February 25, 2021 Startups Beware: The R&D Credit Study Deception
We have prepared tax returns for over 3,000 early-stage startups and see many R&D Credit Studies done by newly-formed R&D Study firms – we will collectively call them the “usual suspects.” You can look at an R&D Study as an insurance policy for your R&D Credit. If your startup is ever audited and cannot produce the proper substantiation for your R&D Credit, in the form of an R&D Study, the IRS will disallow parts, or all, of the credit, and you will have to pay it back with penalty and interest.
The usual suspects are typically headquartered in the Bay Area, have great looking websites, use gadgets such as connecting to your Gusto, QuickBooks, etc., and may offer to fund a small piece of your credit upfront (but reduces that advance by 100% of their fee – not a good deal). They are great at selling and charge a fee of 20-25% of the R&D Credit (so you would pay them $25K for a Study that produced only a $100K R&D Credit).
However, all this really means nothing when you are facing an IRS audit. The only thing that matters is the quality of your Study – will the IRS accept it? Or will it disallow a portion or all of your R&D Credit?
After reviewing a number of these Studies from the usual suspects, we highly doubt they would survive an audit. Subsequently, the IRS would disallow the R&D Credit and demand their money back plus penalty and interest. This frequently happens when there is a lack of substantiation/documentation.
After taking a closer look at a sample of studies from the usual suspects, we found three key reasons why the IRS would disallow them:
- All the Studies that we reviewed were 99% boilerplate (copy + paste). The IRS has warned several times about this practice and will always throw out boilerplate Studies.
- There was no contemporaneous timekeeping info (the IRS gold standard for Studies). Looking at these boilerplate R&D studies, you would not know if the employee worked for a bakery or a software company – the job description and the R&D performed were 100% boilerplate. The IRS would never allow.
- There were no adequate descriptions of the type of R&D conducted. One boilerplate R&D Study by a usual suspect comically used five (yes, 5!) words to describe the R&D. The IRS would never allow this and would disallow the credit.
Do NOT waste your money or time on these boilerplate Studies.
As previously mentioned, the only reason to pay for a Study is to have insurance if you are ever audited. We have been through a ton of IRS audits, and trust us, you have no chance with one of these boilerplate Studies. To add insult to injury, you are going to pay a HUGE fee for the Study.
For software startups needing an R&D Study, we exclusively refer eTaxConnect. They use the info already present in your version control system to generate a Study that is 100% IRS-compliant and audit ready.
Through contemporaneous timekeeping info, detailed R&D descriptions, no boilerplates, and only about 30 minutes of management time, eTaxConnect can produce a study that will stand up to any IRS audit.
If you have 10 developers and your R&D payroll is $1M, the eTaxConnect fee is about $3,500 vs. $25K for a useless boilerplate Study from one of the “usual suspects.”
Do not get deceived and misled by their aggressive marketing and misleading claims.