IRS Attempts To Change Rules On Research Credit Refund Claims | Knowledge
On Friday, October 15, 2021, the Office of Chief Counsel of the Internal Revenue Service (IRS) issued a memorandum (the Memorandum) purporting to answer the question of what a taxpayer should include in a claim for reimbursement of IRC § 41 credit for increased research activities. The memorandum’s conclusions, if followed, would represent a radical change in the IRS’s approach to both research credit claims and research credit in general.
First, the memorandum concludes that in order for a research credit reimbursement request to be valid, the request itself must “identify all of the business components to which the IRC § 41 research credit request relates for that year”. Memorandum to 21. Next, the Memorandum asserts that, for each commercial component identified, the request must “identify all research activities carried out; identify all the people who carried out each research activity; and identify all the information that each individual sought to discover. Identifier. Finally, the memorandum states that the claim must “provide the total salary expenses of qualified employees, the total qualified procurement expenses and the total qualified contract research expenses for the year of the complaint (this can be done at using Form 6765, Credit for Increased Research Activities). ” Identifier.
The last so-called requirement should come as no surprise, as it directs taxpayers to provide the required information on Form 6765, the form on which credit is claimed in the first place. However, the other requirements go far beyond what the courts demand and require a level of detail that could potentially span thousands of pages. The memorandum cites no authority for the other requirements, and requiring the provision of more information than required by Form 6765 could “lead to absurd and manifestly unfair results for taxpayers.” Premier Tech, Inc. v. United States, n ° 2: 20-CV-890-TS-CMR, 2021 WL 2982064 (D. Utah July 15, 2021). In Premier Tech, a federal district court recently rejected the government’s claim that a taxpayer must include in every section 41 refund claim “additional documents dealing with each item [Section 41], for example by describing the research conducted, explaining how this research worked to develop a commercial component, detailing salaries and supplies of the money spent, and proving the amount spent on research over the three years of previous taxation. ” Premier Tech, 2021 WL 2982064 at 4. The court observed that Form 6765 does not ask for any of these details, and “if the IRS wants more information on research tax credits, the IRS could require this information on the form 6765. ” Identifier. The memorandum acknowledges the existence of this authority and states that the IRS is “currently evaluating opinion.” Memorandum to 11, fn. 27.
The memorandum also does not address what a taxpayer who used a valid statistical sample under Rev. Proc. 2011-42 must produce. By definition, the one who uses the sampling has only the information supposed to be necessary for the units in the sample and then extrapolates it to the rest of the population.
Second, the memorandum notes that the IRS may waive its right to consider a claim to be deficient if it proceeds to examine the merits of the claim. Thus, it encourages officers not to initiate the process of verifying a section 41 complaint and reject it as deficient unless the complaint, as filed, contains the information described above. See memorandum on page 21 (“Dismissing a defective claim before initiating an audit (or actively reviewing the claim on its merits) is recommended and should eliminate the likelihood that a court will find that the Service waived the specificity requirement under Treas. Reg. § 301.6402-2 (b) (1). ”).
Finally, in discussing the application of the four-part test that activities must meet to be eligible for the Section 41 credit, the memorandum adopts the language of the recent Tax Court decision. Small sand charcoal decision. Little Sandy Coal v. Commissioner, TC memo. 2021-15 (2021). In that case, the Tax Court determined that a taxpayer must be able to demonstrate quantitatively that 80% or more of his research activities relating to a commercial aspect constitute a process of experimentation (the fourth part of the test in four parts) and that work done by those who directly supervise or support the research cannot be included in the numerator of the fraction used to calculate the 80%, although these activities may qualify for credit if the test is met. As might be expected, the memorandum takes the view extremely favorable to the Commissioners in this Tax Court memorandum ruling, but we believe that the tribunal’s analysis of the treatment of support and oversight activities is incorrect based on careful reading of regulatory language. However, until this flawed conclusion is successfully challenged in court, taxpayers should expect the IRS to follow it up in research credit reviews.
The memorandum appears to herald a new level of aggressiveness on the part of the IRS in challenging research credit reimbursement requests. An accompanying IRS statement said, “The IRS will grant a grace period (until Jan. 10, 2022) before requiring the inclusion of this information with timely filed research credit applications. under section 41 for reimbursement. ” IR-2021-203 (Oct 15, 2021). Taxpayers who are unable to submit claims by this date will need to carefully consider whether they will devote the time and expense necessary to prepare Section 41 claims with the detailed information allegedly necessary to ensure that their review teams review their claims, or whether they are willing to have their claims dismissed for alleged procedural flaws and deal with the issue with IRS appeals (who may be reluctant to review the merits of the claim if the review team relied on the memorandum and did not elaborate on the underlying facts) or in court.