Does the R&D Tax Credit Trigger an IRS Audit?

By: Chelsea Smith, Tax Partner

Does claiming the Research & Development (R&D) Tax Credit automatically trigger an IRS audit?

The short answer is no. Claiming the Research & Development (R&D) Tax Credit does not automatically trigger an IRS audit. However, the credit can receive IRS scrutiny, making accurate calculations, strong documentation and a defensible R&D tax credit study important.

Here’s what businesses should know about IRS audit risk and how to prepare a defensible R&D Tax Credit claim.

Does Claiming the R&D Tax Credit Increase Your Audit Risk?

Claiming the R&D Tax Credit does not automatically trigger an IRS audit.

We don’t know all of the factors the IRS uses to select returns or individual tax positions for examination. What we do know is that an R&D Tax Credit can receive scrutiny just like other items on a tax return. The important distinction is this: claiming the credit does not mean your business will be audited, but you should be prepared to support it if it is reviewed.

Because the R&D Tax Credit provides a dollar-for-dollar reduction in tax liability, it can be meaningful to a business. That makes it especially important to ensure the credit is calculated appropriately and supported by documentation.

Can the IRS Audit an R&D Tax Credit Claim?

Yes. An R&D Tax Credit can be reviewed as part of a broader IRS audit or examined on its own.

In some cases, an IRS agent may specifically request documentation related to the R&D Tax Credit. That doesn’t mean claiming the credit automatically creates a red flag. It means you should be prepared to demonstrate why your activities qualify and how the expenses included in your calculation were determined.

Why Does R&D Tax Credit Documentation Matter?

A strong R&D Tax Credit claim isn’t about identifying the largest credit possible. It’s about identifying and substantiating the credit your business is actually entitled to claim.

A defensible R&D Tax Credit study should demonstrate how your activities meet the Section 41 four-part test and connect the expenses included in your calculation to qualifying R&D activities. Generally, the four-part test considers whether the activity involves:

• A permitted purpose
• Technological in nature
• Elimination of uncertainty
• A process of experimentation

For qualifying projects, the goal is to establish a clear narrative around these requirements and appropriately connect the costs being claimed to the underlying R&D activity.

What Records Should Businesses Keep?

Good documentation starts while R&D activities are happening, not when an IRS request arrives.

Depending on your business and activities, helpful documentation may include project records, payroll information, testing records, records of experimentation and documentation of failed or unsuccessful testing.

Failed testing can be particularly helpful because it may demonstrate the uncertainty and process of experimentation involved. Whenever possible, I encourage businesses to document these activities as they happen rather than trying to reconstruct everything later.

What Happens If Your R&D Tax Credit Is Audited?

If the IRS examines your R&D Tax Credit, it may request documentation supporting the activities, expenses and methodology used to calculate the credit.

That is why preparation matters. Businesses should be able to demonstrate which activities qualify, how expenses were determined and how the claim meets the applicable requirements.

An IRS review does not change the goal: claim the credit your business is entitled to and be prepared to substantiate it.

A Defensible Approach to the R&D Tax Credit

At Squire, our approach isn’t about simply maximizing the R&D Tax Credit. It’s about helping businesses identify the credit they’re entitled to and building the documentation to support it.

Our R&D Tax Credit services are designed with audit readiness in mind. At our standard service level, we:

• Evaluate qualifying activities under the Section 41 requirements
• Identify and substantiate qualified expenses
• Prepare a defensible, audit-ready R&D Tax Credit study
• Maintain supporting documentation for applicable open tax years
• Provide support if the credit is questioned or examined

The possibility of IRS scrutiny shouldn’t prevent an eligible business from exploring the R&D Tax Credit. With the right methodology and documentation in place, businesses can pursue the credit with greater confidence.

How Can Squire Help?

Have questions about your R&D Tax Credit eligibility or how to prepare a defensible claim? Contact us at info@squire.com to connect with our R&D Tax Credit team.

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About Squire

Squire is an audit, tax, and business advisory firm with offices and teams across the Mountain West. With 50+ years of experience, we provide outsourced CFO and controller support, bookkeeping, payroll, sales tax, transaction support, ERP implementation and technology integration—helping businesses operate efficiently, stay compliant and achieve their financial goals. For more information, visit www.squire.com.

The information contained in this article is provided for general informational purposes only and is not intended to constitute accounting, tax, legal, investment, or other professional advice. The information may not be applicable to your specific circumstances. You should consult with a qualified professional before taking any action or making any decision based on this information.