TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

Office of Audit

Highlights

PROCESSES ARE NEEDED TO IDENTIFY SMALL BUSINESSES ERRONEOUSLY CLAIMING THE RESEARCH TAX CREDIT PAYROLL TAX OFFSET

Final Report issued on December 19, 2018

Highlights of Reference Number:  2019-40-014 to the Commissioner of Internal Revenue.

IMPACT ON TAXPAYERS

Title 26 U.S. Code Section 41, Credit for Increasing Research Activities, was enacted in 1981 to stimulate research and development in the United States by helping businesses offset some of the costs associated with increasing their qualified research activities (the credit is hereafter referred to as the Research Credit).  The Protecting Americans from Tax Hikes Act of 2015 made the Research Credit permanent after December 31, 2014, and now allows qualified small businesses to apply a portion of the Research Credit against their employer portion of the Social Security tax.  Qualified small businesses could begin claiming this credit after December 31, 2015.  In Tax Year 2017, over 2,200 Research Credit claims totaling over $53.2 million were made.

WHY TIGTA DID THE AUDIT

This audit was initiated because qualified small businesses could begin claiming the Research Credit to offset their payroll tax liability beginning in Tax Year 2016.  The objective of this review was to determine whether the IRS can ensure that taxpayers who claim the Research Credit against their payroll taxes are eligible to claim the credit and claim the correct amount.

WHAT TIGTA FOUND

The IRS does not have processes to identify small businesses that do not meet the eligibility requirements and dollar limitations for claiming the Research Credit.  TIGTA’s review of 1,467 businesses claiming over $53.2 million in Research Credits on Tax Year 2017 employment tax returns identified 143 businesses that claimed or received about $11.8 million in potentially erroneous Research Credits.  For example, TIGTA identified 81 businesses with potentially erroneous Research Credit claims totaling almost $2.8 million because they did not meet one or more of the eligibility requirements to claim the Research Credit.  TIGTA also identified 55 businesses with potentially erroneous Research Credit claims totaling $586,190 on a return prior to when the credit became available.  The IRS agreed with 50 of the identified cases.  *****************************************2********************************************************* *************************************************************2********************************************************* *********2*********.

In response to our findings, IRS management stated that they are developing post-processing compliance initiatives to ensure that eligibility for the Research Credit has been met as well as to ensure the accuracy of the credit amounts claimed.

WHAT TIGTA RECOMMENDED

TIGTA recommended that the Commissioner, Small Business/Self-Employed Division, review the potentially erroneous Research Credits claimed by the 81 businesses that did not meet eligibility requirements; review the ********************************2*******************************; and timely implement post-processing initiatives.  TIGTA also recommended that the Commissioner, Wage and Investment Division, implement procedures to identify returns that claim the credit prior to when the credit became available and also ensure that the tax accounts for the 50 businesses claiming the credit prior to when it became available are adjusted.  IRS management agreed with all five of our recommendations and plans corrective actions.

READ THE FULL REPORT

To view the report, including the scope, methodology, and full IRS response, go to:

https://www.treasury.gov/tigta/auditreports/2019reports/201940014fr.pdf.

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E-mail Address  /  TIGTACommunications@tigta.treas.gov

Website             /  http://www.treasury.gov/tigta