Internal Revenue Service’s New Guidance for Research and Development Tax Credits: It’s Not as Spooky as it Seems

Written by:

Tanya Donnelly, R&D Tax Manager

Mark Stapleton, R&D Senior Tax Analyst

Geoff Garber, Partner

On October 15th, 2021, the Internal Revenue Service (“IRS”) released Chief Counsel Memorandum 20214101F, which sets forth the information taxpayers must provide with administrative claims for refund or credit under Internal Revenue Code (“IRC”) Section 41, also known as the Research and Development (“R&D”) Tax Credit. BRAYN clients claiming the R&D credit should not fear this new guidance, we already collect this information during the R&D study process. This guidance focuses on information that must be provided for the claim to be valid under Treas. Reg. § 301.6402-2(b)(1), which states that a credit claim or refund must include sufficient information to apprise the IRS of the nature of the claim. Prior to this Chief Counsel Memorandum, only the Form 6765, Credit for Increasing Research Activities, and a statement explaining the amended return reasoning, was required to be completed with the qualified research expenditures for an R&D Tax Credit claim. Now, the IRS will require taxpayers to provide the information listed below with an R&D Tax Credit claim that is included on refund claims:

  • Identify the business components for the Section 41 research and development credit claim.
  • Identify the research activities performed, the individuals who performed each research activity, and the information the individuals sought to discover for each business component.
  • Provide the total qualified research expenses, such as employee wage expense, supply expense, and contract research for the claim year. The Form 6765 may be used to provide this information.

The IRS states that these requirements will allow them to better determine whether an R&D Tax Credit claim for refund should be paid immediately or whether further review is needed.  We are skeptical that this change will improve claims processing. If anything, the requirements will likely reduce the amount of R&D Tax Credit claims submitted due to making the process more burdensome.

The changes bring about several unanswered questions, most notably how and in what format will taxpayers provide the information to the IRS. Due to the complexity of R&D Tax Credit claims, taxpayers will likely need to attach a detailed breakdown of the requested information. We envision that many taxpayers will attach professionally prepared R&D studies to their amended returns and point the IRS to the location of the required information. The CCM states that studies do not have to be attached, but if they are, the taxpayer must clearly identify the location of the required information. For most taxpayers, these attachments will contain a large quantity of information that the IRS will have to scan, review, digest, and respond to, all of which will take agents additional time and resources. We are not confident that the IRS’ outdated systems will be able to manage this process effectively, leading to an increase in the already significant backlog of amended returns. IRS agents often struggle with the complexity of Section 41, leaning on IRS technical specialists to get involved due to the subject matter. So, how will the IRS train its employees to review the submissions when most examiners must already defer to other overloaded R&D-specific agents?

Our current process already includes requesting the now-required information, and we will be working with CPAs and clients to determine the most effective ways to include the additional detail. We encourage anyone that is planning to claim the R&D Tax Credit to reach out to their provider as soon as possible to establish a gameplan to navigate these changes. The IRS is providing a grace period to January 10, 2022, before this information is a required inclusion. After the expiration of the grace period, there will be a one-year transitional period in which taxpayers will have 30 days to perfect claim before a final claim determination will be made by the IRS. We will continue to monitor the IRS’ new guidelines and keep you updated as we learn more.

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