Expect an IRS Exam & Prepare

Will an R&D credit automatically trigger an IRS exam?

Perhaps you’ve asked this question. While the official answer is, “no one knows exactly”, there are things you should know if you file an R&D credit.

Your DIF score

The IRS has many secrets and the Discriminant Function System (DIF) score is one of them. For this reason, there is no need to worry if you don’t know your DIF score, because no one does.

The IRS selects tax returns for exam based on a variety of methods. One of those methods is computer scoring. The IRS has a secret algorithm that scans your return, analyzes various characteristics, and scores your return. The score given is based on the likelihood that an exam by the IRS will result in adjustments.

The higher the likelihood for adjustment, the higher your DIF score. Therefore, the IRS examiners select the highest-scoring returns for exam.

That being said, the DIF score is not the only method used. The IRS examines many large corporations’ tax returns annually. Area offices may select your tax returns for exam based on local compliance projects. Additionally, participants in potentially abusive tax avoidance transactions may have their tax returns selected.

The R&D credit is a lightning rod

The R&D credit has been a hot button for the IRS for 30+ years. Unfortunately, R&D credit exams can be contentious and last several years.

When computing the R&D credit, people make a lot of subjective decisions. These subjective decisions make the IRS suspicious of how you computed your credit.

Over the years the IRS has demonstrated their suspicion of the R&D credit, namely:

  • The IRS has formed teams of specialists to audit the R&D credit
  • IRS leaders have mentioned that almost one half of exam resources are focused on R&D credit issues
  • The IRS has included the R&D credit on the list of top ten potential fraud areas more than once
  • The IRS has ranked the R&D credit as a Tier 1 focus area
  • IRS internal guidance instructs agents to be suspicious
  • IRS internal guidance gives agents the words to use when disallowing your credit

Overall, the IRS has been very public about its suspicions of the credit. It is not certain how this suspicion factors into the decision to examine your tax return.

Expect an exam

If you expect an exam you’ll be prepared. The IRS has provided you with a road map to a successful R&D credit exam. The IRS wants to see a list of all research projects, all qualified costs by project, and documentation that shows how each project meets the qualification tests.

Preparing such a detailed report may have been a challenge in the past. Manually reading every document or creating spreadsheets to present costs can be cost prohibitive.

Many CPAs will even suggest that you just wait and see if you will be audited before preparing. We call this “audit roulette”. Losing at roulette is devastating.

Prepare with SPRX

With today’s technologies, you can quickly and effectively prepare for a potential R&D credit exam. Here at SPRX, we use artificial intelligence (AI) to efficiently read, analyze, and score all of your research documents.

We provide every memo, supporting schedule, document index, and report needed for an IRS exam. In less than three weeks our clients walk away with everything they need, and the confidence no other R&D credit provider can give them.

Don’t play “audit roulette,” simply prepare for an exam with SPRX.

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