Each year the IRS issues a “dirty dozen” list for tax scams. This annually updated list explains each scam so that taxpayers will be aware of what they should and should not do. Excessive and improper business claims have made the list this year, along with eleven other scams.
Improper business claims include fuel tax credit and research credit claims. To claim these credits, specific qualifications must be met. Otherwise, taxpayers may face serious penalties for excessive credit claims.
To learn more about these credit claims, how they’re misused, and potential penalties, read on.
What Are Tax Credits?
Tax credits are meant to cover certain expenses that businesses pay throughout the year. They’re in place to encourage activities and behaviors that benefit the economy, environment, or other important purposes. These credits reduce the amount of income tax that is owed to federal and state governments at the end of the year.
Credits reduce the amount of income tax that you owe dollar-for-dollar. This is different from tax deductions, which reduce the amount of your income that is taxable.
Credits vs Deductions
If you owe a certain amount of taxes, credits directly reduce that tax amount. Deductions, on the other hand, reduce the amount of your income that can be taxed. Tax credits usually end up saving you more money.
For example, if you owe $3,000 in taxes and receive a credit of $1,000, your tax amount is reduced to $2,000. With deductions, if you had an income of $80,000 yet had $20,000 in deductions, you would then be taxed as if you had only made $60,000.
Tax credits have very specific eligibility requirements. These requirements are put in place to combat misuse. However, there are always some who try to circumvent lawful tax activity by making improper credit claims.
Avoiding Improper Business Claims on Your Taxes
Many taxpayers have their taxes prepared by a professional. Sometimes these professionals don’t run an ethical practice. You may find yourself being encouraged to claim tax credits for which you’re not eligible. These preparers aim to create false credit claims in order to generate a more sizable tax refund.
Credits are commonly used by unprincipled preparers. Two, in particular, are frequently abused by these tax preparers. These are the Research Credit (also known as R & D or R & E credit) and the Fuel Tax credit.
The criteria for eligibility is very specific for both of these credits. It’s important for taxpayers to understand that they are responsible for tax errors and scams, regardless of who actually prepares their taxes. Because you’re the responsible party, you must always be aware of and avoid any suggestions by preparers to make excessive business claims on your tax return.
The Purpose for and Eligibility Requirements of Research Credit
Research credit is also known as R & D (Research and Development) or R & E (Research and Experimentation) credit. This credit is found under the Internal Revenue Code in Section 41. Research credit is provided to encourage research and experimentation activities in private industries that will eventually improve their product or processes and in turn, will advance the economy.
These credits are meant to reward businesses for investing in research that can lead to better business efficiency, product quality, or environmental practices. Because of the fast-paced nature of technological advances today, businesses must always evolve and innovate to stay on a level playing field.
Developing new products or improving existing ones and improving other processes can be costly and may not be successful. For these reasons, innovation is often not the priority it should be. Research credit gives businesses more incentive to take these challenges on.
Criteria for Research Credit
In order to claim research credit, you must be able to prove that your activities meet the following criteria:
- They are meant to resolve a technological uncertainty that impacts a business/business design component
- They rely on computer science, biology, physical science, engineering, or another hard science
- They relate to the development of an improved or new component of the business (component being defined as products, techniques, processes, formulas, inventions, and internal use software)
- They all involve an experimentation process that includes testing and consideration and evaluation of alternatives
Internal use software development activities:
- Must be innovative and result in a beneficial cost or performance speed reduction
- Must involve significant economic risk for the business
- Must not be commercially available
Qualified research activities will result in expenses. Research credit aims to reduce the impact of research cost.
Qualified Research Expenses
Qualified research activities will incur sizable expenses. These are referred to as QRE (Qualified Research Expenses). These expenses include:
- Employee wages for services that qualify
- Supplies that are used throughout the process, which are described as tangible property (excluding land and land improvements)
- Research expenses paid to contracted third-party entities that carried out qualified research activities (QRAs) for the taxpayer
- Research payments made to scientific research organizations and qualified educational institutions regarding the eligible research and experimentation
It’s important to point out that this research must be done on United States soil. Taxpayers must properly document their research activities and incurred qualifying expenses throughout the research period to back up their research credit claim.
Exclusions for this credit include:
- Research undertaken after commercial production
- Foreign research
- Customer-funded research
- Social science research
- Duplication or adaptation of existing business components
- Routine data collection, testing, or quality control inspection
- Marketing development or research
Any expenses incurred from the acquisition of fixed assets used in the business or trade of the taxpayer is also excluded from research credit. Activities that present no uncertainty about the taxpayer’s capability or method of achieving the desired result are also excluded.
Research credit scams hold a place in the Dirty Dozen 2019 list from the IRS, a list of the top 12 tax scams. Improper and excessive business claims for research credit typically involve failure to prove or participate in activities that qualify. They may also fail to meet qualified research expense requirements or may not be able to prove the relation of a claimed expense to the qualified activity.
Fuel Tax Credit
The government taxes fuels such as gasoline, kerosene, diesel fuel, alternative fuels, and others. Some commercial uses of fuels are excluded from taxation.
Fuel tax credit is generally intended for off-road business or farming use. These limitations make this credit unavailable to most tax-paying businesses. However, some tax preparers convince people to claim this credit erroneously to increase their refunds.
Additionally, improper claims are also filed by identity thieves as a part of their larger scheme. This form of tax scamming has been hindered by new identity theft screening filters used by the IRS.
Not all nontaxable fuel uses are off-road or farming related. Businesses that buy fuel for qualified purposes can claim the fuel tax credit by filing Form 4136. In order to claim a fuel tax credit, the fuel must be used for the following:
- Farming purposes (or on a farm)
- Vehicles designed for off-highway transportation
- Export (does not include fuel in a vehicle or aircraft tank)
- Commercial fishing boats
- Certain local and intercity buses
- School buses
- Diesel and kerosene for non-fuel use
- Foreign trade
- Certain fixed-wing aircraft and helicopter use
- Qualified blood collection, storage, and transportation vehicles
- Nonprofit educational organizations
- The state, political subdivision of a state, or the District of Columbia
- In military aircraft
- In a vehicle or aircraft owned by an aircraft museum
- In a United States-owned highway vehicle that isn’t used on a highway
These eligibility requirements greatly restrict the number of taxpayers who can claim the fuel tax credit.
Fuel Tax IRS Credit Scams
Fuel credit claims that are fraudulent are considered frivolous tax claims and can result in a $5,000 penalty. Such claims may also prompt closer investigation that can result in criminal prosecution.
If identity theft was the issue, you may need to get the help of an experienced Michigan tax attorney.
Fighting Identity Theft
You may be receiving unexpected and unwanted attention from the IRS or something might be off on your tax return. If you suspect false claims were made on your taxes, don’t hesitate to act.
Identity theft related to taxes isn’t uncommon and can lead to a very complicated, stressful process with the IRS. This is where an experienced tax attorney can help you efficiently navigate the situation.
The Silver Tax Group has over forty years of experience and will thoroughly investigate your issue. You’ll know for sure if your identity has been stolen for fraudulent tax use.
Because our group already has an established relationship with the IRS, we can work with them to ensure that your account is flagged and any further fraudulent activity is halted until the tax fraud investigation is concluded.
If identity theft wasn’t the case, we can still help you negotiate with the IRS for a favorable outcome. Before you file with a tax court, give us a call. Our tax defense lawyers can make sure your rights are protected and can help keep the process from escalating.
Avoid Penalties from Improper Business Claims
Prevention is always best when it comes to filing taxes. Erroneous or fraudulent claims can lead to huge problems down the road.
If you’re faced with tax issues and are unsure of what to do next, we’re here to help. Feel free to contact us for a free initial consultation.