The IRS announced proposed changes to the required disclosures on tax returns that will have a significant impact on how taxpayers claim Research and Development (R&D) tax credits on Form 6765. While the contemporaneous documentation requirements and the level of detailed documentation regarding the various research projects are not changing, the proposed changes will formalize a specific format that will be required directly on Form 6765 in order to claim an R&D credit. Proposed changes to Form 6765 would be effective on 2024 tax returns and are in line with IRS requirements for valid refund claims on amended tax returns that went into effect in January 2022. The proposed changes to Form 6765 include adding two entirely new sections of information.
As the period that will be reported on the 2024 tax returns has already begun, taxpayers should be diligent now in gathering the information required for the new reporting requirements. You should be aware that you will be required to provide the same information for earlier years if taxpayers are selected for IRS examination since this information is part of the current contemporaneous documentation requirements.
What additional information will be required?
Proposed changes to Form 6765 are intended to provide taxpayers with a predefined format for disclosing this information and improve information received by the IRS regarding R&D credits. This is part of the IRS’s pursuit of facilitating increased transparency by taxpayers. The proposed changes are as follows:
New Section F:
One of the requirements for qualified research activities under Section 41 is a “business component” test. This test is met as a result of the research activity developing a new or improved business component by the taxpayer. Under this test, a business component is defined as any product, process, computer software technique, formula, or invention to be held for sale, lease, or license or to be used by the taxpayer in its trade or business.
The new Section F would require the following information for each business component:
- A description of the information sought to be discovered by the research activity as well as the various alternatives evaluated in the process of experimentation;
- Whether the business component is new or improved;
- The type of business component (product, process, formula, etc.);
- The business component’s use (sale, license, used in the trade or business, etc.); and
- Qualifying wages by type (research, supervision, support).
The IRS is considering if there would be additional requirements related to any software “business component.”
New Section E:
This new section would require taxpayers to answer five questions:
- The amount of officers’ wages included in the qualified research expenses;
- Whether the taxpayer acquired or disposed of a major portion of a trade or business during the taxable year;
- Whether the taxpayer has identified any new qualified research expenses;
- The number of business components generating the R&D; and
- Whether current year qualified research expenses follow the ASC 730 Directive.
So What Does This All Mean For Taxpayers?
The proposed changes present many potential challenges for taxpayers, including:
- The IRS needs to provide taxpayers with guidance on the level of detail required to satisfy each new section. The IRS is planning to address this issue in future guidance.
- An additional level of technical review may be required for taxpayers claiming the R&D credit for a business component related to software. Taxpayers must select from various IRS-defined categories of internal use, non-internal use, and dual-function software to identify the qualifying software type.
- If the taxpayer identifies new information after submitting the tax return or has additional documentation not disclosed on Form 6765, it is unclear whether the IRS will accept/consider this information during an audit.
- Regarding disclosing officers’ wages in Section E, it is unclear which officers the IRS is interested in receiving the wage information. This is in an effort to identify high-risk areas.
- The IRS needs to guide taxpayers on the definition of new qualified research expenses incurred during the taxable year, primarily what is considered a category of expenditures and how to determine whether a category is new.
What Taxpayers Can Do Now?
Taxpayers should review their documentation for R&D credit claims on prior current year returns and ensure they are gathering this information for the 2024 years. This information will be required to be disclosed on Form 6765 in 2024 but also may be requested by the IRS during an audit. The IRS has increased its review of R&D credits over the years, so taxpayers should be prepared with the required documentation to support their R&D credit.
GBQ has a team dedicated to assisting clients with evaluating, documenting, and claiming the R&D credit. GBQ can prepare an R&D study for the 2023 tax year and also assist with establishing processes and procedures to comply with the proposed changes to the required disclosure on Form 6765 for the 2024 tax year.
Please contact Jeff Waldeck or Leah Rogers to learn more.
