The Internal Revenue Service released a memorandum in September from its Office of Chief Counsel which states they want more detailed information about all the business components for which the research credit claims relate for that year. 

An additional IRS Release suggests that the “IRS will provide a grace period (until January 10, 2022) before requiring the inclusion of this information with timely filed Section 41 research credit claims for refund.” IR-2021-203 (Oct. 15, 2021).

These changes state that for a research credit refund claim to be valid, the following must be met:

• The claim itself must:
  • Identify all business components that the credit relates to for this year
  • For each of these business components:
    • Identify all research activities performed
    • Identify all individuals who performed each research activity
    • Identify all the information each individual sought to discover
• The cost collection must provide:
  • total qualified employee wage expenses
  • total qualified supply expenses
  • Total qualified contract research expenses for the claim year

The costs can be presented through the Form 6765 – Credit for Increasing Research Activities. The cost portion should be no surprise to anyone who has previously filed for this credit, as these components are already asked for on the form.

The concern from most in the industry surrounds the first requirements. Some companies may have many many projects in the process in any given year, and many staff on each of these projects. This could result in a report stretching into the thousands of pages. 

In a previous court case, Premier Tech, Inc. v. United States, No. 2:20-CV-890-TS-CMR, 2021 WL 2982064 (D. Utah July 15, 2021), the government asserted that the taxpayer must include documents addressing every element in Section 41. The court had ruled in favor of the taxpayer, based on the fact that Form 6765 does not ask for these more in depth details and “if the IRS wants more information about the research tax credits, the IRS could require that information on Form 6765.” 

The same could be said in this case. If the IRS intends to modify the rules outlined in Section 41, the accompanying form should match in order to outline a very clear set of rules to follow. Without this authority or clear guidance, taxpayers are left to guess at the correct method.

These new changes do not address what a taxpayer who used a valid statistical sample under Rev. Proc. 2011-42 must produce. By definition, one who uses sampling only has the supposedly necessary information for units in the sample and then extrapolates from that to the rest of the population. 

One additional change notes that the IRS may waive its right to treat a claim as deficient if it proceeds to examine the merits of the claim. This has raised concern that it may encourage agents to immediately reject a claim as deficient if it lacks these new details rather than initiating an audit process. 

Despite the grace period afforded by the IRS, this could have serious implications for the number of R&D credits claimed and potentially on the rate of innovation within the country. Taxpayers who are unable to submit their claims prior to this grace period date, and for all future claims, will have to carefully consider whether they can contribute the time and expense of preparing Section 41 refund claims with these extensively detailed reports. There will be three key choices – (1) commit the time to file a claim with these extensive details, (2) file a claim as usual, have it rejected, and address the issue with the IRS Appeals court, (3) do not file a claim for the credit. Each option has clear limitations.

Working with an R&D tax specialist may help some taxpayers reduce the burden of time spent on the claim, and smaller companies may find it easier than larger, as they often focus on just a few projects at a time.

Are you conducting research and development activities? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.