Update: A Federal Audit of Dental R&D Credits

Benjamin T. Dyches, DDS, JD

Summary: A recent federal audit and appeal upheld dental-based R&D credits as qualifying research activities. The overall credit was reduced due to inadequate documentation. A focus on detailed reporting and a reasonable application of qualifying expenses is key to success.

We recently learned of a federal audit that included R&D tax credits. To date, this is the first federal audit we know of in the dental field. The case in question is unpublished and not one of our clients. To protect privacy, this update is written in broad terms and is not intended to provide legal advice.

CASE OVERVIEW

Let’s start with a brief overview of the facts of the case:

The practice in question was a General Dental practice.
The audit was not triggered by the R&D credit. The credits were reviewed as part of the overall examination.
The R&D credit calculation included nearly all supply costs (crown lab fees and others)
The R&D calculation dedicated over 70% of employee time to qualifying research activities
The documents provided to examiners were spreadsheet tallies of time with limited descriptions of activities claimed for credit.

OUTCOME

The examiner reduced the overall credit value, finding that, while the credit was appropriate in the dental setting, the documents included for review did not justify the allocations taken. This process is called “shrink-back.” Shrink-back describes a situation in which the examiner recognizes that certain aspects (called subcomponents) of the activity qualify as R&D but that the sum of the subcomponents constitutes less than 80% of the entire activity. The credit is reduced to the value of the identified subcomponents.

After examination, the case proceeded to the appeal stage where it was met with a similar outcome.

EVALUATION

We emphasize that every audit stands on its own and that results could vary, however, there are some important extrapolations from this case:

Clinical activities in a dental setting can be appropriate applications of R&D credits.

Millions of taxpayers in far less technical pursuits successfully claim the credit every year. While this is no surprise, it is a case on point. The dental office in this case adopted the position that every crown prep constituted an R&D activity without further distinction.

A shrink-back analysis is key.

A superficial description of the activities for which credits are claimed is a red flag for additional scrutiny. In October 2021, the IRS outlined a major R&D change requiring a detailed report attached to the return. In his case, it would have been appropriate to identify subcomponents (i.e., evaluating new resin cement or additional ceramics) and detail these activities rather than claiming the crown process as a whole.

A detailed description of wage-based activities and supplies is essential.

Considering that all lab fees and a majority of employee time were claimed for credit, it’s not surprising that the credit was reduced. Especially with little supporting documentation. The wages calculated at 70% of the entire employee payroll would, in our estimation, fall under an aggressive interpretation of this credit. Claiming that all crowns and associated supplies qualify is also an aggressive interpretation. If supplies are claimed, they should have a clear relationship with the activities.

OUR PROCESS

While this is the first federal R&D audit we’re aware of, our team of experts evaluated successful and failed R&D claims in many industries as we developed (and constantly improve) our credit process. The Dr. Tax Credit program already addressed the issues described in the examination above.

1. Clinical Healthcare Activities Qualify.

Those of us in the healthcare industry understand profoundly that we are faced with many techniques and product options. In many cases, it’s up to us to develop our practices based on our clinical experience. We are the only R&D company that works closely with NIH Research Sponsors to provide a backstop to the question of whether what you are doing in the office is R&D.

2. Shrink-back!

Industry expertise is key to recognizing which parts of your procedures will qualify. We always focus on subcomponents as the basis of our reports, which makes them uniquely lengthy (200-300 pages) and informative. It’s not uncommon for us to identify 15-20 subcomponents, each including detailed descriptions of activities.

4. The nexus between employees, supplies, and qualifying activities.

When the subcomponents are considered, we rarely qualify more than 30-40% of employee wage for the credit. Our reports connect the employees, their roles, and qualifying supplies to the research activity.

Overall, we see this as a positive case. The credit was calculated using the most aggressive interpretation of the code. It’s unlikely that the entire crown process was brand new for this clinician, so a reduction based on shrink-back makes sense. Our practices already account for the main issues brought to light in our discussion.

We'd be happy to schedule a quick intro call to see if this credit is a good fit for your practice. You can schedule through this link, by email (welcome@drtaxcredit.com), or with a quick phone call (801-318-5097).