These days in accounting, everyone is under pressure to cut costs. One of the most talked-about ways to do this is by using AI-enabled and other software to reduce labor costs. AI-enabled tools and niche tax software are reshaping tax compliance. This article is for CPAs, enrolled agents and tax directors deciding whether to adopt AI-enabled R&D credit platforms.
Currently, it is common to see aggressive advertisements promising "big" R&D tax credits for work companies have already done, often with little discussion of eligibility or substantiation. That kind of overpromising has hurt the credibility of legitimate R&D work and increased audit risk for clients and their advisors. One new trend we are seeing a lot lately is the move toward using software to help create R&D tax credit filings. Even firms that rarely file R&D claims increasingly rely on third-party platforms their clients have used, making it essential to understand what these tools actually do — and do not — take responsibility for. This article explains what these tools do, where responsibility still sits with you, and a practical division of labor you can safely adopt.
The Increasing Research and Development Tax Credit is a federal tax credit enacted to encourage research and development in the U.S. The idea is that by retaining research in the U.S., we will keep researchers here and thereby increase the U.S.'s competitiveness in global markets.
From offshoring to automation
Historically, the work of creating and documenting tax credit studies was performed domestically by accountants. Around the year 2000, accounting firms began offshoring R&D credit development work to South Asia and the Philippines to reduce their expenses. Section 41 of the Internal Revenue Code requires R&D activities to take place in the U.S. There is currently no requirement that the work developing the R&D tax study itself be performed there. This plan for offshoring tax administration, however, is short-sighted.
Where will tomorrow's tax experts come from if the entry door to the industry is severely constricted for newly graduated American accountants? The move from offshoring tax credit work to Asia to onshoring with AI-enabled systems is just the next step in reducing costs. Offshoring or switching to AI-enabled systems raises the same risk for practitioners: Where does professional responsibility lie when much of the work is delegated? Fundamentally, CPAs cannot outsource their critical thinking to software or offshore teams; the obligation to apply professional judgment remains with the signing professional.
Influence of tax administration
Some technology tools show great promise in reducing the costs of tax administration while increasing the accuracy of tax filings. But none of these tools can determine whether a particular project truly meets the four tests for qualified research; they can only structure the information that a human must evaluate. Charles Rettig, former IRS commissioner and a shareholder at the law firm Chamberlain Hrdlicka, recently stated, "Technology is critically important for the future of tax administration in leveraging important human resources and streamlining the overall effort while often improving the accuracy of the underlying data." Most importantly, he added, "Technology cannot entirely replace the human effort in getting to the appropriate result. Tax administration will forever remain a team approach — people and technology." For CPAs, the practical implication is to treat these tools as amplifiers of human expertise, not substitutes for it.
Reasonable care in preparing submissions and in all representations to the IRS is required by Circular 230, which requires that tax preparers exercise due diligence in (1) preparing, assisting in preparing, approving and filing tax returns and all papers relating to IRS matters; (2) determining the correctness of oral or written representations made to the IRS; and (3) determining the correctness of oral or written representations made to clients regarding any matter administered by the IRS.
This does not mean you cannot rely on information furnished by a taxpayer without verification. But the preparer must make reasonable inquiries to test if the information appears incorrect, incomplete or inconsistent with other facts or assumptions. This is particularly true when dealing with the R&D tax credit, due to the complexity of the underlying work and the large amount of money at stake. It is highly recommended that professional judgment be applied before sending a tax credit study and Form 6765 to the IRS.
Professional judgment is hard to teach or code into an application, even an application based on AI. For this reason, it's important to have a knowledgeable professional review the Form 6765 and tax credit study. At a minimum, perform these steps:
- Check the scope of what the software does and does not opine on (eligibility vs. quantification vs. documentation).
- Review the data for reasonableness and completeness before using.
- Document your own review procedures in the workpapers.
- Ensure the person overseeing the tool has relevant R&D credit expertise.
Circular 230 reasonable care and due diligence
Reliance on AI-enabled tools is still reliance on information provided by another party. Circular 230 due diligence standards apply just as they would to workpapers prepared by a subcontractor.
Circular 230 requires anyone — even an attorney, CPA or enrolled agent — who is compensated to prepare (or substantially assist in preparing) a federal tax return to have a valid Preparer Tax Identification Number issued by the IRS. In the same way that you wouldn't want to be a passenger on a plane piloted by an enthusiastic yet unlicensed pilot, you need an experienced R&D consultant to perform due diligence on any filing created by software before it makes its way to the IRS. Firms should be clear, in engagement letters and internal policies, that only properly credentialed professionals with PTINs will sign or substantially assist in R&D credit claims, even when software plays a major role in preparation.
A practical division of labor for firms
The model most likely to emerge is one in which the software collects and structures data; and a specialist evaluates eligibility, reviews the quantification and signs off. If the IRS audits your tax credit claim, you will need a licensed attorney, CPA or enrolled agent to defend your claim before the IRS. However, most experts will be very cautious about defending an R&D claim they were not involved in creating.
A model in which software is used to organize and document research, and a separate licensed and insured R&D tax specialist who performs due diligence to calculate Form 6765, is the best use of the new tools to create a defensible tax credit claim.
