IRS Introduces New Leaner Approach To Audit R&D Tax Credits
During a government budget hearing earlier this summer, IRS Commissioner John Koskinen testified that, due to various budget cuts over the years, the IRS has lost 18,000 full time agents since 2010. Consequently, this crisis has forced the IRS to implement more efficient income tax audit practices. The auditing approach to the R&D credit is the latest example of this reengineering effort.
On September 11, 2017, the IRS issued a directive to its Large Business & International (“LB&I”) unit regarding the R&D tax credit and what would be considered as acceptable evidence when examining qualified research expenses (“QREs”) to determine the credit. The directive places heavy reliance on the audited financial statement of a taxpayer and the reported R&D expenses pursuant to ASC 730.
For the reported QREs to be accepted by IRS examiners regarding a reported tax credit, all of the following must exist:
- The taxpayer must have $10 million or more of gross assets
- The taxpayer follows U.S. GAAP for their audited financial statements
- The R&D expenses are disclosed separately in the taxpayer’s financial statements (a footnote is acceptable)
- Under penalties of perjury, the taxpayer signs a Certification Statement Claiming Adjusted ASC 730 Financial Statement R&D as QREs
- Either attached to a timely filed return or separately given to an examining agent
- The taxpayer produces bridged reconciliations of the R&D expenses per the financial statements (ASC 730) to the reported R&D tax credit (Form 6765)
If all the above items are satisfied, the IRS will not challenge or separately compute a taxpayer’s reported QRE’s as shown on the tax return. Other components that make up the R&D credit computation, such as the fixed-base percentage, can still be audited and challenged.
Note that this directive is not meant to replace existing tax law of what constitutes qualified R&D, but to act as an administrative option to lessen the burden and cost for both the taxpayer and the IRS. For taxpayers that meet the above parameters, it can be a win-win situation by having the reported R&D tax credit unchanged while saving time and cost to defend it in the face of an IRS audit.