The IRS recently announced another year extension to the transition period which provides taxpayers with an additional 45 days to perfect federal R&D claims. Originally the agency announced specific items that must be included as part of an IRC Section 41 claim in 2022. Since that time there have been two extensions issued to provide taxpayers with additional time to comply with the updated regulations. The rules require that five items be submitted with each claim. This includes all business components related to the claim, identification of research activities performed, name of the individuals who performed the activities, information each sought to discover, and total related expenses. Becoming familiar with these items now will help to reduce delays in the claim process. To help clients, prospects, and others, JLK Rosenberger has provided a summary of the key details below.
Summary of Recent Changes
The IRS recently extended the transition period to January 10th, 2025, allowing taxpayers 45 days to provide any missing information required to process an R&D refund claim. The taxpayer should be notified which of the five pieces of information is missing through IRS letter 6426C or 6428. The taxpayer will then have 45 days from the date of the letter to submit the requested items. It has been indicated the letter should include a fax number and that transmitting the information via fax is preferable.
From our experience, there may be additional letters sent out to taxpayers than the two specified above requesting missing information. It may be helpful to submit the entity return before shareholders or owners of other pass-through entities to avoid processing delays. You must also submit the five pieces of information with the corporate or entity return and individual returns for pass-through entities.
The updated IRS FAQs indicate that efforts will be made to review and make determinations for R&D refund claims within 6 months. This means that you need to be prepared to compile any additional information requested months after submitting an amended tax return. Thus, keeping the correct information to support the expenses reported on Form 6765 is vital. It is also important to note that these five pieces of information are only required for adjustments made to an originally filed return or an amended return to claim an R&D refund versus a return that is amended for a different reason.
What Information is Required to be Submitted?
ITEM ONE: Identify all the business components to which the Section 41 research credit claim relates for that year.
The “Business Component” includes a listing of projects and the IRC Section 41(D)(2)(B) defined business component (i.e., product, process, formulation, technique, invention, or software) sought to achieve in each project.
The best practice example provided in the IRS FAQs to satisfy item one includes a table that has the business component number, project name, and the IRC Section 41(D)(2)(B) defined business component like the example below.
ITEM TWO: For each business component, identify all research activities performed.
To satisfy this requirement, you must provide a description of the goal of the project and the research activities undertaken in each Project by Business Component. Thus, you would need to describe the process of experimentation and qualifying research activities by Business Component number and Business Component Name.
ITEM THREE: name the individuals who performed each research activity, and ITEM FOUR: as well as the information each individual sought to discover.
For Item Three and Item Four, you can either list individuals by name or in groupings if performing similar research activities. You can also satisfy this requirement instead of listing employee names by providing the number of employees in each job category (i.e., 2 – Project Managers) and then a brief description of the research activities performed in each Project by Business Component.
In the IRS best practice example in FAQ No. 20, another layer is incorporated into Item Four. This is the type of activities performed, such as qualified research (or an individual directly performing the research activities), direct supervision, or direct support of the research.
ITEM FIVE: Include Form 6765 or provide the total amount of each qualified expense type: wages, supplies, and contract research.
You are allowed to attach Form 6765 or a table including the total amounts of each type of expenditure. In the IRS’s best practice example, if you claimed the R&D Tax Credit on an original return and then amended to claim additional costs, you should provide the original amount of each expense category claimed, the additional amount in the refund request, and the new total for each type of expense.
How should I provide these five pieces of information with my amended tax return?
The IRS guides that the information can be supplied as part of the explanation, such as Part II of Form 1120X, or as an attachment to the R&D claim for a refund. Based on the updated best practice example provided by the IRS, an attachment may be the better route to be able to cleanly correlate information to each of the five required items. This could be done via a statement on Form 6765 that indicates that these items will be provided in Attachment No. X.
Crossover with the proposed changes to file with original tax returns claiming the R&D Tax Credit?
These considerations are mirrored in the draft changes to Form 6765 for 2024 with some additions, such as:
- The amount of officer or executive wages included in the research expenditures.
- If your business acquired or disposed of any major portions of the business or those performing R&D.
- If any new categories of research expenditures are included in the current year’s calculations.
- If the qualified research amounts reported used the ASC 730 Directive.
If these changes go through, then you would need to file the five pieces of information required for amended returns plus some extras, such as those listed above geared towards making sure the consistency requirement is met. This means that the types of expenses and activities being considered in the current year are consistent with the analysis and types of costs included in the base period. This does not mean that you cannot explore a new category of expense but rather that if you do, for the current year’s calculations, you need to include the same types of costs in your base period. For the Alternative Simplified Method for calculating the Federal R&D credit, this would be the prior three years. In general, the ASC 730 directive would only apply to taxpayers that have $10M or greater in assets. Other form changes move the controlled group election for related entities and reduced credit election or 280c election to an earlier line on Form 6765.
The recently extended transition period for perfecting an R&D claim for another year is welcome news for many businesses. The opportunity to submit additional information and documentation before a final IRS ruling is quite helpful. If you have questions about the information outlined above or need assistance with claiming the R&D credit, JLK Rosenberger can help. For additional information call 949-860-9902 or click here to contact us. We look forward to speaking with you soon.