LB&I Directive – Guidance for Allowance of the Credit for Increasing Research Activities for Taxpayers that Expense Research and Development Costs on their Financial Statements pursuant to ASC 730, September 11, 2017
This directive from the Large Business & International (“LB&I”) division of IRS provides guidance to examiners regarding examinations of the credit for increasing research activities under section 41. This new directive is intended to provide an efficient manner of determining qualified research expenses for LB&I taxpayers that meet the requirements under the directive and to more efficiently manage LB&I’s audit resources.
The directive (LB&I-04-0917-005) describes an approach for determining a category of qualified research expenses (“QREs”) that will fall under a “safe harbor” and will not be challenged by the IRS. LB&I taxpayers (assets equal to or greater than $10 million) who follow GAAP for their certified audited financial statements may be eligible to adopt this approach if they use ASC 730 to calculate their R&D expenses for financial statement purposes.
To use this safe harbor method, several adjustments must be made to the financial statement ASC 730 R&D amount to calculate “Adjusted ASC 730 R&D”. For example, some expenses that are allowed under section 41 will not be included in the safe harbor amount, such as software development expenses and contract expenses. Note that a taxpayer is allowed to claim additional QREs on Form 6765 above the Adjusted ASC 730 amount that falls within the safe harbor requirements, but those additional QREs will be subject to the routine examination procedures and not covered by the safe harbor.
Also, the directive includes significant documentation requirements to support the adjustments. Documents that are required to be retained include items such as R&D cost center detail, chart of accounts, organizational charts, executed contracts, and employee lists with W-2 wages.
How to adopt the Directive:
Taxpayers must execute a certification statement provided in Appendix A, as well as complete Appendices B, C and D reconciling Form 6765 QREs with Adjusted ASC 730 R&D. The certification statement and related appendices may be attached to the taxpayer’s timely filed return, or may be provided to the IRS exam team upon request. The taxpayer must also maintain books and records as provided in the Directive.
The directive applies to original tax returns that are timely filed (including extensions) on or after September 11, 2017.