Preparation is key: Substantial procedure change can burden those looking to claim R&D tax credit
Dean Zerbe, alliantgroup | February/March 2022 Footnote
Editor's note: Updated January 27, 2022
The Internal Revenue Service’s new requirements for taxpayers seeking Research and Development Tax Credit (R&D Credit) refunds have left tax professionals with more work to do and some questions unanswered.
Although the qualifications for the tax credit are technically the same, taxpayers — or more likely their CPAs — now need to provide substantial information upfront for amended returns seeking R&D Credit refunds in order to substantiate their qualification.
The outcome for those who fail to submit the requisite documentation: An invalid claim that might preclude the taxpayer from perfecting or have limited access to any administrative remedy or judicial review.
The new criteria, which recently received agency updates, has pushed some tax professionals to ask when and if the proverbial “goal posts” could be moved again.
The new requirements
As of Jan. 10, 2022 — per the new requirements — for a taxpayer’s R&D Credit refund claim to be considered valid, taxpayers need to provide the agency with information that identifies all business components related to the claimed credit. This includes all research activities performed, all individuals that performed the relevant activities, and all the information each individual sought to discover. In short, if you do not follow these new information requirements, your client’s amended tax return for the R&D tax credit will be rejected out-of-hand by the IRS.
The agency originally announced the new requirements in October 2021, stating that existing U.S. Treasury regulations require “sufficient facts” for a refund claim to be considered valid, adding that a “mere volume of documents will not suffice to meet a taxpayer’s obligations.”
During the fall meeting of the AICPA IRS Advocacy and Relations Committee, Holly Paz, the deputy commissioner of the IRS Large Business and International (LB&I) division, stated that the new requirements only apply to amended returns.
Understanding the review process
In terms of the review process, these new criteria will be used to initially screen claims and determine whether the claim is completed in the required format (i.e., it includes the specific items required for consideration). At that point, the claim can either be accepted for consideration, and either processed or sent to exam. If the claim does not meet the criteria outlined in the guidance it will be rejected.
For claims filed through the grace period end date, taxpayers will receive the 45-day window to perfect the claim. If the claim is not perfected, the taxpayer will receive a “letter of non-consideration” and the claim will not be processed. If the statutory limitation period is open, the taxpayer may file a new claim, otherwise the taxpayer will have no recourse to appeal the denial or litigate the claim. If an exam is already open in the field, the claim can be forwarded to the relevant examination group. At that point, the claim would be sent to Planning and Special Programs (PSP) for their decision, along with IRS Counsel concurrence. To be clear, if the claim is not screened on campus the agents in the field group cannot independently determine that the claim is invalid.
In its original announcement, the IRS stated that both a grace and transition period would be in effect. Specifically, the grace period would last until Jan. 10, 2022, with taxpayers then being required to include the information outlined in the Chief Counsel Memo.
After the grace period expired, taxpayers originally would be given a one-year transition period in which they would have 30 days to perfect an R&D Credit refund claim before the agency’s final determination.
Now, per a Jan. 5 update, taxpayers have 45 days to perfect their refund claim before the agency makes a determination.
The IRS provided additional clarity when it published FAQs answering basic questions surrounding the new guidance. For instance, the agency stated: The “term ‘perfecting’ means taxpayers are given an opportunity to provide missing information that is required to process the Research Credit refund claim. During the transition period, taxpayers will be notified of a deficient claim and provided 45 days to perfect. This date by which a taxpayer must provide the missing information will be on the letter sent to taxpayers.”
Rationalizing the update
In Chief Counsel Memorandum 20214101F, the agency detailed the rationale for the agency’s requiring of the additional information to substantiate R&D Credit refund claims.
Specifically, the agency argued that the “specificity requirement” under Treasury Regulation Section 301.6402-2 requires “certain specific facts be provided in a claim” and “allows the Service to determine if a refund should be paid immediately based on the information provided.” The IRS added that these additional facts, which need to specify the grounds and sufficient facts to form the basis for the refund claim, allow the agency to screen for the likelihood of the taxpayer’s right to the refund sought.
Tax professionals across the country have certainly taken note of the burden involved with providing these substantiating documents. Many have also claimed that piling on these additional steps will disincentivize businesses and their CPAs from attempting to claim the R&D Credit, despite the qualifications for the credit remaining the same.
The American Institute of Certified Public Accountants (AICPA) aired their concerns to the IRS in a November 2021 letter, calling the agency’s memo “a significant interpretation of the regulations,” and asking for a delay to the start of the new requirements until taxpayers have had a “meaningful opportunity to comment.”
The IRS stated in its most recent update that although it would continue to review submitted comments, it will likely not extend the start date for the new requirements and argued in its prior news release regarding the new requirements that it processes thousands of R&D Credit claims each year, and that the additional information will be used to create a more effective and efficient tax administration.
Managing the new requirements
Despite all the handwringing, I would state that from our practice working with thousands of companies in claiming the R&D tax credit — these new requirements are manageable. The IRS is requesting material and information that, for us, is already in hand from the work we are performing for a client.
Taxpayers who consistently have relied on the R&D Credit, or even those who are contemplating claiming the incentive for the first time, need to certainly be aware of these new IRS requirements. Taxpayers should also look closely at the experience of the tax professional they are tasking with calculating and claiming the credit to ensure that they are in compliance with the requirements. Being wrong is too great of a grind in terms of both dollars and time for both CPA firms and companies.
These additional steps require a deep knowledge and understanding of the tax credit and cannot simply be handled by those who are not experienced with claiming the incentive. However, companies should not be dissuaded from taking the R&D tax credit — the most valuable business tax credit available for companies. It’s worth the candle.
Dean Zerbe is alliantgroup’s national managing director based in the firm’s Washington D.C. office. Prior to joining alliantgroup, Dean was senior counsel and tax counsel to the U.S. Senate Committee on Finance. He holds an LL.M. in taxation from NYU and a J.D. from George Mason University.
