On Sept. 10, 2020, the IRS released updated guidance for large companies that are claiming the R&D credit under the previously available ASC 730 Directive. Originally released in 2017, the Directive allows LB&I examiners to accept a taxpayer’s adjusted ASC 730 Financial Statement R&D expenses as sufficient evidence of QREs when the taxpayer complies with the certification requirements outlined in the Directive. Please see our previous coverage here and here.
The new guidance is effective for tax years ending after July 21, 2020, and the previous Directive will continue to apply to any claims properly made under the Directive between Sept. 17, 2017 and July 31, 2020. The new Directive makes several significant changes, including the following:
- Requiring the taxpayer to remove all ASC 350 internal-use software and website development costs from their claim. The previous Directive had allowed internal-use software to be included, which was generally favorable to the taxpayer.
- Expanding the discretion of the exam team to determine eligibility through an expanded “examination guidance” section in the Directive. This expanded section generally describes the power of the exam team to determine if proper documentation and certifications were submitted, and their ability to require the taxpayer to submit more information based on their determination. This guidance also expands on the required process an examiner will go through in the audit and elevated review process.
- Creating new documentation requirements, which includes the new requirement for a written narrative of the methodology and calculations. This will likely be a significant burden on taxpayers.
- Restricting the eligibility to LB&I taxpayers who meet additional criteria regarding their income statements and their book income reconciliation to federal tax income on Schedule M-3.
Takeaways
Taxpayers who take advantage of the Safe Harbor associated with the ASC 730 Directive will now have more requirements to meet before making a claim, and the IRS will have more discretion in the exam process. This may result in fewer taxpayers choosing to utilize the ASC 730 process set forth in the directive. A claim under ASC 730 is a complicated process that has been made more complicated by these new requirements, and any taxpayer making a claim under the ASC 730 Directive should consult with their tax advisor about these new changes.
