CHIEF COUNSEL ADVICE MEMORANDUM 20214101F
On Friday, October 15th, 2021, the Internal Revenue Service published Chief Counsel Advice Memorandum 20214101F. In this memo, the Service describes what information they think taxpayers should include in a research credit claim for the IRS to consider the claim valid. Per the CCA, the IRS plans to require taxpayers to have the following information when filing a refund claim:
- List of the business components (research activities or projects) to which the R&D credit claim relates for that year
- List of research activities performed for each business component
- List of the individuals who performed each research activity, as well as the information each individual sought to discover, and
- The total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year
Additionally, the taxpayer will be required to sign a declaration under penalties of perjury that the facts provided are accurate. The IRS will provide a grace period through January 10, 2022 before requiring this information with timely filed research credit refund claims. After the grace period, there will be a one-year transition period during which taxpayers will have 30 days to perfect a research credit claim for refund prior to the IRS’ determination on the claim. While the IRS could begin to enforce immediately, it is likely they will wait until the end of the grace period, so taxpayers are encouraged to file any amended returns now ahead of the deadline.
How does this impact me as a taxpayer?
First, it is important to note that this applies to claims for refund arising from the research credit. That means amended returns only. Research credits claimed on original or even superseding tax returns are not affected. Second, if you have already filed a Form 1120X or Form 1040X with the Service, you fall under the grace period. If you have already received your research credit study but have not filed your amended returns but wish to take advantage of the grace period, it is advisable to accelerate those filings. Third, after the grace period expires, it will become even more important to work with a qualified firm of R&D tax credit professionals that provides the necessary information to support any research credit amended return filings.
Since its inception, the research credit, which can be seen as an interpretive law, has led to numerous legal battles between taxpayers and the government. Nonetheless, a great many taxpayers filing amended R&D tax credit claims for refund are duly processed and paid by the IRS without incident each year. Throughout its history, the IRS has approached the audit of R&D tax credit claims from various angles. This latest guidance provides insight into what the IRS next steps will be. For some time, the IRS has received push back from taxpayers that the information the IRS seeks to review upon examination has not been properly communicated to taxpayers and that sufficient notice has not been made. In the recent past it has become even more important as district courts issue diametrically opposed opinions defining just what is sufficient notice. The publication of this CCA acts as “providing adequate notice” on what information the IRS will seek to review when processing a refund claim.
Additionally, some taxpayers have been unable to fully answer IRS information document requests during an audit of their R&D tax credit due to not having the information. Without commenting on the relevance or necessity of the information requested by the IRS, this memo should help taxpayers, who are able to provide such data, avoid IRS audits of their research credit refund claims. It will do so by allowing the government to quickly assess the basis for the claim, determine whether the claim needs to be examined, and, if the Service does not see it as meritorious, deny the claim. This level of detail should allow the Service to avoid auditing many research credit refund claims because the claim is obviously valid. The minority of claims that are examined will benefit from more focused audits; the very small minority of claims that are denied at this stage can then proceed through the standard appeals process.
How can Source Advisors help?
As part of our standard process, Source Advisors seeks to provide business component-level detail by individual employee. While this CCA is very specific in wanting employee-level R&D contributions documented, this information is already obtained and can be presented as part of an R&D tax credit refund filing. Since we gather this information as part of our standard process, this new filing requirement should not be as burdensome as it may appear on its surface but will require some additional documentation at the point the amended returns are filed. What is important to note is that a Chief Counsel Advice is written by the Chief Counsel’s National Office to advise IRS personnel. It outlines a legal position that the IRS is advised to take. It does not hold the same authority as the Code, regulations, or case law.
Please feel free to reach out to Source Advisors for more news as this new procedural requirement continues to develop.