Research tax credit audit plan and audit plan for internal-use software

Tax Executive, The, May-June, 1996

Although TEI appreciate that the information listed above may be helpful, we are concerned by the plan's establishing an expectation that such records will exist in the desired format in each and every instance. Hence, we worry that agents may interpret the plan too rigidly, where what is needed is flexibility. More to the point, since companies generally prepare their tax returns based on summary information submitted by their business units, the tax workpapers may well not have the level of detail anticipated by the plan, and we recommend that the plan so inform the agents.

9. Plan Your Audit Strategy (page 4, [paragraph] I.3): The plan states that "[i]n auditing the research tax credit, the examiners should employ a `two-prong' approach. First examine the underlying expenses and then examine the underlying technology." Thus, the plan implies that the two-prong approach for testing compliance with sections 41(b) and 41(d) is sequential -- first do one, then the other. In practice, however, the audit is often an integrated procedure conducted as a single process for the sake of efficiency. This efficiency should not be sacrificed, especially (as explained above) since the bottom-up approach evinced by the plan could have the effect of creating unnecessary work.

In addition, we suggest that the caption of this part of the plan be changed from "Plan Your Audit Strategy" to "Plan the Audit." Some of our members have interpreted the word "strategy" negatively, as intimating that examining agents should develop an approach to "trip up the taxpayer" rather than to "collect the proper amount of tax" (as prescribed in the IRS's Mission Statement).

10. Request a Written Description of Each Account (page 6, [paragraph] II.2): The plan states that --

Regardless of the methodology the taxpayer used to compute the credit, request a written description of each account included in the calculation of the credit. These descriptions should identify the function of each account. By reviewing the description or profile of each account, the examiner may find non-qualified accounts such as fringe benefits, travel, capital assets, etc., included in the computation of the credit.

The detailed chart of accounts -- which the agent will typically request at the commencement of the audit -- invariably contains this information. Requesting a written description of each account would be redundant.

In addition, we believe the audit plan's reference to fringe benefits as constituting a "non-qualified account" needs to be clarified. Many components of a company's "fringe benefits" account qualify for purpose of the research tax credit. For example, in some companies, taxable vacation pay, the taxable portion of group-term life insurance, and sick pay are included in the fringe benefits account (along with some nontaxable benefits). The key is whether the amount is includible in wages. Hence, if a benefit (such as a company-provided automobile) is taxable to the employee and reported on the Form W-2, it may well be properly taken into account in computing the research tax credit.