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

On Oct. 30, 2023, the IRS released further clarification about the standards for documentation of refund claims based on the research and development (R&D) tax credit. These updates supplement the previous releases of FAQs, interim guidance for agents, and an extension to the “perfection period” set forth in the initial guidance.

Five items needed to document a refund claim based on the R&D tax credit

The standards announced in October 2021 require that a claim for refund based on the research credit includes the following five essential pieces of information:

• The identification of all business components that form the basis for the research credit claim.
• A description of all research activities performed by each business component.
• A list of all individuals who performed each research activity within each business component.
• The information each individual sought to discover with the research performed.
• The total qualified employee wage expenses, supply expenses, and contract expenses related to the research activities.

The October 2021 guidance states that the IRS will apply these standards to R&D credit refund claims filed on or after Jan. 10, 2022. The IRS also provided a perfection period for taxpayers who file an R&D refund claim that the IRS determines doesn’t include the five essential pieces of information. During this perfection period, taxpayers will be given the opportunity to “perfect” their filing before the IRS officially rejects the claim for refund.

“Perfection period” extended for new R&D reporting requirements

The October 2021 guidance provided a one-year transition period during which taxpayers who failed to include the five essential pieces of information would be given 30 days to amend their filing to “perfect” the claim. That transition period, or perfection period, has since been extended an additional two years through Jan. 10, 2025, and was most recently extended by the October 2023 release. A January 2022 update also modified the perfection period to allow taxpayers up to 45 days to provide the information that the IRS deems to be lacking. Once the perfection period ends, if the R&D credit claim doesn’t include the five essential pieces of information, any claim for refund that includes an R&D tax credit claim will be rejected in its entirety.

A notable update in the October 2023 FAQs points out that if a taxpayer’s response to a notice of deficiency during the transition period “only repeats the research credit legal definitions and requirements under the Internal Revenue Code or Treasury Regulations,” it will be deemed insufficient to satisfy the IRS requirement that the taxpayer provide the five essential pieces of information. The edits also clarify that taxpayers can provide the information as part of the explanation field on the claim for refund or as an attachment. The IRS can only accept information provided on paper or submitted via facsimile, and one of the FAQs in the original release notes that “faxing is the best way to provide this information to the IRS.”

The October 2023 updates also explain that the five items are required for any research credit claim for a refund, whether the claim is formal or informal. They go on to admonish Form 1120 filers that the option for an informal claim is not available to them and that any claim for refund for the research credit will require filing a formal amended return.

Individuals can be identified by title for R&D tax credit refund claims

The FAQs include a clarification that individuals can be listed by title instead of name when describing who performed each research activity. In the case of a group of individuals attempting to discover the same information for a specified business component, that group can be combined to avoid repetition.

No change in effective date

Since the release of the initial guidance in October 2021, several key stakeholders have raised concerns about the new documentation standard and asked the IRS to delay implementation. To date, none of the subsequent releases from the IRS included such a delay. Additionally, since Jan. 10, 2022, taxpayers filing a claim for refund based on the R&D tax credit have needed to meet the new IRS standards. However, as mentioned previously, the perfection period during which taxpayers will be notified of a deficiency and given the opportunity to supplement their claims for refund has been extended an additional two years, through Jan. 10, 2025.

Sample submission offers some insights, but questions on R&D documentation remain

Most notable in the October 2023 update is a new FAQ that provides a “best practice example submission” for the five items of information. The guidance gives taxpayers some insight into a format that the IRS would prefer for documentation supporting a claim for refund based on the R&D credit. It’s also helpful in that it offers some suggestions for the level of detail that the IRS is seeking for these claims. It identifies four business components of a fictional company and outlines, in bullet-point form, the research activities performed for each business component. The FAQ then uses a chart to identify the individuals participating in the research activity, the activities they performed, and the information they sought. Lastly, it includes a chart of the qualified research expenditures broken down by expense type.

Up to this point, the IRS has yet to address concerns about what constitutes a “business component” when preparing this documentation. The IRS has stated that it will “continue engaging with stakeholders on research credit issues,” so it’s possible that more guidance will be forthcoming. All taxpayers who 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.