Page 181 - TaxAdviser_2022

standards rather than industry- and cases and so designated the research because of an objection from FASB,
client-specific decision-making, which credit as an ACI. Similarly, IRS Exams which did not wish to be the target
frequently frustrated both local agents wished for greater coordination and of lobbying campaigns (Statement of
and taxpayers and increased the time consistency and so designated the David J. Kautter (former Sen. Danforth
and costs of exams (see Johnson, “The research credit as a Tier 1 issue. But tax legislative assistant) to internal
Demise of the IRS Tiered Issue Pro- both programs had frustrating backlogs, RSM R&D Credit Practice, via video
gram,” JD Supra (Dec. 3, 2012)). leading to the decentralization of the teleconference (Sept. 22, 2021)). The
In a follow-up to the 2007 Tier 1 ACI research credit program and to the remarkableness of the IRS’s partially
designation, the LMSB Division (now demise of Tier 1. relying on ASC 730/FASB for research
known as the Large Business & In- Bottlenecks due to overcentraliza- credit purposes — especially in light of
ternational (LB&I) Division) issued a tion may have decreased, but ongoing FASB’s earlier stated preference not to
Research Credit Claims Audit Techniques difficulty in examining research credit be involved — highlights the ongoing
Guide, which suggested the IRS was claims did not. So, the IRS sought to struggles the IRS has had in examining
frustrated concerning R&D credit streamline its reviews of research credit research credit claims. It may also show
claims even after the credit was desig- claims through a 2017 directive, Guid- the desire of the IRS to pass the difficul-
nated a Tier 1 issue: “There is a growing ance for Allowance of the Credit for ties of auditing the research credit to
trend among taxpayers, and their repre- Increasing Research Activities Under someone else.
sentatives, to submit prepackaged mate- I.R.C. Sec. 41 for Taxpayers That Ex- In September 2020, the IRS issued
rial to support research credit claims” pense Research and Development Costs additional guidance relating to the ASC
(LMSB-04-0508-030 (May 2008)). on Their Financial Statements Pursuant 730 directive that restricted the direc-
Perhaps in recognition of these to ASC 730, LB&I-04-0917-005 (Sept. tive’s applicability (LB&I-04-0820-0016
problems, Rev. Proc. 2011-42 provided 11, 2017) to allow LB&I taxpayers to (Sept. 10, 2020)). The restrictions as part
taxpayers with guidance regarding the use R&D costs reported on financial of the additional guidance included:
use of statistical samples for tax return statements under FASB Accounting 1. Requiring taxpayers to remove all
positions. While previous field directives Standards Codification (ASC) Topic ASC Topic 350 internal-use software
and revenue procedures had authorized 730, Research and Development, as suf- and website development costs from
the use of statistical samples, the revenue ficient evidence of qualified research their claim;
procedure stated that statistical sampling expenditures (QREs). This directive 2. Creating new documentation re-
was authorized for broad use by taxpay- allowed the IRS to minimize review of quirements, which included a written
ers, including for purposes of claims for research credit claims by relying on the narrative of the methodology and
refund or credit. Due to frustration over work performed by auditors to create a calculations; and
the tiered process, and perhaps because safe harbor for some of the key aspects 3. Restricting the eligibility to LB&I
the problems that the tiered process of the R&D credit. For a specific group taxpayers who meet additional crite-
was supposed to address were partially of large businesses that follow U.S. ria regarding their income statements
addressed by statistical sampling, effec- GAAP to prepare their certified audited and their book income reconciliation
tive Aug. 17, 2012, the IRS decided to financial statements, the ASC 730 direc- to federal tax income on Schedule
no longer use the tiered management tive relieved a substantial burden relating M-3, Net Income (Loss) Reconciliation
process to set examination priorities for to documentation and quantification of for Corporations With Total Assets of
any issue (LB&I-4-0812-010 (Aug. 12, R&D QREs. $10 Million or More.
2012)). As initially proposed in 1980 by Sen. This may have been the first sign that
To replace the tiered approach to John Danforth, R-Mo., the research the IRS’s pendulum was swinging back
audits, the IRS developed issue prac- credit would have explicitly defined to requiring more documentation — and
tice groups and international practice qualified R&D expenditures in the that Danforth may have been right in
networks, which provide local IRS same way as accountants define R&D his ultimate decision not to base the
examination teams with specific techni- in preparing financial statements (see S. credit on financial accounting R&D.
cal advice. The issue practice groups still 2906, 96th Congress; see also “Danforth Now, with FAA 20214101F, the IRS
exist but are now referred to as practice Introduces Research and Develop- has once again revised its examination
networks (IRM §1.1.24.3.2(1)(a)). ment Credit,” 11 Tax Notes 88 (July 14, approach for research credit claims,
There are parallels in the histories 1980)). However, this explicit connec- leveraging the specificity requirement
of these programs: IRS Appeals wished tion with financial statement R&D was to reject claims that do not meet its
for greater uniformity in research credit done away with in the legislative process guidelines. Perhaps the new FAA will

www.thetaxadviser.com April 2022 11