How to Evaluate an R&D Tax Credit Provider: 3 Questions to Ask
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The R&D tax credit is one of the more valuable credits available to US businesses. It’s worth up to $250,000* if used to offset payroll taxes, and even more than that if used against income taxes.
The value of the R&D tax credit makes it very appealing – both for businesses looking to claim the credit, and for tax preparers, who generally collect a percentage in fees for helping to make the claim. This means there are a lot of providers offering help with the R&D tax credit.
Not all of those providers, however, have an equally rigorous process, and claiming the R&D credit incorrectly has major downside potential. So how do you know if you’re choosing the right R&D tax credit provider for your business?
Why getting it right matters
When you’re filing for the R&D credit, you’ll want a top-tier tax preparer for two reasons:
- You can lose a lot of money, if you do it wrong. If you make mistakes in your filing or claim unqualified expenses, you can get hit with big fines and penalties.
- You can go through a painful, drawn-out audit process if there are irregularities with your claim. If the IRS suspects that you have a questionable claim, they will drag you through a stressful and painful audit process.
The IRS pays close attention to any tax filing that includes an R&D credit claim. Because the R&D credit is so valuable, many businesses want to claim it – and because it’s so complicated, many of them claim it incorrectly.
Some of these mistakes happen because a tax preparer is sloppy and doesn’t check their details. Others, however, might happen because the tax preparer genuinely misunderstands if a company’s research qualifies.
The R&D credit also attracts attention from scammers, who might file claims for non-qualifying (or entirely fictitious) research. This is so prevalent, the R&D credit made the IRS’s “Dirty Dozen” list of scams:
“Excessive Claims for Business Credits: Taxpayers should also avoid misuse of the research credit. Improper claims often involve failures to participate in or substantiate qualified research activities or satisfy the requirements related to qualified research expenses.” (IR-2019-42)
Regardless of whether mistakes are intentional or not, the end result is that claiming the R&D tax credit increases your chances of being audited. That’s why it’s so important to have a good tax partner who will help you put together a strong justification for your claim: there’s a good chance you’ll need to prove that claim in an audit.
The bottom line: The R&D tax credit is great for businesses with qualifying research expenses. But if you want to avoid penalties and high compliance risk, you need to do it right – and the easiest way is to work with the right R&D credit preparer.
Here are the three key questions to ask a potential R&D tax provider, before you make a decision.
Question 1: What’s Your Technical Background?
This is rarely a question you’ll ask a tax preparer, but it’s important with the R&D tax credit. Because in order to qualify, your research has to pass the IRS’s technical 4-part test. Here’s what’s involved:
- Your R&D expenses must be used, in a technical or experimental way, to eliminate some kind of uncertainty. This refers to the development or improvement of a product. Qualified expenses relate to the nature of the R&D activity, not the nature of the product.
- The expenses must be used for discovering information that is technological in nature. This must fundamentally rely on the principles of physical and biological science, engineering, or computer science.
- Your company must be developing a new or improved business component. In plain English, ‘business component’ generally refers to a product or invention. But, the list of qualified business components can get long (and technical).
- It must involve a process of experimentation. The IRS generally defines this as a process that evaluates one or more alternatives, through – you guessed it – experimentation.
Many otherwise-excellent tax preparers won’t be able to properly evaluate if your research meets the rules, if they don’t have a technical background. This is a problem, because if a tax preparer doesn’t fully understand the research you’re doing, and how it lines up with IRS requirements, they may end up filing for the R&D credit when your business isn’t truly qualified.
The best R&D credit providers have a technical team on staff that can accurately assess expenses for qualification. This can help make sure you don’t get into any trouble with the IRS.
The IRS also recently provided more guidance on how to properly claim the R&D credit. They are very specific on high-risk, medium-risk, and low-risk projects that you can claim, and what kind of technical documentation you require to file for the R&D credit.
The bottom line: This is an important question to ask because you’ll want a tax partner with the technical experience to accurately prepare your claim.
Question 2: What Am I Paying For With An R&D Study?
When you engage with an R&D tax credit partner, the primary deliverable that they should produce for you is an R&D study. This document explains everything in your claim, and why it’s qualified based on the IRS 4-Part Test. If your R&D tax credit claim does get audited, your R&D study is your primary defense to justify your case to the IRS. So, it’s important that your R&D tax credit preparer does things right.
Your R&D study should include:
- Clear, contemporaneous financial and technical records for all expenses included in your claims.
- Documentation on what each expense was for, how it relates to your research, and why it’s qualified.
- Project descriptions, and qualification for the four-part test.
(For a more concrete example, see the sample outline in our article on R&D with Pilot: How it Works).
When you ask your tax preparer what you’re getting, you want to make sure that they’re being thorough. You can also ask them to see a sample study. This will help you get a feel for how comprehensive their R&D reports are.
It’s also smart to ask your tax preparer about their information gathering process – and how much of the work falls on you. Some providers might interview your team and analyze your records to build your study; others might simply ask you to fill out an online form and then generate “documentation” from your answers. This can mean having to do a lot of the legwork yourself, versus having your partner do it for you, and also mean that the “R&D study” has significant differences in quality.
The bottom line: If you get audited (and it’s fairly likely when you file for an R&D credit since 20-30% of all R&D claims are audited each year), this study is your first line of defense. It’s also the main chunk of work that your R&D tax credit preparer should do, and the bulk of what you should be paying for, so be thorough when asking about what to expect.
Question 3: Have you gone through an R&D tax credit audit with your customers?
If you do get audited, you want to know that your provider will back you up with the documentation, and help you make sure everything goes smoothly. So it’s only natural that you should ask your R&D tax credit preparer if they’ve ever had to go through an R&D credit audit with their customers.
Like technical knowledge, audit experience counts here. Ideally your R&D tax partner should already know how the audit process works, what the IRS will want to see, and how to defend your claim successfully.
If your tax preparer has never actually gone through an audit with a customer, recognize that you’re taking a risk by partnering with them. It doesn’t mean they won’t do a good job – it just means that they are untested. Audits get tricky, and you don’t want your business’s audit to be the first time an R&D tax credit preparer has ever run the gauntlet.
The bottom line: You want an R&D tax credit preparer that can support you through an audit. If they’ve got successful experience with other customers, that’s a good sign.
What comes next
The three questions we discussed here will help you find an R&D tax credit partner that can help you successfully claim your credit. With the right provider, you’ll be able to have peace of mind that the process is being handled correctly, your claim will stand up in an audit, and you’re that much closer to getting your money.
If you’re looking for a team that’s been there and done that, reach out to us at Pilot. We’ll take you through your R&D tax credit process from start to finish. And go ahead and ask us the three questions in this piece – we’re ready to help.
*$500,000 for 2023 tax year, $250,000 for 2022 tax year
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