Postponed research credit regulations and discovery test.

• Author: Packard, Pamela
• Position: Tax credits

On Dec. 27, 2000, Treasury issued final regulations (TD 8930) covering the research credit's computation under Sec. 41(c) and the definition of qualified research under Sec. 41(d). The effective date generally was to have been for expenditures paid or incurred after Jan. 2, 2001. The regulations were widely criticized by taxpayers and practitioners, because of the substantial changes made to proposed regulations. Many commentators believed Treasury should have re-issued these new regulations in proposed (rather than final) form to allow for additional public comments.

On Feb. 1, 2001, the Bush Administration indefinitely postponed these regulations' general effective date and re-opened the comment period through Apr. 2, 2001 (Notice 2001-19). While Treasury stopped short of withdrawing the regulations, it indicated that any changes would be announced as proposed regulations following a review of the final regulations, including consideration of previous and new comments. In effect, these regulations reverted to proposed regulations less than a month after they were generally effective. Nonetheless, taxpayers can rely on these regulations during this review.

Practitioners and taxpayers affected by the regulations generally applauded their withdrawal. Many commentators believed these regulations responded inadequately to problems inherent in the original proposed regulations. One of the principal points of contention between the IRS and taxpayers is the discovery test.

Discovery Test

To qualify for the credit, Sec. 41(d)(1)(B) requires that research be undertaken "for the purpose of discovering information which is technological in nature, and the application of which is intended to be useful in the development of a new or improved business component."

Under Prop. Regs. Sec. 1.41-4(a)(3), "discovering information" is defined as "obtaining knowledge that exceeds, expands, or refines the common. knowledge of skilled professionals in a particular field of technology or science."

The Service and Treasury believe that discovering information is a separate statutory requirement. Taxpayers claiming the credit and their tax advisers, on the other hand, maintain that this phrase merely links the term "research" with the types of information required as the subject of the research.

Before the 1998 proposed regulations, the IRS had not published guidance on this issue. However, many taxpayers and advisers concluded that discovering information as used...