Recently, many states are starting to allocate more resources towards examining claims for their respective Research and Development Tax Credits. This includes specifically targeting R&D claims for examination, as opposed to reviewing the claim as a part of a general audit. As this trend continues, taxpayers and their CPAs should view the audit exposure at the state level to be on par with that at the federal level.
In some states, this new focus on R&D credit claims presents a few issues.The first issue is the lack of a formal review process when determining the worthiness of a credit claim. Claims are being examined within the same processes used for general tax reassessments, by the same general tax examiners. This can sometimes lead to another potential problem. Too often the examiner tasked with reviewing the R&D credit claim lacks the experience and expertise to properly apply the applicable state and federal laws and regulations in their determination. Finally, most states lack substantial tax court precedents relating to their respective R&D credits. This necessitates reliance on federal tax case law which may not be an apples to apples comparison.
To prepare for increased state audit exposure and potential issues within an examination, there are a few considerations taxpayers should make. First is to be fully aware of the similarities and differences between state law and Federal IRC Section 41. A strong foundation of knowledge will allow a taxpayer to be confident their state claim is compliant with state law. In addition, equal documentation should be kept as evidence to support a R&D claim at the state level as kept for a federal claim. Much of this documentation will overlap, but it is important to have state specific evidence where necessary.
With increased attention being paid to state R&D Tax Credit claims, working with a firm who has the experience and expertise in handling examinations at the state level, as well as the federal, can facilitate a successful audit defense. Careful preparation and the knowledge to correctly comply with state requirements can make all the difference in maneuvering through an inconsistent and ever evolving process.