The Million-Dollar Engineering Problem Coming for Middle-Market RTC Credit Claims

There’s a shift happening in how companies compensate top technical talent. This trend is creating greater exposure to IRS scrutiny for taxpayers with Research Tax Credit (RTC) claims under Internal Revenue Code (IRC) Section 41.

Growth in artificial intelligence (AI) and other advanced technologies is pushing compensation higher for top engineers, often through a mix of equity awards, milestone incentives and retention packages.

Although attention often centers on large technology companies, this trend is emerging in the middle-market. These shifts carry important implications for companies claiming RTC.

The Middle-Market Exposure

Taxpayers don’t need a $50 million compensation package to draw IRS attention. For example, a $350,000 vice president of engineering at a growth-stage SaaS company, a $500,000 director of AI at a mid-cap manufacturer or a founding chief technology officer with a complex equity stack at a private equity-backed portfolio company can all lead to similar lines of inquiry during an exam even at lower compensation levels.

When compensation stands out relative to the rest of the workforce on an RTC claim, IRS examiners notice. At that point, the question often shifts from “Did the company conduct qualified research?” to “What specifically did this person do, and can you prove it?”

Middle-market companies are often more vulnerable in this situation than their Fortune 500 counterparts because their documentation infrastructure tends to be less developed. To illustrate, a $200 million revenue manufacturer with three highly paid engineers included in an RTC claim may have limited contemporaneous documentation to support the claim beyond a project list and potential timesheets. Without more detailed support, those higher compensation levels can place added pressure on the claim during an examination.

What Better Documentation Looks Like

Advising a company to enhance audit readiness without a roadmap is similar to telling someone to eat healthier without a meal plan. A more structured approach can help companies support highly paid individuals (HPIs) included in an RTC claim.

Time allocation discipline: The time allocation should be credible and granular. A blanket “80% qualified” assumption for someone earning $600,000 won’t hold up under individual-level scrutiny. The methodology needs to defensibly split that person’s time across qualified activities including research categories (i.e., direct research, direct supervision of research and/or direct support of research) and nonqualified work, such as administration, strategy and recruiting. The more complex the compensation structure, the more important it becomes to document the time period each component relates to and the work it covers.

Technical narrative quality: The narrative needs to explain the work rather than restating a job description. For example, a job description may state “leads technical architecture decisions.” An audit-ready report should reflect how that responsibility translates into qualified activity: “In Q2, [Name] led iterative experiments to resolve uncertainty around [specific technical challenge]. The team evaluated three architectural approaches and determined that [approach C] was viable after completing [specific testing].” The documentation must connect the individual’s role to the technical uncertainty and the process of experimentation. It should provide enough specificity that enables a nontechnical IRS examiner to follow the performed activities.

Supporting documentation and artifacts: Build the artifact inventory before an IRS inquiry. For each HPI, practitioners should be able to point to version control commits, design documents showing alternatives considered, meeting notes capturing real-time problem-solving, patent applications or development logs that corroborate the timeline. The goal is to understand which documentation or artifacts exist and align them to qualified activities before any IRS inquiry arises.

The Real Risk

IRC Section 41 does not impose a cap on qualified wages, and the statute does not treat a highly paid individual’s work differently from that of other employees. The primary consideration is evidentiary, not legal. Exposure arises when there is a gap between “We paid this person a significant amount” (i.e., level of compensation) and “Here’s exactly what they did that qualifies” (i.e., the ability to clearly support qualified activities performed).

These considerations can also extend into financial reporting. If the FIN 48/ASC 740-10 analysis cannot sufficiently support HPI wage claims at a “more likely than not” threshold, the company may be carrying a credit position that doesn’t align with its own accounting standards, regardless of whether the IRS examines the claim.

Key Takeaways

The tech industry talent war shows no signs of slowing, and rising compensation for talent is expanding the RTC base. At the same time, it raises the bar on how those wages are supported, particularly for companies that have historically treated documentation as an afterthought.

A practical takeaway is that when an individual included in an RTC claim earns significantly more than their peers, the supporting documentation should reflect a similar level of rigor. This is not driven by a change in the law, but by how claims are evaluated during an IRS examination.

Are you facing increased review around RTC claims involving highly compensated technical talent? Contact us. Our tax team can help strengthen your documentation and supportability, enhance your RTC framework and better align it with IRS expectations to improve audit readiness.

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