IRS May Soon Require Significantly More Documentation for R&D Tax Credits

Background

Taxpayers claiming a research and development (R&D) credit may soon need to dramatically increase the scope of their recordkeeping.

The Internal Revenue Service (IRS) recently proposed substantial changes to Form 6765, which is used to claim the federal R&D credit. While some changes are quite minor, the proposed form would require additional information that could spell trouble for unprepared taxpayers.

The proposed changes include a schedule that would require companies to report specific information on a business component-by-business component basis. For simplicity, a “business component” can be thought of as a “project” or, in certain cases, a group of closely related projects. The following information would need to be provided for each business component:

• The controlled group member performing the research activities;
• The name of the business component;
• The information sought to be discovered and one or more alternatives evaluated in the process of experimentation for each business component;
• Whether the business component is new or improved, and if it is a product, process, software, technique, formula, or invention;
• Whether the business component is used in the taxpayer’s trade or business or leased, licensed, or sold;
• If the business component is software, detailed information on whether it is internal use software (IUS) or non-IUS;
• Wages broken down by business component into the following categories: direct research wages for qualified services, direct supervision for qualified services, or direct support wages for qualified services; and
• Supplies, rental or lease cost of computers, and the applicable amount of contract research expenses by business component.

It’s important to note that the current research tax credit form does not request any of the above information. Many taxpayers may not be tracking data in a way that allows for these questions to be answered without investing significantly more time and effort.

How the Proposed Changes Could Impact Taxpayers 

These proposed changes signal a continuation of the IRS’ efforts to require taxpayers to provide additional and more detailed information to receive the R&D credit. In October 2021, the IRS issued stricter requirements to include specific details when requesting a research tax credit refund. These requirements drew significant criticism for the additional administrative burden they place on taxpayers, and generated questions as to whether there was a legal basis for requiring this level of comprehensive information. The proposed Form 6765 goes even further and requires detailed qualified research expense (QRE) information by project, which may be extremely difficult for taxpayers to provide.

If adopted, these changes could take effect as early as the 2024 tax year. The IRS has asked for public feedback on the proposed revisions, including whether certain claims based on company size or QRE amount should be excluded from such requirements.

Navigating Evolving IRS Reporting Demands

It’s unclear which proposed changes will appear in the final draft, and if certain taxpayers may be exempt from some of these reporting requirements. Regardless, this is another clear signal from the IRS demonstrating what they will be looking for in the event of an audit. It’s also possible that some states may follow a similar line of thinking and request additional documentation during audits.

For this reason, taxpayers should begin planning ways to modify their information gathering and record keeping processes to have better documentation should these rules be implemented and/or should the company be audited.

For help reviewing your existing R&D credit claim or to discuss opportunities to file for the credit, contact a KSM advisor or complete this form.