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IRS safe harbor streamlines R&D credit claims for certain taxpayers

A recently released directive to all IRS Large Business and International (LB&I) employees directs examiners not to challenge Qualifying Research Expenses (QREs) for businesses that meet underlying requirements and follow extensive, specific steps. By removing QRE challenges, which account for up to 90 percent of exam time in typical credit claims, the IRS is creating a substantially streamlined path to realizing Research & Development (R&D) credits.

Background

The directive (LB&I-04-0917-005) provides Sec. 41 R&D examination guidance for addressing claims by taxpayers expensing R&D costs on their financial statements according to ASC 730. With this directive, the IRS is preparing to better manage LB&I’s scarce audit resources with a streamlined oversight process for those LB&I taxpayers that can meet the conditions of the directive.

Threshold for certification

Companies with more than $10 million in assets who follow U.S. GAAP and prepare certified audited financial statements are eligible for the streamlined process.

Among the requirements, taxpayers seeking certification must:

  • Make use of ASC 730 standards for identifying, accounting for, and disclosing R&D costs;
  • A very detailed four-step process that includes reconciling QRE’s to adjusted R&D financial statements (ASC 730) and obtaining a signed certification statement claiming this work to have been done; and
  • Retain contemporaneous documentation substantiating qualifying expenses.

In order to comply with this directive, taxpayers must adjust their R&D amounts by certain exclusions. For example, the directive:

  • Does not allow taxpayers to include contract research costs in their calculation; and
  • Qualified wages of direct researchers and first-level managers are qualified at 95%, while upper-level managers are qualified at 10%.

Taxpayers must access this directive and applicable appendices to determine:

  • 1)If they can comply with the onerous details; and
  • 2)Whether or not the directive results are actually favorable for the taxpayer. Eligible taxpayers need to determine whether directive R&D amounts will be better than their historic R&D credit claim less the IRS examination support and scrutiny.

The terms of the directive apply only to original timely filed returns and extensions filed on or after Sept. 11, 2017.

The takeaway

Not only is this a significant change in the way the IRS examines R&D credits, it could be a significant opportunity for eligible businesses. However, each eligible taxpayer must assess if this is right for their company. This could be a very beneficial process for many taxpayers but not the right direction for others.

Since the directive is in the form of examination guidance and is not law, and the eligibility requirements are complex, businesses should work closely with their tax advisors to see that adequate documentation and credit justification steps are taken.

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Mark Dunning can be reached by phone at 720.227.0420 or email at mdunning@taxops.com. Follow Mark on LinkedIn.

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