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each component satisfies the four-part Requirements for a valid refund Although taxpayers should have already
test of Sec. 41(d) and is not subject to claim gathered the detailed information
any exclusions. Under the four-part test, The Chief Counsel memorandum does necessary to support the claim, the sup-
qualified research must satisfy the Sec. not purport to modify any of the under- porting detail may not be presented in
174 test, the technological-information lying requirements for qualification of a way that would clearly address each
test, the business-component test, and a research credit claim on the merits. It of the factual details requested by the
the process-of-experimentation test. does, however, establish an initial pro- memorandum. In short, taxpayers with
The first of the four, the Sec. 174 cedural threshold that, if not met, will hundreds of business components and
test, requires a taxpayer to show that allow the IRS to reject claims as being thousands of employees could expect
the expenses related to the research invalid without any administrative or to spend significant amounts of time
were incurred in connection with the judicial recourse. This new procedural preparing summarized reports just to
taxpayer’s trade or business to elimi- hurdle will effectively represent a fatal satisfy these requirements. The IRS has
nate uncertainty through research and flaw to any claim that is determined to not addressed how onerous this would
development. Next, taxpayers must be invalid after the statute of limitation be to smaller taxpayers who may not
satisfy the technological-information has expired and perfection of the claim have the resources to handle this type of
test, which requires that the research be is no longer permissible. administrative burden.
“technological in nature” (i.e., it relies on When submitting a refund claim, These requirements for a valid refund
principles of physical or biological sci- taxpayers should continue to comply claim further hinder taxpayers, as the
ences, engineering, or computer science). with the basic requirements for the IRS states that a taxpayer that volun-
The business-component test requires research credit as previously discussed. tarily provides documents with the claim
taxpayers to show that the information Considerable uncertainty exists under must specifically identify where in the
obtained through research is intended the new rules, however, regarding the documents the facts responsive can be
to develop a new or improved business exact level of detail needed to make found. As such, the IRS has shifted the
component of the taxpayer. Lastly, the the claim procedurally valid. While obligation onto the taxpayer to provide
process-of-experimentation test requires the Chief Counsel memorandum lists documentation exceeding what was
that substantially all (i.e., 80% or more) certain elements of detail that taxpayers originally required to file a refund claim,
of the taxpayer’s research must constitute must provide, it fails to precisely describe while delegating the IRS’s responsibility
elements of a process of experimentation the level of detail that the taxpayer must of review to the taxpayer through the
related to a new or improved function, provide to establish “sufficient facts” requirement of specific identification
performance, reliability, or quality of the under the specificity requirement. of required facts. Finally, taxpayers will
business component. It is also concerning that the memo- need to evaluate their methodology for
Each of the taxpayer’s business randum requires the taxpayer, for each computing and substantiating a research
components must satisfy all four-part business component, to identify all the credit refund claim. This is particularly
test requirements separately. Taxpay- information each individual perform- true for taxpayers that employ a cost
ers can include certain in-house ing research sought to discover, which center or hybrid approach (i.e., a com-
expenses (wages and supplies) and implies that the four-part test should bination of business component and
contract research expenses related to a be applied and evaluated at the indi- noncomponent) for determining QREs.
qualified business component. Sec. 41 vidual level rather than the business- From Jennifer Frost, Esq., LL.M.,
allows taxpayers to claim a nonrefund- component level. It is uncertain what Washington, D.C.; Pinky Shodhan, CPA,
able credit for incremental qualified detail would be required for individuals J.D., LL.M., MBA, Washington, D.C.;
research expenses (QREs) over a base who are directly supporting or directly John Andress, CPA, Atlanta; and Kevin
amount. Also, the IRS Audit Tech- supervising the performance of qualified Benton, E.A., Dallas
niques Guide for research credit claims research. It is also surprising that the
(LMSB-04-0508-030) discusses the IRS would not require the nexus detail, The research credit: Using
concept of nexus as the process of con- discussed above, when evaluating if a statistical sampling
necting qualified activities (specific taxpayer provided details for all business This item discusses the Sec. 41 research
business components) to the underlying components and all employees. credit and how statistical sampling can
QREs. The Audit Techniques Guide These requirements could also pres- be used to efficiently satisfy the four-
states that research credit studies lacking ent a further burden for taxpayers with part test that governs whether research
this relationship have failed to establish claims comprising a significant number activities qualify for the credit. The
nexus and, therefore, are disallowed. of business components and employees. focus here will be on guidance recently

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