What is the new IRS Memorandum for the R&D tax credit?
The IRS released a legal advice memorandum on October 15, 2021. The purpose of the memorandum is to explain the new filing requirements that taxpayers will need to meet in order to qualify for a refund for the R&D tax credit.
According to the new requirements, the IRS wants taxpayers to provide the following information for each tax year:
- Identify all the business components related to your R&D claim
- For each business component, identify all research activities performed
- Identify the individuals who performed each research activity
- Identify the information each individual sought to discover
- Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses
Sounds confusing? Let’s break it down.
The IRS defines a business component as “any product, process, computer software technique, formula, or invention to be held for sale, lease, or license or to be used by the taxpayer in its trade or business.” In other words, the research expenses you claim for R&D must be related to something that you sell or use to create revenue for your business.
Once you’ve identified all the business components, you then need to identify the research activities for each business component and name the individuals who performed them. In the course of conducting the research activities, you must also clarify the information each individual sought to discover.
The final requirement of providing the total Qualified wages and expenses are fulfilled by filing the 6765 form.
When does it apply?
The new filing requirements will take effect on Jan. 10, 2022. However, the IRS will provide a one-year transition period during which taxpayers will have 30 days to substantiate R&D credit claims for refunds.
To qualify for the R&D Tax Credit, research activities must:
Why did the IRS issue this memorandum?
The IRS explained the need for the memorandum with the following statements:
- Each year, the IRS receives thousands of research and experimentation (R&E) claims for credits in the hundreds of millions of dollars from corporations, businesses, and individual taxpayers.
- Claims for research credit under section 41 are currently examined in a substantial number of cases and consume significant resources for both the IRS and taxpayers.
- The legal advice released today is the result of ongoing efforts to manage research credit issues and resources in the most effective and efficient manner. By requiring taxpayers to provide the listed information, the IRS will be better able to determine if a research credit claim for refund is to be paid immediately or whether further review is needed.
To summarize, the IRS wants to reduce the large number of disputes by making the requirements clearer. It’s now up to the taxpayer to provide initial documentation to substantiate their R&D credit claim upon filing their return, rather than providing it later in case of an audit. This will likely reduce the workload of the IRS, but at the expense of an increased burden on taxpayers. The silver lining is that if your claim with supporting documentation is accepted, there may be a lower risk of an audit down the road.
Please check with your tax professional (R&D tax credit provider) and ensure that they’re prepared to meet the new requirements for R&D tax claim refunds. Take a look at our R&D Tax Credit FAQ If you have any questions or concerns, please don’t hesitate to contact us
Sources: IRS Memorandum (Jan 5, 2022)