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New R&D Credit Refund Requirements Create Hurdles

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The IRS has added a new layer of complexity for those who intend to claim a research credit refund. Eric Hylton, director of compliance at alliantgroup, discusses how taxpayers are now having to provide more information to the agency to substantiate their refund qualification.

It’s undeniable that the research and development, or R&D, tax credit, provided under IRC Section 41, is already one of the more difficult tax provisions to deal with.

In fact, the U.S. Tax Court has grappled with the difficulty of taxpayers claiming the research credit itself, including in the 2014 case of Suder v. Commissioner.

Now, it seems the IRS has added an additional layer of complexity for those who intend to claim a research credit refund. As many have seen by now, the agency released a chief counsel memorandum in October 2021 detailing several new requirements that must be met when a taxpayer files for refund:

  1. A taxpayer must identify all business components to which the claim relates for the claim year.
  2. For each of those business components, taxpayers must identify all research activities performed, name the individuals who performed each research activity, and specify what information each individual sought to discover.
  3. The taxpayer must submit totals for the tax year of qualified employee wage expenses, qualified supply expenses, and qualified contract research expenses.

Taxpayers will use Form 6765, credit for increasing research activities, to detail expenses related to qualified employee, supply, and contract research expenses for the year at issue.

Despite the technical qualifications for the credit remaining the same, taxpayers, or more likely their CPAs, are now having to provide more information to the agency to substantiate their refund qualification.

As a former commissioner at the IRS, I certainly can understand the agency’s rationale that having more information up front will create an easier administrative processing system, especially with IRS resource constraints. I can also venture a guess that, through these new requirements, the IRS is attempting to weed out any “fly by night” businesses that are looking to claim shaky credit refunds.

However, what’s crystal clear to me is that these new requirements will make it more difficult for many taxpayers whose activities merit a refund to obtain one, as these new hurdles will simply prove to be too much work. This is especially true for small businesses, the heartbeat of America, and potentially could stifle much needed innovation for future growth.

The IRS defended the move, stating that existing Treasury regulations already require “sufficient facts” for a refund claim to be considered valid. According to the agency, these new requirements will not be satisfied by “a mere volume of documents” being submitted.

The IRS also added that the additional facts provided by the taxpayer will need to specify the grounds and sufficient facts that formed the basis for the refund claim, which will allow the agency to screen for the likelihood of the taxpayer’s right to the refund.

Although this type of information is already sought out by the agency, primarily during an audit, it surely creates burdens for taxpayers who simply will not have the bandwidth to supply this information up front.

In its memo, the IRS detailed a variety of case decisions regarding the “specificity requirement,” including Stoller v. United States, where the U.S. Court of Appeals for the Fifth Circuit held that meeting the “specificity requirement” is a “jurisdictional prerequisite to filing a suit for refund.”

However, the agency failed to adequately acknowledge the consequences of the government’s loss in Premier Tech, Inc. v. United States, in which a federal district court rejected the government’s argument that a taxpayer’s amended returns didn’t meet the “specificity requirement” when the taxpayer failed to include information similar to what is now required under the chief counsel memo.

These new requirements have raised concerns from the world of tax professionals, some of whom have raised potential Administrative Procedure Act concerns, claiming the agency failed to allow for a meaningful notice and comment period.

In the latest message from the IRS, the agency stated that it would review comments but that it likely will not extend the start date for the new requirements as the American Institute of Certified Public Accountants, or AICPA, had requested.

Since the new requirements were first released, the IRS said that a grace and transition period would be in effect. The grace period lasted until Jan. 10, 2022, and taxpayers are now required to include the information outlined in the chief counsel memo.

After the Jan. 10 grace period expiration, taxpayers originally were given a one-year transition period where they would have 30 days to “perfect” an R&D credit refund claim before the IRS made a final determination.

Now, per a Jan. 5 update from the IRS, those taxpayers who need to perfect a refund claim will have 45 days before the agency makes its determination.

Holly Paz, the deputy commissioner of the IRS Large Business and International division, announced during the fall meeting of the AICPA IRS Advocacy and Relations Committee that these new requirements would only apply to amended returns.

This might be true for now. However, taxpayers and their financial professionals should be on the lookout for the agency applying these new requirements, or some variation thereof, across the board.

About the Author

Eric Hylton held several prominent positions at the IRS, including serving as Deputy of the Criminal Investigation Division and as CI’s head of International Operations. As National Director of Compliance, Eric employs his years of experience at the IRS to assist alliantgroup’s clients as an ambassador for U.S. small and medium sized businesses (SMBs) and in helping others become tax compliant.