In October 2021, the IRS Office of Chief Counsel issued a memorandum for taxpayers wishing to apply for the research and development (R&D) tax credit refund claim. The guidance outlines the information the IRS requests for a refund claim to be deemed as valid and to meet the requirements of existing legislation. Subsequently, taxpayers wishing to apply for the R&D refund claim will face an increased documentation burden to meet these standards.  

Doeren Mayhew’s business tax pros highlight the memorandum as well as key background information on new capitalization rules so you can apply for the R&D refund claim with confidence. 

Background on the R&D Credit 

The R&D tax credit was originally implemented in 1981 to incentivize the development of new products and processes in different industries. It generally applies to expenditures paid or incurred for qualified research, including discovering information that is technological in nature. Its application must be intended for use in developing a new product or process, or improving an existing product or process. The research must include a process of experimentation to improve function, performance, reliability, quality or significantly reduce cost. 

TCJA Impact 

Before the Tax Cuts and Jobs Act (TCJA), taxpayers had a choice under IRC Section 174 when deducting R&D expenses. They could either expense all qualified expenditures in the year incurred or amortize expenditures for up to five years. When the TCJA was passed, it removed the immediate expensing of R&D costs and required companies to amortize over five years for costs incurred within the U.S., beginning with tax years after Dec. 31, 2021. Foreign R&D expenses must be amortized over 15 years for costs incurred outside the U.S.  

TCJA New Capitalization Rules 

The Tax Relief for American Families and Workers Act of 2024 was recently passed by Congress and currently awaits a Senate vote. It includes a retroactive elimination of the capitalization requirement for domestic R&D expenses, while foreign R&D would continue to be amortized over 15 years. This pending legislation is significant for business owners, as it stands to remove the financial burden of this expensive requirement.  

Research credit rules are not impacted by the new capitalization rules, but the impact on taxable income and quarterly payments should still be considered. Further Section 174 expenses, including facilities costs or foreign research that does not qualify for the credit, should be reviewed for the new capitalization rules. In preparation, businesses should review their Section 174 expenses, as many companies have them but do not claim the research credit. 

IRS-Required Information for Refunds of Valid R&D Credit Claims 

For a taxpayer’s refund claim for the R&D tax credit to be valid, they must identify: 

1. All business components the research credit claim relates to for that year. 
2. All research activities performed for each business component. 
3. All individuals who performed each research activity for each business component. 
4. All the information each individual sought to discover for each business component. 
5. Total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses. 

To support these claims, taxpayers must provide a signed declaration stating the facts provided are accurate, under the penalty of perjury. Typically, a signature on Form 1040X or Form 1120X is sufficient. Taxpayers should provide the above claims in a written statement, versus a pile of documents. However, if documents are provided in lieu of a statement, taxpayers must state the exact page(s) supporting the specific facts. Loosely providing documents will not suffice to meet the taxpayer’s obligations.  

 Doeren Mayhew’s business tax pros are here to show you the way when applying for the R&D refund claim.