On September 11, 2017, the LB & I Division of the IRS issued a new directive that allows IRS examiners to accept a taxpayer’s determination of its qualified research expenses (QREs) to the extent that the QREs are computed in accordance with ASC 730 Financial Statement R&D. The new directive is a step in the right direction and gives taxpayers who qualify a potential partial safe harbor in calculating the research credit. However, the new directive leaves many open questions.
That the IRS would create such a safe harbor is encouraging, but many taxpayers looking for certainty in their credit calculations will not be able to take advantage. In order to use the directive, certain requirements must be met:
- Taxpayers must have assets of at least $10 million
- Taxpayers must have certified financial statements which expense R&D pursuant to ASC 730
The financial statements cannot have a qualification, contingency or adverse opinion with respect to ASC 730. In addition, the taxpayer must compute their credits in accordance with the directive on their original returns. As alliantgroup’s Jeremy Fingeret notes, “It’s encouraging to see the IRS take steps toward making more safe harbors for the R&D Tax Credit. However, a taxpayer-friendly R&D Tax Credit shouldn’t be just for the Fortune 500, but for all businesses. Innovative small and medium sized businesses should benefit from these safe harbors as well and we encourage the IRS to issue more guidance particularly on issues of substantiation, funding and statistical sampling.”
Even taxpayers that qualify to use the directive may not find it advantageous. Numerous limitations exist with regard to application of the directive such as:
- The directive only applies to current year QREs (the historic base period is not included)
- Taxpayers must exclude all research performed under contract, even if the research is not “funded” pursuant to the code
- Contractor costs are barred
- All wage expenses must be reduced
Taxpayers considering using the directive should consult their trusted advisors to determine whether utilizing the directive would help in the application of their research credit.