Every July, the Internal Revenue Service issues its “Dirty Dozen” scams list, an annual warning to taxpayers about tax promotions the IRS believes are abusive. This year’s list includes the Credit for Increasing Research Activities, a.k.a., the R&D tax credit.
Many integration companies qualify for the credit, and we have helped quite a few of our clients apply for and receive the credit. The purpose of this article is not to tell you what the credit is, or how to get it; my purpose is to warn you about the way in which your company applies for the credit.
Although the credit has been around since 1981, a few years ago some firms began aggressively marketing the credit to any company owner who would answer the phone. Their method of operation is to cold call businesses and entice the owners to look into taking the credit.
They charged a percentage of the credit, so it seemed like a no-cost tax benefit. While some integration companies clearly qualified for the credit, many fell into a gray area and some didn’t qualify at all.
The firms engaged in what is referred to as “audit lottery” by submitting as many credits as possible and counting on the IRS only auditing a small amount of the tax returns claiming the credit.
Some of the firms even connected with alarm associations by claiming they provided a valuable service to their members. While most companies that applied for the credit received a nice windfall, some lost the audit lottery and ended up with a gut-wrenching audit.
The IRS has been tracking what they consider to be rogue firms that aggressively recruit clients and spend little time getting to know their operations, but nonetheless apply for these credits. Every professional tax preparer has an identification number they have to put on every return that they prepare. The IRS uses algorithms to track preparers and when they see a pattern developing —such as a high incidence of complex credits being taken — they may begin focusing on the preparer’s work.
Just like anything else if it sounds too good to be true, it just may be. It is best to have a long-term relationship with your tax professionals and let them evaluate your qualifications for tax credits. It is better to pay for an hour or two of their time than to be sitting across the table from an auditor who selected your return based upon you being associated with what the IRS refers to as a susceptible preparer.