On Sept. 15, 2020, the IRS’ Large Business and International division (LB&I) released a directive and FAQs providing guidance on examination of the research credit under IRC Section 41. The 2020 directive revises and clarifies a 2017 LB&I directive that established a framework for determining qualified research expenses (QREs) based on Accounting Standards Codification (ASC) 730, “Research and Development,” financial statement research and development (R&D) amounts. The directives operate as an administrative solution for determining credit eligible expenses because examining agents are instructed to accept adjusted ASC 730 financial statement R&D amounts determined in accordance with the directive as sufficient evidence of QREs for purposes of the IRC Section 41 research credit. The 2020 directive provides a potentially more efficient and taxpayer-favorable way to determine QREs eligible for the R&D credit.
LB&I taxpayers with assets equal to or greater than $10 million that follow U.S. GAAP are eligible for the credit under the 2020 directive if they prepare their certified audited financial statements showing the amount of currently expensed financial statement R&D as either 1) a separate line item on the income statement included in their certified audited financial statements, or 2) separately stated in a note to their certified audited financial statements. The revised directive also introduces a new eligibility requirement that limits the directive’s application to taxpayers that use these same U.S. GAAP financial statements to reconcile book income to federal tax income on their Schedule M-3, “Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More.”