Press Room: Tax Release
IRS Offers New Research Credit Safe Harbor to Taxpayers with More Than $10 Million in Assets
The IRS published a Directive that allows taxpayers to certify, under penalties of perjury, that their ASC 730 book research and development (R&D) expense, with certain adjustments, should be respected as Qualified Research Expense (QRE) for the purposes of the federal Credit for Increasing Research Activities (the research credit). The Directive applies to all taxpayers with assets equal to or greater than $10 million, and who follow ASC 730 for reporting R&D expense on their U.S. GAAP financial statements. Taxpayer compliance with the Directive is voluntary, and is available to corporations and pass-through entities. For corporations, the certification statement must be signed by an individual authorized to sign the corporate income tax return. IRS examiners are instructed not to challenge the QREs that are determined through the procedures outlined in the Directive.
The Directive requires certain adjustments to book R&D expenses to eliminate expenses that do not qualify for the research credit, or are not covered by the safe harbor. The required adjustments to the book expense include the subtraction of non-U.S. research expenses, the cost of research performed for third parties, payments for contract research, and prototype expenses. Wages and stock-based compensation are also limited. W-2 wages and stock-based compensation for employees and first level managers performing qualified research are allowed at 95%. Upper Level Manager compensation is allowed at the lesser of 10% of all other employee QRE, or 100% of the actual W-2 wages associated with Upper Level Manager participation in qualified research. The balance of the ASC 730 book R&D expense that results from these adjustments represents the portion of QRE that is protected by the safe harbor.
Taxpayers may claim additional QRE, but the added expense will not be protected from examination. For example, taxpayers may add back QRE for contract research, but IRS reserves the right to determine whether the expenses constitute funded research. Thus, the Directive effectively separates core R&D expense from categories of QRE that have historically been sources of controversy. Taxpayers may comply with the Directive beginning with the first timely filed original income tax return (including extension) that is filed after the Directive was published (returns filed after September 11, 2017).
All taxpayers will have to evaluate the cost/benefit of adopting the new safe harbor procedures. Taxpayers are encouraged to consult their Andersen Tax advisor to determine how the new Directive may apply to their business.