On Sept. 11, 2017, the IRS Large Business and International (LB&I) division issued a directive providing taxpayers with certified financial statements the option of treating an adjusted amount of Accounting Standard Codification (ASC) 730, “Research and Development,” financial statement research and development (R&D) costs as qualified research expenses (QREs) for purposes of determining the credit for increasing research activities under IRC Section 41. The directive is intended to give taxpayers an efficient manner of determining QREs and to more effectively manage the LB&I’s audit resources. Under the directive, LB&I examiners will not challenge QREs that are the adjusted ASC 730 financial statement R&D costs for the credit year to the extent eligible taxpayers follow the outlined certification requirements.
Under the safe harbor, taxpayers may treat 95 percent of the taxable wages of qualified individual contributors and first-level supervisor managers as QREs, to the extent the employees’ wages are charged to ASC 730 cost centers and are related to services performed in the United States. Taxpayers also may elect to determine a limited amount of QREs under the safe harbor for upper-level managers whose wages are charged to ASC 730 cost centers. Taxpayers may choose not to apply the safe harbor to wage QREs for upper-level managers if they determine it does not accurately reflect their wage QREs.
The directive permits qualification under the safe harbor of supply and computer rental and lease costs incurred by ASC 730 cost centers in the United States; however, the directive specifically excludes contract research expenses from qualification. Additionally, wages incurred to perform R&D under third-party contracts, wages used in computing the work opportunity credit, patent costs, severance pay, wages incurred for research conducted outside the United States, and prototype overhead costs are excluded from qualification under the safe harbor. Any QREs determined outside the safe harbor are subject to an IRS risk assessment.
The directive applies only to LB&I taxpayers (taxpayers with assets equal to or greater than $10 million) who follow U.S. generally accepted accounting principles to prepare their certified audited financial statements, which show ASC 730 financial statement R&D costs as a separate line item in the income statement or in a footnote disclosure. Taxpayers following the directive are required to complete a certification statement and reconcile ASC 730 financial statement R&D costs to QREs claimed on Form 6765, “Credit for Increasing Research Activities.” The directive applies to original returns timely filed (including extensions) on or after Sept. 11, 2017, for LB&I taxpayers who choose to follow the terms of the directive.
The directive provides taxpayers greater certainty about R&D credit claims. However, determining QREs under the directive might require taxpayers to analyze significant accounting details relative to their ASC 730 financial statement R&D costs. Therefore, taxpayers should review their internal accounting and employee organization records to ensure they are adequately able to identify ASC 730 financial statement R&D costs. Furthermore, taxpayers should analyze all relevant ASC 730 financial statement R&D cost center accounting and employee data to determine whether they will benefit from computing eligible QREs under the safe harbor.