IRS outlines guidance for documentation of R&D tax credit refund claims

New guidance from the IRS indicates that “claims for refund” based on the research and development (R&D) tax credit should be supported by extensive disclosures about the business components to which the claim relates. For each business component that performs activities that qualify for the credit, the taxpayer must identify:

• All research activities performed.
• All individuals who performed each research activity.
• All the information that each individual sought to discover.

This information should be provided “in a written statement rather than through the production of documents,” but document production can be sufficient if the taxpayer identifies “the exact pages that support a specific fact.”

An information release that accompanied the guidance states that, “The IRS will provide a grace period (until Jan. 10, 2022) before requiring the inclusion of this information with timely filed Section 41 research credit claims for refund.” The release says that, “further guidance will be forthcoming” and provides an email address to which taxpayers and other stakeholders can send comments.

What’s a “claim for refund?”

In this context, it appears that the IRS is referring to claims for refunds of taxes paid with previously filed returns. A claim like this would typically be made by filing an amended return. However, it’s possible that the IRS could start asking for this level of documentation anytime it challenges an R&D tax credit.

Breaking down an R&D tax credit claim by business component

Perhaps the most significant and potentially burdensome requirement here is that taxpayers claiming a refund based on the R&D tax credit would have to break out the specific efforts related to each “business component.” The existing form on which taxpayers claim the credit has lines for total wages, total supply expenses, and total contract research expenses, but no indication that a unit-by-unit breakdown is required to support the claim for the credit.

Taxpayers claiming a refund based on the R&D tax credit would have to break out the specific efforts related to each business component.

The term “business component” means any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or used in a trade or business of the taxpayer. Depending on how one interprets it, some businesses could have hundreds or even thousands of “components” for which research activities are performed. A written statement that identifies each component, all of the research activities performed for each component, all of the individuals who performed each activity, and the information each individual sought to discover could easily be thousands of pages long.

Uncertainty about next steps

The format in which the IRS published this guidance has resulted in some ambiguities about what happens next. This type of modification to the process for claiming a refund based on a credit is often released in a proposed form with a specific period for comments from affected taxpayers and other stakeholders. In this case, an internal memo has been released to the public accompanied by an information release that says the service won’t require the disclosures described in the memo for several months and that comments can be emailed to a specific address. No specific comment period is listed. The release indicates that further details will be forthcoming, but it doesn’t indicate what form those details will take.

For now, taxpayers who are planning to file an amended tax return claiming a refund based on the R&D tax credit should be aware that they may be subject to a significantly higher documentation requirement after Jan. 10, 2022. All taxpayers that claim the R&D credit on their returns should monitor developments on this issue and contact their tax advisors with any questions related to their specific facts and circumstances. To learn more about how this guidance might affect your claim for an R&D tax credit, please give us a call.