The IRS Large Business and International (LB&I) division has updated an LB&I directive (2017) concerning the research credit under section 41. The updated directive continues to allow IRS examiners to accept research and development (R&D) expenses as reported on taxpayer financial statements, but with several new restrictions and limitations.
Read the updated LB&I directive LB&I-04-0820-0016 (dated September 10, 2020)
This 2020 LB&I directive revises and clarifies the 2017 LB&I directive, and provides LB&I examiners with guidance regarding examinations of the credit claimed by taxpayers for increasing research activities under section 41.
According to the updated LB&I directive, the IRS independently determining the correct amount of research credit imposes a significant burden on LB&I taxpayers and examiners. This directive is intended to provide an efficient methodology for determining “qualified research expenses” (QREs) for LB&I taxpayers that meet certain requirements and allow for more efficient management of LB&I’s audit resources.
If the IRS determines that a taxpayer has satisfied all the requirements of this revised LB&I directive, then this directive provides an administrative solution for LB&I examiners to accept, as sufficient evidence of QREs, the Adjusted ASC 730, Financial Statement R&D for the Credit Year—comprising the R&D costs currently expensed on a taxpayer’s certified audited financial statements pursuant to ASC 730 for U.S. GAAP purposes (“Financial Statement R&D”), subject to certain specified adjustments made to the Financial Statement R&D.
The LB&I directive only applies for LB&I taxpayers (those with assets equal to or greater than $10 million) that follow U.S. GAAP to prepare their certified audited financial statements showing the amount of currently expensed financial statement R&D either as:
This LB&I directive also does not apply unless the taxpayer uses these same U.S. GAAP financial statements to reconcile book income to federal tax income on Schedule M-3.
The 2017 LB&I directive continues to apply to LB&I taxpayers that chose to calculate their QREs using the requirements of that directive on original returns timely filed (including extensions) on or after September 11, 2017, for tax periods ending prior to July 31, 2020. The revised LB&I directive applies to LB&I taxpayers that choose to calculate their QREs using the requirements of this directive on original returns timely filed (including extensions) for tax periods ending on or after July 31, 2020.
Additional details regarding the new restrictions and limitations are described in the LB&I directive.
The 2020 LB&I directive modifies the 2017 LB&I directive by:
If the IRS determines that a taxpayer has satisfied all the requirements of this revised Directive, then this Directive provides an administrative solution for LB&I examiners to accept, as sufficient evidence of QREs, the Adjusted ASC 730 Financial Statement R&D for the Credit Year.
For any software development activities performed and which costs are included in U.S. Financial Statement R&D, remove all software development costs for software that is not for sale, lease, or otherwise marketed by the taxpayer. Software sold to related parties or as part of a cost sharing arrangement for internal use is not software for sale, lease or otherwise marketed.
If the exam team determines the requirements of this Directive have not been satisfied, the exam team may request information in addition to the documentation requested in Part V of this Directive. The exam team must receive approval from the Territory Manager or his/her delegate to request additional information not listed in Part V of this Directive.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.