January 17, 2022

IRS Clarification – New R&D Refund Documentation Requirements

IRS Clarification – New R&D Refund Documentation Requirements

Beginning in January 2022, companies looking to claim a refund under IRS Section 41 – better known as the federal Research and Development tax credit – will now have to supply more documentation. Outlined in Office of Chief Counsel Memorandum – 20214101F the extra information, which must be submitted with the annual tax return, is expected to help process R&D credit refunds faster and more efficiently.  Now that the IRS has issued guidance for the new requirements, businesses claiming the credit can work closely with providers to ensure the proper documentation is submitted. To help clients, prospects, and others, Wilson Lewis has provided a summary of the key details below.

New Instructions for Claiming the R&D Tax Credit

In the fall of 2021, the IRS released instructions on new information that taxpayers would need to provide. Five items will be needed for all R&D credit refund requests, including:

  1. All business components
  2. All research activities performed
  3. All individuals who performed each research activity
  4. All information everyone looked to find
  5. Total qualified employee wage, supply, and contract research expenses

When providing the documentation, taxpayers should use Form 6765. Official certification can be done using either the signature on Form 1040,1120 or by specifying which page(s) in the R&D credit study support the refund claim.

Part of item #4 pertains to the R&D credit’s four-part test. Recall that the claim must refer to an activity that’s technological in nature, part of a process of experimentation, looks to eliminate uncertainty and has a specific purpose or goal. In clarifying who was involved in certain research activities, new information must include the purpose or goal of anyone involved in the process.

While taxpayers adjust to the new requirements, there will undoubtedly be situations where partial or incorrect information about the R&D credit refund is submitted. The good news is that the IRS will give taxpayers a grace period in the first year to fully follow the new requirements.

Clarifications from the IRS on Changes

The impetus for new documentation to claim the R&D credit refund is to help the IRS process returns quicker and get refunds to taxpayers faster. The new FAQs clarify that the agency will decide on complete claims within six months.

Grace Period and Incomplete Refund Claims

Initial instructions said that the IRS would give taxpayers a 30-day grace period to follow the new requirements in the first year. The grace period has been extended to 45 days. If the IRS decides that any part of the information is incomplete or incorrect, the agency will notify the taxpayer in writing via Letter 6426C or 6428. Missing information can be sent back to the IRS using fax or mail. Electronic file transfers will not be allowed.

This grace period is only effective for the first year of transition. During the transition year, if a taxpayer does not supply the required information within the 45-day grace period, the refund claim will be denied. After January 9, 2023, any incomplete refund claim will simply be rejected.

Information Request

Many of the questions about the new instructions surrounded the required information.

Taxpayers can identify the relevant business components based on “what the taxpayer did and how they did it” without going into details about how each business component complied with the four-part test. Business components are further defined in IRC § 41(d)(2)(B), which states that a business component is “any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer.”

The IRS has confirmed that individuals involved in the refund claim should be denoted using titles or positions; names aren’t necessary; however, be prepared to supply full names if the IRS asks for a substantive review. When a group of individuals worked together to find the same information for a business component, the taxpayer can list all their titles or positions as one group.

Note that whether the refund claim is formal or informal, all five information items must be supplied. Taxpayers can submit the information in a list, table, or narrative format using Form 6765. Form 1120 taxpayers don’t have the choice to file an informal claim; they must file a formally amended return.

It is important to note, taxpayers can still use statistical sampling to support credit refund claims; however, they are still required to provide the total number of qualified employee wage, supply, and contract research expenses.

What’s Next

Even though the new information is part of a set of new requirements – and not regulations, which would allow for public comment before full implementation – the IRS is still accepting public input for a year. It’s possible that the instructions could be revised based on necessary modifications. The AICPA asked for the start date to be pushed back, which hasn’t been the case. Some in the industry are concerned that forging ahead with the current implementation date will open the door to administrative headaches and potentially tax litigation to resolve disputes.

Contact Us

While the federal R&D Tax Credit remains a powerful tax savings tool the additional documentation requirement may create additional complications in the process. Ensuring all required information is submitted on a timely basis will ensure that refunds are made on a timely basis. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.

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