The IRS has revised guidance for examiners in the Large Business & International division (LB&I) reviewing the amounts claimed for the tax credit for increasing research activities.
The guidance to auditors issued today modifies a directive issued in 2017. The credit for increasing research activities (Internal Revenue Code § 41) enables taxpayers to receive a tax credit for qualified research activities (QREs).
Independently determining the correct amount of this research credit claimed by large corporate taxpayers can be resource intensive for those taxpayers and IRS examiners. This revised directive provides an efficient methodology for determining QREs for these taxpayers that meet the requirements of the updated directive.
The IRS will accept, as sufficient evidence of QREs, the Adjusted Accounting Standards Codification (ASC) 730 Financial Statement R&D for the Credit Year. Adjusted ASC 730 Financial Statement R&D is made up of the research and development costs currently expensed on a taxpayer’s Certified Audited Financial Statements pursuant to ASC 730 for U.S. GAAP purposes and includes certain specified adjustments made to Financial Statement R&D.
This directive only applies to LB&I taxpayers with assets equal to or greater than $10 million who follow U.S. GAAP to prepare their Certified Audited Financial Statements showing the amount of currently expensed Financial Statement R&D either as 1) a separate line item on the income statement included in their Certified Audited Financial Statements, or 2) separately stated in a note to their Certified Audited Financial Statements. In addition, this revised directive does not apply to any taxpayer unless the taxpayer uses these same U.S. GAAP financial statements to reconcile book income to federal tax income on Schedule M-3.
This revised directive modifies the 2017 Directive by:
- Refining definition of an eligible taxpayer,
- Clarifying exam audit and elevated review process,
- Expanding the LB&I Commissioner’s discretion for determining taxpayer eligibility,
- Identifying additional documentation requirements, and
- Removing all ASC 350 Internal-Use software and website development costs.
Eligible taxpayers may choose to follow the terms of the updated directive on original returns timely filed (including extensions) for tax periods ending on or after July 31, 2020. At the beginning of an examination that includes the Research Credit, the audit team will verify whether the taxpayer followed the directive. For taxpayers choosing to follow the revised directive, the audit team will ensure the taxpayer complies with the eligibility requirements provided in the revised Directive.
Revised FAQs are available to further explain and clarify changes on the revised Directive.
The updated directive is not an official pronouncement of law, and cannot be used, cited or relied on as such. In addition, nothing in the directive should be construed as affecting the operation of any other provision of the Internal Revenue Code, Treasury Regulations or guidance thereunder.
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