The IRS recently provided procedural guidance (LB&I-04-0122-0001) for applying Field Advice 20214101F to claims for refund that include a Section 41 research credit. The recent guidance provides Large Business and International (LB&I) and Small Business/Self-Employed (SB/SE) divisions with procedures for determining if a research credit refund claim is valid.
The IRS describes the minimum level of factual detail required to be included with the return to establish a valid refund claim, including the identification of all the business components to which the Section 41 research credit claim relates for that tax year.
For each business component, the following must be identified:
- All research activities performed
- All individuals who performed each research activity
- All information each individual sought to discover
The taxpayer must also provide:
- Total qualified employee wage expenses
- Total qualified supply expenses
- Total qualified contract research expenses for the claim year
In addition, the taxpayer must submit with a claim a declaration signed under the penalties of perjury verifying that the facts provided are accurate. Failure to include the required items will result in a deficient or invalid refund claim and may result in a rejection of the claim.
This new documentation requirement applies to all research credit refund claims filed on an amended return beginning on or after Jan. 10, 2022. There will be a one-year transition period during which taxpayers will have 45 days to perfect a research credit claim for refund prior to the IRS’s final determination on the claim.
The guidance provides taxpayers with insights into the level of detail that will be required going forward for research credit refund claims. For example, when identifying all research activities performed, taxpayers must include a description of what the taxpayer did—and how they did it—by business component. While the information does not need to describe the Section 41(d) “four-part test” in detail, it cannot simply restate the requirements under the Code and regulations.
The IRS also recently published an FAQ document containing more details on the documentation requirements. The document explains the IRS will review each research credit refund claim and make a determination within six months of receipt. In addition, the document explains that if a taxpayer has a group of individuals who performed research activities and sought to discover the same information for a business component, the taxpayer may list all employees by name (or, in lieu, title/position) for that one business component and describe the information they sought to discover. The document also explains that if a taxpayer utilized statistical sampling pursuant to Revenue Procedure 2011-42, the documentation for all units in the sample must contain the items mentioned above with one exception (the taxpayer is still required to provide the total QREs by type which may be done using the Form 6765).
Given that the new requirements are structured in terms of business components, taxpayers will need to evaluate their methodology for computing and substantiating the research credit to provide the required information with the amended return. This is particularly important for taxpayers that rely on a cost-center or hybrid approach to ensure that the appropriate analysis by business component is performed and documented for the refund claim to be valid.
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