IRS: Taxpayers Can Use Financial Statements to Prove Expenses for R&D Tax Credit

The Internal Revenue Service (“IRS”) issued new guidance intended to make it easier for large business and international (“LB&I”) taxpayers to calculate their qualified research expenses (“QREs”) when claiming a research credit under Internal Revenue Code (“IRC”) Section 41. At the same time, it’s also meant to reduce the burden on LB&I examiners when analyzing and verifying QRE amounts. The IRS put out a summary of the directive in a news release on September 22, 2017 (IR-2017-158).

The IRS directive, “Guidance for Allowance of the Credit for Increasing Research Activities under I.R.C. Section 41 for Taxpayers that Expense Research and Development Costs on their Financial Statements pursuant to ASC 730,” which was issued on September 11, 2017, instructs LB&I examiners to accept certain financial statements of LB&I taxpayers as evidence of their QREs, as long as the financial statements follow U.S. generally accepted accounting principles (“GAAP”). The directive is only applicable to LB&I taxpayers (i.e., taxpayers with assets equal to or greater than $10 million) that take advantage of the research and development (“R&D”) tax credit.

The directive allows taxpayers to submit their Adjusted Accounting Standards Codification® (“ASC”) 730 Financial Statement R&D to the IRS for the credit year, which the IRS should accept as sufficient substantiation of their QREs for that year. The justification is that an Adjusted ASC 730 Financial Statement R&D consists of the R&D costs currently expensed on a taxpayer’s certified audited financial statements. The certified statements should include the amount of the currently expensed ASC 730 Financial Statement R&D as a separate line item on the income statement or in a note on the statements, so the documents essentially cross-reference each other. Taxpayers must also attach a certification statement, as described in the directive.

Examiners are not supposed to challenge a QRE amount that’s claimed on the Adjusted ASC 730 Financial Statement R&D. However, any additional QRE amounts claimed by a taxpayer over the Adjusted ASC 730 Financial Statement R&D amount could potentially be challenged.

Takeaway

If you qualify as an LB&I entity and claim the R&D tax credit, this new development could save you a lot of time, money, and hassle by letting you use certain financial statements as evidence of your QREs. The directive is persuasive, but it cannot be cited or relied upon as legal precedent. Audit challenges will likely remain, since the directive is not a true safe harbor.

The directive applies only to timely originally filed returns (including extensions) on or after September 11, 2017. One question this directive doesn’t answer is whether or not taxpayers can retroactively apply this treatment to years being audited by the IRS.

Still have questions about how the directive may affect you and your business? Need help determining if you qualify for the R&D tax credit? Please reach out to Cherry Bekaert’s Credits and Accounting Methods team for guidance. They’ve helped clients claim and defend millions of dollars in research credits. They’ll be happy to answer all your questions and see if you could save some money, too.