New R&D credit documentation requirements clarified

By Paul Bonner

The IRS provided guidance to taxpayers and internally on its new documentation requirements for administrative refund claims of the Sec. 41 business tax credit for increasing research activities (the R&D credit).

The taxpayer guidance comes in the form of 16 frequently asked questions (FAQs) posted Wednesday on the IRS's website. At the same time, the IRS issued internal guidance to its employees in the form of a memo and revisions to its Internal Revenue Manual (IRM).

The new requirements take effect Jan. 10, 2022. An R&D credit refund claim on an amended return must contain certain specified items of information before it can be deemed to meet the specificity requirement of Regs. Sec. 301.6402-2(b)(1) by containing sufficient information concerning the grounds and facts upon which the claim is based. This is a threshold requirement for the IRS to accept the claim as valid.

According to the FAQs, claimants must:

  • Identify all the business components to which the claim relates for the claim year;
  • For each business component, identify all research activities performed, name the individuals who performed each research activity, and specify what information each individual sought to discover; and
  • Provide totals for the tax year of qualified employee wage expenses, qualified supply expenses, and qualified contract research expenses (which may be done using Form 6765, Credit for Increasing Research Activities).

The FAQs indicate that the IRS will likely not follow the AICPA's recommendation in its Nov. 18 comment letter to delay imposing the requirements beyond Jan. 10, 2022, to allow more time for the public to comment and the IRS to consider those comments. The American Bar Association Section of Taxation has submitted a similar letter.

The FAQs (No. 2) state that the new requirements will apply to refund claims postmarked on or after Jan. 10, 2022. The IRS set that date when it first announced the new requirements in October 2021.

Members of the AICPA IRS Advocacy and Relations Committee in its fall meeting in November told Holly Paz, deputy commissioner of the IRS Large Business and International (LB&I) Division, that they were disappointed that the requirement was not first proposed as a regulation, which would have allowed formal deliberation and input.

Paz said then that the IRS would invite comments via a dedicated email inbox, which the FAQs include. FAQ No. 1 gives the email address irs.feedback.recredit.claims@irs.gov and says the Service will monitor and consider comments received during a one-year transition period announced earlier.

Practitioners expressed continuing concern over the requirements and how the Service is implementing them.

"The IRS appears to be putting processes in place to make these procedures permanent," said Rochelle Hodes, J.D., LL.M, principal, Washington National Tax, Crowe LLP, and vice chair of the AICPA committee that heard from Paz. "However, taxpayers and practitioners remain concerned that these procedures are too onerous and burdensome."

Hodes said she also anticipates administrative difficulties and taxpayer controversy resulting in litigation.

"These procedural challenges will divert IRS R&D expertise and resources from other compliance and enforcement activities and will not advance efforts to reduce the complexity in the R&D area," she said.

In an apparent change from earlier IRS statements, FAQ No. 8, in answering what it means to "perfect" a claim, states that taxpayers will be notified by letter of information deficiencies, which they may remedy by suppling the information within 45 days after being notified, 15 days longer than the IRS had said previously. FAQ No. 7 says this notification will be made by a Letter 6426C or 6428, which will note which information is missing. This perfection allowance applies only during the one-year transition period. However, FAQ No. 4 states that if the IRS does not receive the additional information or it is still considered insufficient, the Service will reject the entire claim for refund.

The FAQs also address another concern expressed by the committee, the time in which the IRS processes the submission. FAQ No. 5 states that the IRS will process a claim "as expeditiously as possible" and make determinations within six months of receipt. It was not immediately clear whether this refers to the initial review of documentation, a determination that includes perfection of a claim, or a determination of the claim on its merits. The IRM revisions state that the initial determination of sufficiency of information should generally be completed within 30 days after receipt.

FAQs No. 10 and 11 provide guidance on identifying individuals who performed research. Claimants may identify such individuals by listing their title or position rather than first and last names, but taxpayers "may be asked to provide specific names upon substantive review of the claim." A group of individuals who together performed research activities and sought to discover the same information for the same business component may be listed together by name or title/position.

The internal memo provides procedural guidance for Field Attorney Advice 20214101F, which initially outlined the requirements in October and provides three IRM revisions. The memo notes that the purpose of the documentation requirements is to initially determine the validity of a claim for an R&D refund credit before examining the claim on its merits.

A revision to IRM Section 4.46.3 describes further each of the information items, what elements they must contain, and, in some cases, how the information may be presented by the taxpayer. For example, describing the research activities by business component must include "what the taxpayer did and how they did it," for each component. However, the description need not encompass "in detail" the four-part test of Sec. 41(d)(1).

The revision also specifies that the business components to be identified are those that form the factual basis of the claim and are defined under Sec. 41(d)(2)(B). Both the identity of the individuals who performed each research activity, by business component, and the information each individual sought to discover, by business component, may be presented in a list, table, or narrative. The IRM revision also specifies that, for Form 6765 to satisfy the requirement to provide total qualified expenses of employee wages, supply expenses, and contract research, the form (or its equivalent) must be "properly completed."

Another new IRM provision states that during the one-year transition period, a claim that would otherwise be considered timely under Sec. 6511(a) but that does not meet the documentation requirements will be considered timely if perfected within the 45 days allowed. However, after Jan. 9, 2023, no perfection period will be allowed, the IRM states.

— To comment on this article or to suggest an idea for another article, contact Paul Bonner at Paul.Bonner@aicpa-cima.com.

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