The IRS has updated its practice unit on Computing Qualified Research Expenses. The overview is as follows:
Examining the credit for increasing research activities under IRC 41 (research credit) involves significant resources of both taxpayers and the Internal Revenue Service. Taxpayers following U.S. Generally Accepted Accounting Principles (GAAP) for book, use Accounting Standards Codification (ASC) Topic 730: Research and Development when disclosing research & development (R&D) costs on their financial statements. The definitions of R&D under ASC 730 and research and experimental under IRC 174 and IRC 41 have many similarities. These similarities coupled with the taxpayer’s attestation that the costs reported as qualified research expenditures (QREs) are ASC 730 R&D costs, less specifically excluded costs (for example, general and administrative, foreign research, and quality control), may assist the Exam team (Exam) in significantly reducing the scope of the examination and the resources required for the taxpayer and the Service.
On September 10, 2020, the Commissioner of the Large Business & International Division (LB&I) issued a revised directive titled, “Guidance for Allowance of the Credit for Increasing Research Activities under IRC 41 for Taxpayers that Expense Research and Development Costs on Their Financial Statements Pursuant to ASC 730” (Revised Directive). This Revised Directive clarifies the same titled directive signed on September 11, 2017 (Original ASC 730 Directive). The purpose of the Revised Directive, like the Original ASC 730 Directive, is to provide an efficient manner for determining QREs. This Practice Unit (although similar to the Practice Unit titled “ASC 730 Directive – Computing Qualified Research Expenses”) provides guidance regarding the Revised Directive.
The Revised Directive and this Process Unit only apply to LB&I taxpayers who follow GAAP to prepare their Certified Audited Financial Statements (CAFS). The CAFS must show the amount of the currently expensed Financial Statement R&D costs as a separate line item on the income statement or separately state such costs in a note to the CAFS. This Revised Directive only applies to taxpayers who use these same GAAP CAFS to reconcile book income to federal tax income on Schedule M-3.
In addition, the Revised Directive and this Process Unit only apply to LB&I taxpayers who choose to calculate their QREs using the requirements of the Revised Directive on original timely filed tax returns for tax periods ending on or after July 31, 2020. If the IRS determines that a taxpayer has satisfied all the requirements of the Revised Directive, then the Revised Directive provides an administrative solution for LB&I examiners to accept, as sufficient evidence of QREs, the Adjusted ASC 730 Financial Statement R&D for the Credit Year.
Eligibility for the Revised Directive requires the taxpayer to fully complete and provide the following four disclosure statements included as appendices in the Revised Directive:
- Appendix A – Certification Statement Claiming Adjusted ASC 730 Financial Statement R&D as QREs,
- Appendix B – Reconciliation of Form 6765 QREs to Adjusted ASC 730 Financial Statement R&D (reconciliation should include a breakdown of costs as detailed in Appendix B),
- Appendix C – Computation of Adjusted ASC 730 Financial Statement R&D, and
- Appendix D – Adjusted ASC 730 Financial Statement R&D Wage Detail (calculating the wages and upper management wage limit).
In addition, LB&I taxpayers following the Revised Directive must properly retain and timely submit (following the LB&I Information Document Request (IDR) enforcement process) the documentation listed in Part V of the Revised Directive when requested by Exam.
Posted by Jessica Ji, Associate Editor, Wealth Strategies Journal.