The Internal Revenue Service’s recent move to set new requirements for claiming refunds on research tax credits is provoking an uproar among tax professionals.
Last month, the IRS released a September memorandum from its Office of Chief Counsel essentially saying it wants more detailed information about all the business components for which the research credit claims relate for that year (see story). For each business component, companies will need to identify all the research activities they’ve performed and name the individuals who performed each research activity, along with the information each individual sought to discover. Refund claims for the research and development credit will also need to detail the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year, using Form 6765.
The new requirements are likely to have a big impact on many companies by asking them to provide much more detailed information on all their research activities to claim the tax credit. Some tax professionals and their clients are already concerned about the change, as the extra requirements could discourage businesses from seeking legitimate R&D credits.
“The credit has been around for 40 years, and the intent of that credit was to incentivize R&D jobs to stay in the United States and to stay competitive globally in this space,” said Shelby Ford, leader of the R&D tax credit practice at Crowe LLP. “The scrutiny under exam that already exists today before the [Chief Counsel Advice] can be really intimidating for taxpayers of all sizes to comply with the documentation requirements. The IRS is challenged with understanding what documentation does this taxpayer have available to support why they qualify. They’re asking for the information to be canned in a certain way, and this one-size-fits-all approach could be really frustrating for a taxpayer to say what documentation do I have and how do I put it in this format. How do I have certainty when I have the best intentions to comply? And I have no certainty that I even did it correctly to have a valid claim.”
Taxpayers and tax professionals won’t have much time to get ready for the new rules. “This came out on the afternoon of Oct. 15 with an effective date of Jan. 10, 2022, so it’s about a three-month period in which this will go into place,” said Ford. “Essentially it says if you are filing a R&D credit for a refund, extra documentation must be available upon filing versus waiting for your notice that you are under exam. So far, it’s a timing issue and it needs to be available as you file. The other issue with that is it’s new criteria that may or may not have been a part of a normal exam cycle, so it could catch taxpayers out of the blue with identifying new information that they may or may not have available.”
The Chief Counsel Advice is unclear on several aspects. “They put out the guidance, which is less than authoritative regulatory guidance, but the indication is that this Jan. 10 date might apply looking back at refund claims that were filed and that are sitting at the IRS on that date as well,” said Rochelle Hodes, a principal in the Washington National Tax Office at Crowe. “That’s unclear. The other thing that’s not particularly clear is folks have looked at the CCA, and it looks like it applies based on some language to claims on amended returns when you’re claiming a refund. But there is language in the CCA that could indicate the IRS is looking to apply this additional documentation requirement on original returns that claim a refund that also contain an R&D claim on it. So there’s a lack of clarity, but it could be extraordinarily broad.”
The IRS has periodically listed improper claims for the R&D tax credit among its Dirty Dozen tax scams. The new criteria could be a way to crack down on such claims, but the guidance could leave taxpayers with legitimate claims second-guessing themselves.
“The IRS has publicly stated that they want to focus on higher-risk claims and provide a more seamless experience both for their exam teams as well as for taxpayers, meaning better clarity and better consistency of application to the law,” said Ford. “This CCA is coming out saying this will help everyone get on the same page. The gap in that is it will likely cause additional frustrations rather than minimize the frustration. Because there are new criteria, that’s not something that can be cited as precedent, and so even with this criteria, a taxpayer could feel like they’ve hit all the points they need to hit and still be denied that claim. That’s a grave concern for many taxpayers in this space.”
In case there’s a dispute with the IRS, it may be impossible to get a court to take up the claim.
“It’s not even a claim denial,” said Hodes. “The IRS will treat a claim that comes in with information that doesn’t meet their criteria— and some of it is quite vague, so how do you know if you met it? — as a deficient claim for refund. Well, if you file this ‘deficient’ claim for a refund within the period of limitations — generally three years from the date you filed your original return — you have to perfect that deficient claim, or else not only won’t you get your money from the IRS at the administrative level, but without filing a valid claim for refund with the IRS, you are foreclosed from getting a court jurisdiction to file a refund suit. So I’m trying to meet these requirements and file this claim, but I don’t know if I’ve met the requirements. Meanwhile, the IRS is sitting on my claim, and if they sit on my claim for six months, I could go to refund court after six months. But then the IRS could come in and say, ‘Well, that was a deficient claim and so, refund court, you don’t have jurisdiction.’ Or the three-year period could lapse. I could go into court and the IRS could say, ‘It was a deficient claim, so court, you don’t have jurisdiction.’ So it’s basically heads, you lose, tails, you lose.”
The IRS is asking for comments on the new criteria to be emailed to IRS.Feedback.RECredit.Claims@irs.gov, but that’s not the same as the open comment period it generally follows when it proposes new regulations.
“The difference is that when you’ve got a proposed regulation, there’s an open comment period that’s public,” said Hodes. “This is behind closed doors, so the comment period is giving both practitioners and taxpayers some discomfort because it’s not public and many people in this space would like access to see what are the questions and then also have access to the answers to those questions, whether they ask them themselves or they were asked by someone else. A public comment period that’s defined and that has the IRS responding consistently to all of those claims and, again, having access to all of that information would be immensely helpful for taxpayers.”
Taxpayers may be left with few other options than to hope they have met the criteria for documenting their claim. “In order to get their refund, they really have to comply with these procedures, regardless of whether or not the form of the guidance in which this requirement was imposed was the appropriate form, because basically, if you look at the end of the CCA, there’s language that indicates that if the service center believes the claim was deficient, they should just hold onto the claim,” said Hodes.
Small and midsized companies may not have enough resources to pull together all the documentation needed to justify their claims. “This will be very intimidating and overwhelming for them to get their arms around,” said Ford. “Tax departments are resource constrained already. This is already a part of the law that requires a lot of resources to get the right documentation in place. This is just one more thing that could preclude a taxpayer from pursuing the credit.”
The new guidance is sparking discussions among tax practitioners. “I’d say there are a lot of conversations in the community about how to move forward with constructive feedback,” said Ford. “Taxpayers want more certainty as well. They want the same things that the IRS has publicly stated that they want, so everyone is stating they want more certainty, consistency and application of the law. They want an easier exam process as well, but this doesn’t seem to be getting all the parties going in the same direction. It actually sends us off in different directions.”
Ford believes there are better ways for the IRS to validate R&D tax credit refund claims. “The IRS has continually stated that they want more information to validate the quality of a claim, and that information can be achieved through the normal exam process with targeted questioning that’s specific to each claim,” she said. “The law in this space is so broad. By definition it was intentionally broad to keep these jobs in the United States and allow lots of taxpayers to qualify. So to put this kind of standard of all claims must fit into this standard really, in my opinion, goes against the intention of looking at each unique claim and how that taxpayer fits the criteria within the law.”