The campaigns cover fuel mixture credits and R&D credit issues
The IRS Large Business and International (LB&I) division recently announced that it has added fuel mixture credits under section 6426 and research activities under sections 41 and 174 to its list of current compliance campaigns.
On Jan. 13, 2017, LB&I identified and selected 13 initial campaigns to be a part of its new targeted auditing technique. The stated purpose of the campaigns is to redefine compliance work and build a supportive infrastructure by addressing significant compliance and resource challenges. LB&I currently has 53 active campaigns and six retired campaigns.
Section 6427 fuel credits
The new campaign targeting fuel credits received pursuant to section 6426 is specifically designed to target taxpayers who received fuel mixture credits but did not treat the credit as a reduction in their excise tax liability under section 4081. The stated goal of the campaign is, “to bring taxpayers who maintain that the credits are merely refundable credits, which do not affect the deduction for any excise tax liability, into compliance.”
Section 4081 imposes an excise tax on the removal, entry or sale of most fuels. When active, section 6426 allows a credit against the tax imposed by section 4081 for taxpayers who use the taxed fuel to produce certain fuel mixtures that are sold or used in the taxpayer’s trade or business. The tax treatment of these credits has been the subject of much debate in the recent years. However, the issue was recently settled when the Supreme Court denied certiorari in Sunoco Inc. v. United States, 908 F.3d 710 (Fed. Cir. 2018), cert. denied, Sup. Ct. Dkt. No. 18-1474 (2019). (See our prior alert.)
In Sunoco, the IRS denied the taxpayer’s claim that it was eligible to take deductions for the fuel excise tax liability that it paid and also claim a credit for the same fuel under section 6426. The taxpayer contended that the credits were refundable credits and should not affect the deductions for excise tax liability. The Court of Federal Claims held for the IRS and, upon appeal, the U.S. Court of Appeals for the Federal Circuit affirmed the lower court, holding that the mixture credit first reduces the taxpayer’s excise tax liability, and any associated deduction, with any excess amount of the credit payable to the taxpayer under section 6427.
Despite this holding, the IRS has found that many taxpayers do not reduce the deduction claimed for fuel excise tax upon receiving a fuel mixture credit under section 6426. Therefore, the IRS has stated that it has added the fuel mixture credit to its list of compliance campaigns in order to use issue based examination to “bring taxpayers who maintain that the credits are merely refundable credits, which do not affect the deduction for any excise tax liability, into compliance.”
The campaign focusing on the sections 41 and 174, respectively the research and development credit and the research and experimentation deduction, is meant to address issues related to the two code provisions. The LB&I announcement did not specify what issues LB&I will focus on with the campaign. However, the research credit has long been an area that has received extra attention by LB&I and the IRS as a whole.
Prior to the LB&I’s compliance campaigns, the research credit was treated as Tier I issue by the LB&I predecessor division. The IRS made the research credit a Tier I issue in 2007. At the time, the heightened scrutiny was because the IRS was concerned that a large number of research credit studies were marketed on a contingent fee basis and were based on high level estimates, biased judgement samples, lacked a nexus between the business component and qualified research expenses or lacked adequate contemporaneous documentation. The IRS ended the tiered issue process in 2012.
The newly announce compliance campaign for research issues will employ issue-based examinations, form updates and requests for guidance. The campaign’s objective is to promote voluntary compliance and focus resources on the highest risk research issues, while increasing the consistency of examinations. Again, however, the campaign’s announcement does not provide any insight as to what those issues are.
It is important for taxpayers to realize that with the addition of compliance campaigns these subject matter areas will receive higher scrutiny from the IRS.
With regard to the fuel mixture campaign, taxpayers should be aware that including the credit in income is only required where the credit offsets an excise tax liability that was previously deducted from income. Fuel mixture credits that exceed the amount of the fuel tax liability can be claimed as a payment under section 6427(e) and are then not included in income. Furthermore, the compliance campaign notes that its intention is to focus on fuel mixtures, it therefore would be appropriate to assume that the alternative fuel credit of section 6426(d) is not included in this campaign because it does not constitute a mixture and does not offset tax associated with section 4081. Taxpayers should be aware that the area of fuel taxes, and their associated credits, can be complicated and have onerous requirements. Taxpayers should consult their tax advisers regarding the requirements to claim fuel credits and the tax consequences of those credits.
Taxpayers that have experience claiming the research credit are already familiar with the increased scrutiny informally imposed by the IRS on research issues. The new campaign formalizes that scrutiny, and hopefully future communications will clarify what issues LB&I will focus on with the campaign.