On Friday, September 30th the Internal Revenue Service (the “Service”) set forth administrative guidance indicating that it is extending the transition period during which taxpayers are required to adhere to the much more arduous and onerous R&D Tax Credit reporting requirements in connection to amending tax returns within open statute years for R&D Tax Credit claims for refund. This new transition period has now been extended through January 10th of 2024 in which taxpayers are afforded a full 45 days to perfect a R&D Tax Credit claim for refund with reporting deficiencies prior to the Service’s final determination on the claim.
It should be duly recalled under previous administrative authority issued by the Service in 2021 that went into effect earlier this year on January 10th of 2022 taxpayers filing a valid R&D Tax Credit claim for refund under I.R.C. § 41 must provide, at a minimum, five essential pieces of contemporaneous documentation including:
1) The Identification of all the business components that form the factual basis of the R&D tax credit claim for the claim year (i.e., Business Components as statutorily defined under I.R.C. § 41(d)(2)(B) must be clearly identified);
2) All research activities performed by business component (i.e., this must include a description of what the taxpayer did, and how they did it, by business component. It does not need to describe the four-part test under IRC § 41(d)(1) in detail. Language that simply restates the requirements under the Code or Treasury Regulations is insufficient);
3) All individuals who performed each research activity by business component. (i.e., this can be a list, table, or narrative but must include the first and last name, and the title/position of the person or persons engaged in the R&D by business component);
4) All the information each individual sought to discover by business component. (i.e., this can be a list, table, or narrative providing the information each individual sought to discover); and
5) The total qualified expenses of employee wage expenses, supply expenses, and contract research expenses. The claim should provide the total amount of each of these expense categories. If the Form 6765 is properly completed, that will satisfy this requirement.
In addition to the aforementioned five criteria, a declaration signed under the penalties of perjury verifying that the facts and circumstances provided are accurate is now required. In most cases, the signature on Forms 1040X or 1120X serves this function.
From a best practice and risk mitigation perspective, in order to mitigate or avoid income tax return paid preparer penalties pursuant to I.R.C. § 6694 (e.g., penalties that are assessed on both paid tax return preparers and tax advisers that are deemed paid tax return preparers due to their consulting on matters that constitute a substantial portion of their client’s tax returns even if they were not engaged to prepare nor review the tax return), a “More-Likely-Than-Not” standard should be satisfied.
The subsequent standards of the applicable levels of opinions should be assiduously analyzed when assessing a tax return filing position pursuant to Circular 230, the Internal Revenue Code, and the corresponding Treasury Regulations:
- “Will” Standard: Generally, a 95% or greater probability of success if challenged by the IRS. A “Will” opinion generally represents the highest level of assurance that can be provided by an opinion;
- “Should” Standard: Generally, a 70% or greater probability of success if challenged by the IRS. A “Should” opinion provides a lower level of assurance than is provided by a “Will” opinion, but a higher level of assurance than is provided by a “More-Likely-Than- Not” opinion;
- “More-Likely- Than- Not” Standard: A greater than 50% probability of success if challenged by the IRS. The “More-Likely-Than-Not” standard is the highest level of accuracy required for purposes of avoiding the accuracy-related penalties under I.R.C. 6662A;
- “Substantial Authority” Standard: Typically, greater than a “Realistic Possibility of Success” standard and lower than “More-Likely-Than-Not” standard (i.e., 40% probability of success);
- “Realistic Possibility of Success” Standard: Approximately a one-in-three or greater possibility of success if challenged by the Service;
- “Reasonable Basis” Standard: Significantly higher than the “Not Frivolous” standard (i.e., that is, not deliberately improper) and lower than the “Realistic Possibility of Success” standard. The position must be reasonable based on at least one tax authority that can be cited as valid legal authority;
- “Non-Frivolous” Standard: Approximately a 10% chance of being upheld upon examination by the Service and accordingly under no circumstance should a tax professional ever render services with this level of comfort; and
- “Frivolous” Standard: Approximately a percentage less than a 10% chance of being upheld upon examination by the Service and accordingly under no circumstances should a tax professional ever render services with this level of comfort.
It should be duly noted that each of the aforementioned standards above has a relevant meaning to both the taxpayers and tax professionals when evaluating a tax position and the related disclosure requirements. Noting, the percentages listed for “More-Likely-Than-Not” and “Realistic Possibility of Success” are specifically provided for and discussed in the treasury regulations. In contrast, the percentages for “Substantial Authority”, “Reasonable Basis”, “Non-Frivolous”, “Frivolous” have been developed based upon their relative importance in the hierarchy of standards of opinion as principally provided for in congressional committee reports. Moreover, while not mathematically calculable, the percentages are still practical in demonstrating the relative strength of one level as opposed to another level.
The Service continues engaging with stakeholders on R&D Tax Credit matters and such comments should be directed to email@example.com
The Service’s September 30th press release can be reviewed in its entirety at https://www.irs.gov/newsroom/irs-sets-forth-required-information-for-a-valid-research-credit-claim-for-refund
Have a question? Contact Peter Scalise, Practice Leader, Federal Tax Credits and Incentives, Prager Metis CPAs.
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