The Credit for Increasing Research Activities, better known as the R&D Tax Credit, is one of the business community’s most utilized tax credits, with the federal government subsidizing an estimated $12 billion each year to thousands of U.S. businesses as an incentive for their R&D activities.  

Thanks to the Path Act of 2015, the credit was made permanent and allows businesses to utilize their R&D credits on a dollar-for-dollar basis from their tax liability in the year that qualified activities occur. Unsurprisingly, the credit finds particular favor in the tech and biosciences spaces, where startups and mature companies alike are heavily reliant on research to bring innovative products and solutions to the market. The ubiquitous use of the credit in tech and life sciences, however, could soon make for major headaches for the industry, as an IRS auditing campaign related to the credit takes effect.  

The IRS stated “issues involving the research credit and research and experimental expenditures under [Internal Revenue Code] Sections 41 and 174 are some of the most prevalent tax issues within [the] Large Business and International [Division], utilizing significant examination and taxpayer resources.” Essentially, the IRS suspects the credit is being misused or applied too liberally. However, the challenge for businesses (and for tax planners) stems, ultimately, from the way the R&D credit itself is written.  

The concept of incentivizing innovation in the form of immediate deductions for research and development expenses was first introduced in the 1950s through Section 174. Later, in the 1980s, the Reagan administration created what was meant to be a temporary R&D tax credit seen in Section 411. To be eligible to claim the 41 R&D credit, a company must first identify its expenses as being eligible under Section 174. Therefore, the notion of what is considered as eligible draws from examples of research activities provided under Section 174.  

The “temporary” R&D credit was so popular that it was renewed over a dozen times until finally being made permanent. The initial description of what constitutes “qualified research” was meant to be broad, so businesses of all industries could make use of it. However, when the legislation was first drafted, the U.S. economy was heavily weighted toward manufacturing, and the language of the law today still reflects that.  

In fact, 70% of all R&D credits are claimed by manufacturers, when it seems more obvious that companies in the tech and life science space should be taking advantage of the benefit.  

The upshot of this is that interpreting the R&D credit to maximize tax savings while staying in compliance of IRS guidance requires a great deal of judgment. Companies can seek highly specialized tax professionals with deep experience working with the R&D credit to help them navigate the balance of capturing a valuable tax saving credit, while not running foul with the IRS or state tax authorities.   

For companies that are singled out, the IRS’s campaign, which kicked into gear only last September, comes with headaches at best — and at worst, major penalties. Consequences of failing to pass the IRS’s audit could include not just immediate loss of the credit, and the major tax burden that could produce, but also penalties and interest on unpaid taxes that arise.  

The best thing you can do to avoid these consequences is to have an experienced and reputable R&D tax professional on your team. If your claiming of the R&D credit is found to be problematic, they can help you come up with strategies to minimize the pain associated with making it right. But moreover, even if your business has been prudent and reasonable with claiming the R&D credit, the audit process itself involves significant back-and-forth and ultimately requires a dedicated team or individual so as to not cause business interruption. 

Companies from all sorts of industries have turned BPM’s R&D Credit team to produce thorough, defensible R&D analyses to maximize clients’ opportunities for tax savings, particularly in the technology and life science industry groups. Based in the heart of California’s tech industry, BPM knows what tax issues the industry faces, and is fully equipped to assist businesses of all sizes, from brand startups to mature publicly traded enterprises. To learn more about what BPM’s R&D Credit team can do for your business, contact Andre Shevchuck, partner and R&D Tax Credit Consulting practice leader.