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Getting Ahead of Tax Credit and Incentive IRS Issues
Recent events in the media have shone a spotlight on issues surrounding bad practices when it comes to tax credits and incentives. This increased attention is likely to result in an influx of audits by the Internal Revenue Service (IRS) as they crack down on the Research and Development (R&D) tax and the Employee Retention Tax Credit (ERTC) in the coming years. We recently released an article detailing the red flags to look out when dealing with tax credits and incentives providers. If you think you could be at risk for future IRS issues, there is much you can do now to take a proactive approach and mitigate future negative impact. In the following, we break down steps you can take now to better understand and manage your exposure.
An overview of tax credits and incentivesDesigned to encourage investment and development, job creation, growth, and certain business activities, tax credits and incentives provide an opportunity to reduce the amount of tax owed for performing certain activities. Credits and incentives are categorically different than tax deductions, which reduce the amount of taxable income. These incentives often target desirable industries or activities like research and development, job creation for at-risk populations, and expanded growth in underdeveloped areas. When leveraged correctly, credits and incentives can be a powerful tool to funnel back resources into your organization to fuel activities you are already doing. Even more enticing, these credits can often apply retroactively if you determine you qualify for certain credits or incentives after the fact. There are three basic types of tax credits: nonrefundable, refundable, and partially refundable. A few of the different types of tax credits pertaining to businesses in different classifications, industries, or activities performed include R&D tax credits, the employee retention tax credits, IRC Section 179D, and the work opportunity tax credit. To learn more about their eligibility rules, visit our previous article.
Understanding the risk of IRS tax auditsThere is a three-year statute of limitations from the due date of the tax return or the filing date (whatever is later) for the IRS to assess your filings. That means if you think you may be exposed but escaped the IRS’ notice, you could still receive an audit notice for previous years’ returns. And if you do get audited, and the IRS determines you owe back taxes, you will get charged penalties and interest dating back to the infraction itself. This is even more risky when considering the IRS’s extreme backlog. These IRS tax audits can sometimes take years to complete and if your credit and incentive calculations are the topic of interest, you’ll need to halt any future credit analysis until the situation is resolved. Meanwhile, you’ll be devoting crucial resources, time, and effort working with the IRS for something that yields no financial value and distracts from more conducive business activities.
Reasons to get a head-start and address issues nowEven though there is no guarantee you will get audited, you are still taking a risk if you do not address potential tax credit and incentive exposures in your organization. It may seem easy to “roll the dice” and hope the issue will remain uncovered, but it could come at a cost — especially if you are planning to make some big moves, like engaging in transaction of your business (M&A), going public, or embarking on another major transaction. During the due diligence period of these transactions, it is almost certain any uncovered tax issues will emerge. You will likely not recover the value of these credits or remain on the hook for potential liability. Even worse, the exposure of these issues reflects negatively on your accounting and control system, potentially lowering the purchase value of your organization or undermining whatever deal you had in place prior to the due diligence. Often your transaction partners will start to question your organization's trustworthiness, and reputation ... due to something that may be no fault of your own.
So, you’ve been exposed … but haven’t received an IRS audit noticeHere is the deal: you know for certain you have been exposed, but you have not been notified by the IRS yet. You probably have a lot of questions — will you get an audit notice? Have you escaped unscathed? Do you need to address the issues preemptively, just in case? It may be overwhelming to decide how to proceed once you realize the exposure. We suggest working with a qualified CPA firm to review your tax filings. A full-service accounting firm will review your organization holistically at a minimum rate, uncover any exposures, and deliver valuable peace of mind. If the firm does find issues, you have two options:
- Update your credit and incentive filings moving forward.
- While this will likely decrease the amount you can deduct, it exemplifies transparency.
- Issue a Voluntary Disclosure (VA) if the exposure is significant and you do not have a lot of time to fix the issue.
- Essentially, you are volunteering to correct your mistakes by recalculating the credits claimed and paying back the difference.
- While this may sting a little, the IRS looks favorably upon organizations who are proactive to fix the issue by filing a VA and they are likely to waive any penalties or interest you would have had to pay.
You’ve received an IRS audit notice. Now what?Well, it happened. You received an audit note from the IRS. Before you panic, here is what you need to do:
- Start preparing your documentation right away. The sooner you have your ducks in a row, the sooner you are prepared to handle the audit.
- Check the contract you signed with your original provider and verify if they provide controversy support services for situations like these.
- If they do, reexamine the quality of their work. Do they have any of the red flags mentioned in this article? Could something they have done have caused the audit?
- Consider engaging a qualified CPA firm as your new provider to handle the subsequent controversy support. Someone you trust can get you ready for any available credits and incentives moving forward, too.
- If you used a provider that displays any red flags, you could have some leverage for a reasonable cause defense. Because the “professional” firm handled it for you and made a mistake, you could utilize a first-time penalty abatement, which means you can get relief from a penalty if you:
- Did not previously have to file a return or if you do not have any penalties for the three years before the tax year you received a penalty;
- Filed all currently required returns or an extension of time to file; and
- Paid or have arranged to pay any tax due.
- Verify your contract with the original provider to determine if you have any recourse to seek compensation from them. If the IRS does issue any penalties, you will want to ensure you do not have to pay.