The IRS Is Using AI to Pick Who Gets Audited — And There's a Big New R&D Deduction on the Table
The IRS runs 126 AI programs to select audits. The OBBBA also restored R&D expensing with a retroactive window closing July 6, 2026. Here's what Bay Area business owners need to act on now.
Two things happened in 2026 that every Bay Area business owner should understand.
One is a little scary. The other is actually really good news — if you act before July.
The scary one: the IRS has transformed how it decides who gets audited. It's not a person flipping through returns anymore. It's machine learning running six times a year, cross-referencing your reported income against third-party data, looking for patterns across millions of returns at once.
The good news: a major tax law passed last summer restored one of the most valuable deductions for companies doing R&D. If your business spent money on research, engineering, or software development from 2022 through 2024, there may be a significant refund sitting in amended returns you haven't filed yet. But the window closes in July.
Let's talk through both.
The IRS Now Has 126 Active AI Programs
That number comes from a landmark government watchdog report (GAO-26-107522) published March 24, 2026. The IRS was running just 10 AI programs in 2022. Now it's 126.
The machine learning has been baked directly into the IRS's core audit selection system — the one that decides which returns get flagged for human review. That system now runs about six times per year, getting smarter with each pass. It cross-references what you reported against bank data, payment processors, and other third-party sources. It flags returns where the numbers don't add up compared to your industry peers.
EisnerAmper's breakdown of AI at the IRS and Capitol Tech University's audit algorithm overview are both worth reading if you want to understand how this works in practice.
What the AI Is Looking For
The system is trained to notice things like deductions that seem high relative to your industry, round numbers on expense categories, travel and meal expenses that don't match your business type, and R&D credits without solid supporting documentation. Attorney Katie Lawson's 2026 audit risk breakdown covers the main red flags in plain English.
The practical takeaway is simple: clean, contemporaneous documentation is your best protection. If your expense tracking is loose or your bookkeeping is inconsistent, that's what the system is designed to catch. We've covered the top IRS audit red flags before — they're even more relevant now that selection is automated.
The R&D Deduction Is Back — And It's Retroactive
For a few years, Section 174 of the tax code forced businesses to spread their R&D deductions over 5 years instead of taking them immediately. For any Bay Area company spending real money on engineering, software development, or product research, this was genuinely painful.
The OBBBA (One Big Beautiful Bill Act), signed July 4, 2025, fixed this. Under the new Section 174A, domestic R&D is fully deductible in the year you spend the money again — effective for tax years starting after December 31, 2024. Grant Thornton's OBBBA R&D analysis and StrikeTax's breakdown explain who benefits and how.
The Retroactive Window — July 6, 2026 Is the Deadline
Here's the time-sensitive part.
For R&D spending from 2022 through 2024 — when you were stuck with the five-year amortization — there's a retroactive relief provision. You can deduct all remaining unamortized domestic costs either entirely in 2025 or spread across 2025 and 2026.
Small businesses (average annual gross receipts under $31 million) can go further and amend their 2022–2024 returns directly. But the deadline is July 6, 2026.
If your company spent meaningful money on domestic R&D during those years and was forced to amortize it, there may be a significant refund available. Brady Ware's Section 174A guide covers what qualifies — including software development costs. BDO's IRS procedural guidance on OBBBA R&E treatment explains how to actually claim the relief.
We've helped a lot of Bay Area startups capture R&D tax credits and deductions they didn't know they were entitled to. If you haven't had this conversation, now is the time.
A Quick Note on California
California runs its own R&D rules and doesn't automatically follow federal law. Under California SB 711, all R&E costs remain fully deductible for state tax purposes — and California updated its R&D credit with expanded options for startups. BDO's California R&D conformity update is the best reference if you want the details. The main thing to know: starting tax year 2026, the IRS requires enhanced reporting on Form 6765 for R&D credits, so your documentation needs to be tighter than it's been.
The Bottom Line
If your bookkeeping is messy, the AI audit selection system is more likely to flag you. Fix that.
If you had R&D spending from 2022–2024 and were forced to amortize it, talk to your CPA this week about amended returns. July 6 is not far away.
Great firms doing solid work in this space: KBKG specializes in R&D tax credits, Sensiba has deep California expertise, and Kruze Consulting focuses specifically on startup tax work in the Bay Area.
Asnani CPA Keeps Bay Area Businesses Ahead of the Curve
At Asnani CPA, we work with founders, startups, and growing Bay Area businesses across San Francisco, Palo Alto, Menlo Park, Mountain View, and Redwood City.
Whether it's chasing down retroactive R&D deductions before the deadline or strengthening your documentation against AI audit selection — we're here.
