Historically, R&D credits have been subject to full IRS examination and often result in prolonged audits that companies must address. However, the IRS released guidance that states the IRS won’t challenge certain qualified research expenses (QREs) that are a taxpayer’s adjusted ASC 730 financial statement R&D costs.
With this guidance, taxpayers now have the option to reconcile ASC 730 with the QRE claimed on their tax return by adjusting ASC 730 financial statement R&D costs to the amount the IRS considers as qualifying for safe harbor. For those expenses specifically excluded from the directive, traditional R&D credit qualification may still apply and those costs may still be claimed on the tax return; however, in that instance those items would be subject to full IRS examination.
The opportunity is for taxpayers with more than $10 million in assets who follow US generally accepted accounting principles (GAAP) to prepare certified audited financial statements. This includes C corporations, S corporations, partnerships and LLCs that claim R&D tax credits.
With the newly provided directive methodology, taxpayers may benefit from the safe harbor noted above, which may result in more predictable IRS exams. Further, use of the directive may result in an increase to overall credit generated, and enable reduction in reserves taken against R&D credits on tax provision.
Those taxpayers performing domestic-based R&D that’s self-funded and self-performed could benefit the most from electing the ASC 730 directive method. Self-funded means there’s no outside government funding or customer contracts, and self-performed means the majority of R&D expenses are allocated to internal employee costs rather than services by third-party contractors.
In addition to assessing for self-funded and self-performed R&D, taxpayers should also consider the availability of supporting detail to enable use of the directive method. The directive requires a broader dataset than that of the historic R&D credit calculation, so it will be important to consider whether additional planning is necessary from an accounting standpoint, specifically related to the book R&D expense and how those are categorized and reported.