D credits and then expense the qualifying research activity against their current tax liability. (An expense add-back was in place to prevent double dipping). However, the Tax Cuts and Jobs Act of 2017 eliminated the immediate expensing of R&D costs, starting in 2022.
Now taxpayers are no longer permitted to immediately expense research costs. Costs incurred in U.S.-based innovation must now be amortized over five years, and costs incurred internationally must now be amortized over 15 years. This change in amortization rules could seriously impact a filer’s income level.
Given the closer scrutiny the IRS is imposing on all R&D tax credit claims that come across its desk, it’s important for taxpayers to consult the official IRS Plan now for two major changes to R&D credits, which provides insight into what IRS agents are looking for in their examination of a claim’s validity. When you understand how demanding the terms of the audits are, you’ll appreciate why it’s important to have your claims verified independently by a long-standing, credible firm. A software program doesn’t capture nuances, which means the DIY approach, at least for the R&D credit, isn’t easier; it could actually be much harder.
Kreig Mitchell, a Houston tax attorney and former IRS attorney who has dealt with multitudes of R&D tax credit claims presented to the IRS, shared this advice.
“It isn't easy getting R&D studies past the IRS and state auditors—even if the study is perfect,” he said. “To be able to say that the study was prepared by an engineer, CPA, or attorney before it was filed carries a lot of weight. I wouldn't want to have an R&D credit on my tax return unless I could say that it was prepared by a third-party professional. The dollars and risk are too great. An online calculator that pulls in wage data is simply not good enough.”
If you’re a company that has invested a substantial amount of hard-earned capital in research and development activities, leaving the complexities of your R&D tax credit validation to an online software solution could result in unnecessary risk and unexpected consequences. It’s one place where investment in a professional R&D tax credit study performed by recognized, proven professionals like Engineered Tax Services could save you much, much more than it costs.