A new safe harbor for LB&I taxpayer R&D credits.

• Author: Shi, Debbie
• Position: IRS Large Business and International Division, research and development

The IRS Large Business & International Division (LB&I) released a directive to its examiners (LB&I-04-0917-005) that effectively provides large taxpayers with a new safe-harbor method for calculating certain qualifying research expenditures (QREs). In summary, the directive allows taxpayers to use research and development (R&D) costs reported on financial statements under FASB Accounting Standards Codification (ASC) Topic 730, Research and Development, as the starting point for computing QREs. This method could eliminate duplicate efforts and reduce the work required to document and substantiate qualified research costs.

The guidance outlines a method for taxpayers to start with the R&D costs as calculated on their certified audited financial statements under Topic 730, make certain adjustments, and end with QREs for claiming the R&D credit under Sec. 41.

The directive is a result of the efforts of the Silicon Valley Tax Directors Group working with the IRS through the Industry Issue Resolution Program. The directive acknowledges that certain activities and costs clearly qualify for the R&D credit, and efforts to substantiate clearly qualified activities and costs should be simplified when possible. This directive is akin to the Pharmaceutical Industry Research Credit Audit Guidelines issued in the past. It is not authoritative, and taxpayers cannot use, cite, or rely upon it as an official pronouncement, but LB&I examiners are instructed not to challenge QREs computed in accordance with this guidance. In addition, the directive applies only to LB&I taxpayers, i.e., those with assets equal to or greater than $10 million. The directive requires that taxpayers following the directive present Topic 730 R&D expenses in their certified audited financial statements as a separate line item on their income statement or a separately stated note.

Applying the directive

While the directive is a positive step forward and will be beneficial for some taxpayers, the safe harbor is limited to certain specific costs:

* Qualified individual contributors: 95% of the taxable wages of qualified individual contributors whose wages are charged to Topic 730 cost centers;

* First-level supervisor managers: 95% of the taxable wages of first-level supervisor managers whose wages are charged to Topic 730 cost centers; and

* Upper-level managers: Up to 10% of the amount computed above for qualified individual contributors and first-level supervisor managers is eligible...