Information For...

For you and your family
Standard mileage and other information

Forms and Instructions

Individual Tax Return
Instructions for Form 1040
Request for Taxpayer Identification Number (TIN) and Certification
Request for Transcript of Tax Return

 

Employee's Withholding Allowance Certificate
Employer's Quarterly Federal Tax Return
Employers engaged in a trade or business who pay compensation
Installment Agreement Request

Popular For Tax Pros

Amend/Fix Return
Apply for Power of Attorney
Apply for an ITIN
Rules Governing Practice before IRS

FAQS - IRC 41 QREs and ASC 730 LB&I Directive

These Frequently Asked Questions (FAQs) supplement the information contained in the Large Business & International (LB&I) Directive “Guidance for Allowance of the Credit for Increasing Research Activities under IRC Section 41 for Taxpayers that Expense Research and Development Costs on their Financial Statements pursuant to ASC 730” (Directive), signed on September 11, 2017. The questions and answers contained in these FAQs apply solely to the use of the Directive. Further, the intent of this document is to clarify the methodology followed in the Directive and the costs allowed within. These FAQs do not provide a complete analysis of all relevant law under IRC 41 or 174. This document is not an official pronouncement of law and it cannot be used, cited or relied on as such.

Index


Accounting Standard Codification (ASC) 730

Q1. Are taxpayers required to report research and development (R&D) on their financial statements under Accounting Standards Codification (ASC) 730?
A1. Yes. Taxpayers who follow U.S. Generally Accepted Accounting Procedures (GAAP) for book shall disclose their ASC 730 R&D costs on their financial statements. ASC 730-10-50-1 states that: “Disclosure shall be made in the financial statements of the total research and development costs charged to expense in each period for which an income statement is presented. Such disclosure shall include research and development costs incurred for a computer software product to be sold, leased, or otherwise marketed.” (See the section on Software Development Activities Questions 1 and 2 below for software sold, leased, or otherwise marketed.)

Back to Top

Q2. Does the Directive treat the research activities under ASC 730 as qualified research activities under IRC 41 and IRC 174?
A2. No. The Directive does not determine as a matter of law whether ASC 730 research activities are research activities which constitute qualified research (commonly referred to as qualified research activities) under IRC 41 and IRC 174. The Directive simply provides an administrative solution to accept as sufficient evidence of qualified research expenses (QREs) the Adjusted ASC 730 Financial Statement R&D (ADJ ASC 730 FS R&D) for the credit year.

Back to Top

Q3. Where can I find the ASC?
A3. All the ASCs are available through Westlaw.

Back to Top

Q4. Are there other ways to obtain ASC 730 if I don't have Westlaw Access?
A4. Yes. ASC is available for free at FASB.ORG once you register for the Basic View.

  1. Go to fasb.org
  2. On the top line menu click on STANDARDS
  3. Then Accounting Standards Codification
  4. At this point, you will need to Log in, the Basic view is free
  5. Go to first time users – Basic or Professional View
  6. Click SELECT under FASB Accounting Standards Codification Basic View – Free Access
  7. Enter a User Name and click SUBMIT
  8. Complete the Registration form, click SAVE & CONTINUE

Read and accept the licensing agreement. This will bring you to a confirmation page which shows an order number and no charges. Link from here to the ASC login page.

On the ASC page, the “type in codification number” search feature is disabled for Basic View. To get to ASC 730 click on Expenses and scroll across to ASC 730 Research and Development. (The “Join All Subtopics” option is not available in Basic View so you will need to review each subtopic separately.)

You must click through each paragraph separately. After opening the paragraph, select the print button on the bottom of the screen (the only option for Basic View is Printer Friendly) and print to a pdf if you choose or an actual paper copy. When finished with a subject area, click on “10 Overall” and pick the next paragraph you want to review.

The paragraphs under ASC 730-10 Overall include the following:

  • 00 Status
  • 05 Overview and Background
  • 10 Objectives
  • 15 Scope and Scope Expectations
  • 20 Glossary
  • 25 Recognition
  • 50 Disclosure
  • 55 Implementation Guidance and Illustrations
  • 60 Relationships
  • 75 XBRL Elements

Back to Top


Software Development Activities

Q1. What is software developed for sale, lease or market under GAAP?
A1. ASC 985 is the U.S. GAAP accounting standard for software marketed externally. Under this standard, selling, leasing, or otherwise marketing software requires more than simply planning to generate revenue with the software. Software developed for customers who have the contractual right and ability to take possession of the software and run it on their own hardware (or hardware of another party unrelated to the vendor) rather than simply accessing it online is software for sale, lease or market. For such software, the vendor follows ASC 985 to record their software development costs.

If a vendor of online software does not sell, lease, or separately market the software according to such an arrangement, then the vendor utilizes the software in providing services. Vendors account for the costs associated with the development of such software (services) under ASC 350-40. Accordingly, taxpayers account for the software development costs for most online software and cloud computing services software under ASC 350-40 rather than the externally marketed software standard under ASC 985-20.

Computer software to be sold, leased, or otherwise marketed also includes software that is part of a product or process to be sold to a customer. For example, the scope of the externally marketed software standard under ASC 985-20 includes software designed for and embedded in a semiconductor chip because it is an integral part of the product. By contrast, software for internal use, though possibly used in developing a product, is not part of or included in the actual product or service sold.

Back to Top

Q2. Are all the costs associated with the development of software for sale, lease or market included in the ASC 730 costs expensed as R&D on the Certified Audited Financial Statements?
A2. No. Not all costs associated with the development of software the taxpayer intends to sell, lease, or market are ASC 730 costs.

ASC 985-20 is the U.S. GAAP accounting standard for Costs of Software to Be Sold, Leased, or Marketed. Under this standard, taxpayers book specified costs up to the point of establishing technological feasibility as ASC 730 R&D costs. ASC 985-20-25-1 states, “All costs incurred to establish the technological feasibility of a computer software product to be sold, leased, or otherwise marketed are research and development costs. Those costs shall be charged to expense when incurred as required by Subtopic 730-10.”

However, ASC 985-20-25-2 further states, “for purposes of this Subtopic, the technological feasibility of a computer software product is established when the entity has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements.”

At the point the software meets technological feasibility, the activities and costs are no longer ASC 730 activities and costs.

Back to Top

Q3. Are the costs associated with the development of internal-use software by the taxpayer included in the ASC 730 FS R&D amount reported on the taxpayer’s Certified Audited Financial Statements?
A3.  In general, no. (See exceptions in Question 4 below in this section.) The amount reported as ASC 730 R&D on the financial statements does not include costs associated with the development of internal-use software. ASC 350-40 provides guidance on accounting for the costs of developing or obtaining computer software for internal use and for determining whether software is for internal use.

Under ASC 350-40 internal-use software has both of the following characteristics:

  • The software is acquired, internally developed, or modified solely to meet the entity’s internal needs, and
  • During the software’s development or modification, no substantive plan exists or is being developed to market the software externally.

Additionally, ASC 350-40 specifies that if using software in the production of a product or in providing a service when the customer does not acquire the software or the future right to use it, the software is internal-use software and follows the guidelines under ASC 350-40 for reporting software development costs.

ASC 350-40-55 provides 21 examples illustrating when computer software is for internal use or not for internal use.

Back to Top

Q4. Are there any exceptions to the general rule under ASC 350-40 (See Question 3 in this section) which require accounting treatment for internal-use software under ASC 730?
A4 . Yes. ASC 350-40-15-7 provides that taxpayers account for the following R&D activities of internal-use software (which are relatively rare and immaterial in comparison to other internal use software development activities) under Subtopic 730-10:

  • Purchased or leased computer software used in research and development activities where the software does not have alternative future uses, or
  • All internally developed internal-use computer software (including software developed by third parties, for example, programmer consultants) in either of the following circumstances:
    1. The software is a pilot project (that is, software of a nature similar to a pilot plant as noted in paragraph 730-10-55-1(h)). (In general, such pilot projects are separate and specialized endeavors within an organization intended to explore and demonstrate new concepts and applications of new technology for internal use. It is important not to confuse a pilot project with an early stage of a standard internal-use software project, or with other common activities in standard internal-use software projects such as iterative prototyping or beta testing.)
    2. The software is used in a particular research and development project, regardless of whether the software has alternative future uses. (This situation is similar to the exception from Internal Use Software (IUS) treatment for software developed for use in an activity that constitutes qualified research (other than the development of the IUS itself), Treas. Reg. 1.41-4(c)(6)(ii)(A)).


Back to Top 

Q5. For internal-use software development costs determined as ASC 730 research, does ASC 730 have requirements like those in the 3-part High Threshold of Innovation Test?
A5. No. In general, the amount reported as ASC 730 R&D does not include costs associated with the purchase or development of internal-use software. Accordingly, ASC 730 does not have specialized requirements or tests like the High Threshold of Innovation test.

For the definition of Internal-use-software under ASC 350-40, please see question 3 in this section. For a review of Internal-use software reporting for U.S. GAAP, see ASC 350-40.

Back to Top


Certified Audited Financial Statements

Q1. What are Certified Audited Financial Statements?
A1. As defined in the Directive, a Certified Audited Financial Statement is “A financial statement that is accompanied by the report of an independent (as defined in the American Institute of Certified Public Accountants Professional Standards, Code of Professional Conduct, Rule 101 and its interpretations and rulings) Certified Public Accountant. A financial statement is ‘certified audited’ for purposes of this Directive if it is:

  • Certified to be fairly presented (an unqualified or “clean” opinion),
  • Subject to a qualified opinion that such financial statement is fairly presented subject to a concern about a contingency (a qualified “subject to” opinion) other than a concern relating to ASC 730 reporting,
  • Subject to a qualified opinion that such financial statement is fairly presented, except for a method of accounting with which the accountant disagrees (a qualified “except for” opinion) where such disagreement does not relate to ASC 730, or
  • Subject to an adverse opinion not relating to ASC 730, but only if the accountant discloses the amount of the disagreement with the statement.

Any other statement or report, such as a review statement or a compilation report that is not subject to a full audit is not a certified audited statement."

Back to Top

Q2. Taxpayers use other words to describe R&D activities on their Certified Audited Financial Statement. How do I know if the amount reported is ASC 730 R&D? Will the Directive apply to taxpayers who identify development activity using other names?
A2. ASC 730-10-50-1 states:" Disclosure shall be made in the financial statements of the total research and development costs charged to expense in each period for which an income statement is presented."

Taxpayers can and do report their ASC 730 R&D costs with other categories of expenditures on the Income Statement included with their Certified Audited Financial Statements. For example, taxpayers use the terms Product Development, Software Development, Engineering research, etc., in addition to R&D expenses.

However, only LB&I taxpayers, who show as a separate line item on the Income Statement included in their Certified Audited Financial Statements or show separately in the notes to the Certified Audited Financial Statement the amount of currently expensed ASC 730 R&D, receive the benefits of the Directive. Therefore, taxpayers who fail to separately identify the ASC 730 R&D costs currently expensed on their Certified Audited Financial Statements are ineligible for the benefits of the Directive.

Exam should verify that the costs reported are certified and audited by external third parties as ASC 730 R&D. In addition, Exam should further tie the amount claimed as R&D to taxpayers’ books and records. (See section on Directive Audit Steps below.)

Back to Top

Q3 . In the notes to the Certified Audited Financial Statements, the taxpayer separately identified R&D credits as deferred income tax assets. Does this meet the requirement for separately showing the R&D expenses?
A3. No. Credits are different from ASC 730 R&D expenses. The Directive only applies to ASC 730 R&D expenses.

Back to Top

Q4. If changes occur to the Sarbanes-Oxley Act of 2002 (SOX) or the U.S. Securities Exchange Commission (SEC) regulations, etc., will LB&I’s reliance on the ASC 730 costs expensed as R&D on Certified Audited Financial Statements to determine QREs continue?
A4. Possibly. LB&I may reconsider its reliance on U.S. GAAP standards for ASC 730 R&D if changes to the SOX or SEC regulations occur. More importantly, if the Financial Accounting Standards Board makes significant changes to the U.S. GAAP standards for ASC 730 R&D, LB&I will consider revisions to the Directive and the templates contained within it.

Back to Top

Q5. Is the Directive applicable to taxpayers who prepare their Certified Audited Financial Statements following International Financial Reporting Standards?
A5. No. The Directive only applies to taxpayers who follow U.S. GAAP accounting for book and the preparation of their Certified Audited Financial Statements.

Back to Top

Q6. What prevents non-public companies from overstating ASC 730?
A6. The accounting profession has several oversight review boards related to the preparation of Certified Audited Financial Statements. The Public Company Accounting Oversight Board (PCAOB) establishes auditing and related professional practice standards for registered public accounting firms to follow in the preparation and issuance of audit reports. The PCAOB oversees public accounting firm compliance with Generally Accepted Auditing Standards and ensures that these firms conduct audits with professional skepticism and remain independent.

In addition, the American Institute of Certified Professional Accountants (AICPA) established the Code of Professional Conduct (Code). This Code provides that accounting firms must establish a set of internal quality control policies and procedures as well as a system to monitor and report on compliance.

AICPA members in public practice should follow “due care” which requires providing services with competence and diligence whether the service involves publicly held or non-publicly held entities.

Significant oversight and accountability exists in the audit of financial statements. This reasonably ensures that the financial statements are free from material misstatements and represent the true economic picture of the taxpayer.

Falsifying ASC 730 on the financial statements can equate to fraud. Most Certified Professional Accountants (CPAs) will not risk their certification or that of their business to falsify the ASC 730 amounts.

In addition, if a taxpayer commits fraud on its financial statement, the taxpayer is likely to be in default with its loan covenants and its entire debt would become currently payable.

Back to Top

Q7. Who are third party auditors? Can they be the same individuals who prepared the research credit studies?
A7.
Third party auditors are CPAs who attest to the financial statements. There are rules regarding what a CPA can or can't do in other capacities for a taxpayer. Typically, the functions between Accounting/Auditing and Tax are separate and distinct. In addition, since Auditors cannot opine on their own work/study, it is unlikely they would prepare research credit studies.

Back to Top


ASC 730 Directive

Q1. To whom does the Directive apply?
A1. The Directive specifically states that it only applies to LB&I taxpayers (i.e. assets equal to or greater than $10,000,000) who follow U.S. GAAP to prepare their Certified Audited Financial Statements which show as a separate line item on the income statement included in their Certified Audited Financial Statements or show separately stated in a note to their Certified Audited Financial Statements the amount of the currently expensed ASC 730 FS R&D.

Back to Top

Q2. Could the Directive apply to a taxpayer in the Compliance Assurance Program (CAP)?
A2.
Yes, if the CAP taxpayer meets the requirements in Question 1 of this section.

Back to Top

Q3. What are the benefits of using the Directive to determine the ADJ ASC 730 FS R&D QREs on original tax returns filed on or after 9/11/2017?
A3.
For taxpayers who comply with the certification requirements in Part IV of the Directive and compute their ADJ ASC 730 FS R&D costs following both the methodology in Appendix C and the definitions provided in Part III (Appendix E) of the Directive, LB&I examiners will not challenge QREs which are the ADJ ASC 730 FS R&D costs for the credit year.

Back to Top

Q4. What is the meaning of the Original Return Requirement?
A4.
The Original Return Requirement means that only original returns filed on or after 9/11/2017 are eligible for the benefits of the Directive.  Amended returns are ineligible for the benefits of the Directive.

Back to Top

Q5. For research credits originating from tax returns filed prior to 9/11/2017 and carried forward to tax returns filed on or after 9/11/2017, do the benefits of the Directive apply to the credits carried forward?
A5.
No. The benefits of the Directive only apply to credits from originally filed tax returns filed on or after 9/11/2017. Credits carried forward from tax returns originally filed prior to 9/11/2017 are not eligible for the benefits of the Directive.

Back to Top

Q6. If the taxpayer did not follow the Directive when it originally claimed the research credit on its tax return filed on or after 9/11/2017, may the taxpayer request to follow it during examination?
A6.
Yes. If the taxpayer follows U.S. GAAP accounting and separately reports ASC 730 R&D costs on its Certified Audited Financial Statements, the taxpayer may inform the exam team that it would like to follow the Directive.

Back to Top

Q7.  If a taxpayer filed its return before 9/11/2017 and is subsequently audited, is the taxpayer eligible for the benefits of the Directive?
A7.
No. Only a taxpayer who files its return on or after 9/11/2017 is eligible for the benefits of the Directive. However, Exam can use the Directive as an audit tool in assessing the taxpayer’s eligible QREs, subject to full risk analysis and normal audit procedures.

Back to Top

Q8. If an employee has wages reported both inside ASC 730 FS R&D cost centers and outside these cost centers, what amount of W-2 wages qualifies for the benefits of the Directive?
A8.
The Directive only applies to wages separately reported as ASC 730 R&D on the Certified Audited Financial Statements. Therefore, only the book wages recorded as ASC 730 R&D qualify. The Directive does not apply to wages reported outside of ASC 730 in determining the QREs under the Directive.

Back to Top

Q9. Are wages reported outside of the ASC 730 FS R&D amount eligible for the benefits of the Directive?
A9.
No. Only those employees’ wages treated for book as ASC 730 R&D and reported as such on the Certified Audited Financial Statements are eligible for the benefits of the Directive.

Back to Top

Q10. For the benefits of the Directive to apply, must a taxpayer attach the Certification Statement and required Appendices to the taxpayer's filed federal income tax return?
A10.
No. The taxpayer does not have to attach the Certification Statement and the required Appendices to the return. Upon examination, a taxpayer who separately states ASC 730 FS R&D on its Certified Audited Financial Statements, may request to follow the Directive and complete the Appendices and Certification Statement at that time

Back to Top

Q11. For the benefits of the Directive to apply, when must the taxpayer provide the completed Certification Statement and Appendices?
A11.
If the taxpayer does not voluntarily attach the Certification Statement and required Appendices to the tax return, Exam should verify with the taxpayer at the beginning of the audit whether they followed or plan to follow the Directive. If the taxpayer plans to follow the Directive, Exam should allow a reasonable amount of time for the taxpayer to prepare the Certification Statement and Appendices.

Back to Top

Q12. Can the methodology in the Directive for determining QREs apply to open examinations for tax returns filed prior to 9/11/2017 or amended returns filed after 9/11/2017?
A12.
Yes. Exam may use the methodology in the Directive as an audit tool if the taxpayer follows U.S. GAAP accounting for reporting ASC 730 R&D costs for book and separately states those same costs on their Certified Audited Financial Statements as R&D. However, all QREs claimed by the taxpayer are subject to risk analysis and normal examination procedures.

Back to Top

Q13. Can Small Business Self Employed taxpayers who have ASC 730 R&D on their Certified Audited Financial Statements receive the benefits of the Directive?
A13.
No. The Directive only applies to LB&I taxpayers and LB&I examiners.

Back to Top

Q14. How do taxpayers choose to participate in the Directive?
A14.
Taxpayers may participate in the Directive either by voluntarily attaching the Certification Statement and the Appendices to their tax return, or upon notification of audit, by informing the exam team that they would like to follow the Directive. Early in the audit process, Exam should verify with taxpayers who follow U.S. GAAP and separately state R&D on their Certified Audited Financial Statements whether they followed or plan to follow the Directive.

Back to Top

Q15. Does a taxpayer who follows the Directive still report an Uncertain Tax Position (UTP) for the Research Credit?
A15.
Possibly. An UTP may still exist if the taxpayer:

  • Reports QREs in columns B or C of Appendix B or
  • Is uncertain about the types of accounts included or excluded in the adjustments on Appendix C of the Directive.

Back to Top

Q16. Once a taxpayer chooses to follow the Directive, must the taxpayer follow the Directive in all subsequent years?
A16. No. A taxpayer makes a tax year by tax year choice whether to follow the Directive.

Back to Top


ASC 730 Directive Appendix B

Q1. May taxpayers claim QREs in addition to the ADJ ASC 730 FS R&D amounts included in the Directive?
A1.
Yes. The Directive only applies to the ADJ ASC 730 FS R&D Costs, i.e., the costs determined from Appendix B, column A. Taxpayers may report additional QREs they believe qualify as research expenditures in columns B & C of Appendix B. Taxpayers then total rows A, B & C and report the appropriate costs on the Form 6765.

Back to Top


ASC 730 Directive Appendix C

Q1. In computing the ADJ ASC 730 FS R&D, must the taxpayer remove amounts that might otherwise qualify as IRC 41 QREs?
A1.
Yes. A taxpayer choosing to follow the Directive must adhere to the steps in Appendix C and D and the definitions in Appendix E of the Directive to properly calculate its ADJ ASC 730 FS R&D QREs. The taxpayer must appropriately remove costs not eligible for the benefits of the Directive. However, if the taxpayer determines that the costs removed from ASC 730 qualify under IRC 41, the taxpayer may report the appropriate amounts in column B of Appendix B.

Back to Top

Q2. Does Appendix C adjust for indirect costs reported in ASC 730 accounts?
A2.
Yes. The taxpayer adjusts on line 5 of Appendix C, the costs not eligible under IRC 174. The taxpayer further adjusts on Appendix C, line 6, those indirect costs which are neither wages nor supplies nor contract expenses. Then, on line 10, the taxpayer adjusts costs such as prototype overhead, patent costs, or severance payments.

Back to Top

Q3. Why are all contract costs removed on lines 7 & 8 of Appendix C?
A3.
Appendices C & D make mechanical adjustments to the ASC 730 FS R&D amount. Determining the allowance of contract costs requires more than a mechanical review of the costs claimed. Allowing contract costs requires a review of the contract to determine potential funding issues (i.e., a non-mechanical analysis.) Therefore, the Directive removes all contract costs from the computation of the ADJ ASC 730 FS R&D.

Back to Top

Q4. Does the removal of contract costs prevent the taxpayer from claiming any costs associated with contract research as QREs on the Form 6765?
A4.
No. If the taxpayer determines that a contract involves qualifying research activities not otherwise excluded (including rights and risks), the taxpayer reports the IRC 41(b) costs in Appendix B, column B (costs from ASC 730 FS Cost Centers) or column C (costs outside of ASC 730 Cost Centers).

Back to Top


ASC 730 Directive Appendix D

Q1. Is the taxpayer required to claim both the 95% limitation and the 10% limitation when calculating the taxable W-2 wages allowed as ADJ ASC 730 FS R&D QREs?
A1.
No. There is no requirement to claim either or both limitations. However, if the taxpayer chooses not to take the 95% limitation for the Qualified Individual Contributors (QIC) and 1st Level Supervisor Managers, then the QIC, 1st Level Supervisor Managers and Upper Level Managers wage QREs are zero for purposes of the Directive.

For example, if the taxpayer had (before the 95% or 10% limitation):

  • $100,000 in QIC Base & Stock Option W-2 wages
  • $50,000 in 1st Level Supervisor Managers Base & Stock Option W-2 wages, and
  • $1,000,000 in Upper Level Managers W-2 wages,

they would report $95,000 ($100,000 * 95%) and $47,500 ($50,000 * 95%) respectively on lines 3 & 6 of Appendix D.

Following the instructions in Appendix D, taxpayers then calculate the Upper Level Managers wages by limiting the amount allowed to the lesser of 10% of the combined amounts on lines 3 & 6 (10% of $142,500, i.e. $14,250) or the W-2 wages paid to Upper Level Managers ($1,000,000). In this example the Upper Level Managers wage limit is $14,250 since it’s less than the $1,000,000.

If a taxpayer wants to claim an amount above 95% of both their QIC and 1st Level Supervisor Managers W-2 wages as QREs, the taxpayer reports zero wages on line 3 and 6 of Appendix D. Zero wages reported on both these lines means zero Upper Level Managers wages allowed.

Thus, if the taxpayer chooses not to take the 95% limitation for the QIC and 1st Level Supervisor Managers, no wages are eligible for the benefits of the Directive.

In addition, if the taxpayer claims 95% for the QIC and 1st Level Supervisor Managers, they may not claim the remaining 5% as QREs on columns B or C of Appendix A.

See Question 2 in this section regarding the 10% Upper Level Managers limitation.

Back to Top

Q2.  What steps must a taxpayer follow to claim (as QREs) more Upper Level Managers wages than the limitation imposed by Appendix D?
A2.
If the taxpayer wants to claim more than the limitation calculated on Appendix D for the Upper Level Managers wages, the taxpayer must not claim any of the Upper Level Managers wages as part of the ADJ ASC 730 FS R&D QREs. The taxpayer reports $0 Upper Level Managers wages on line 7 of Appendix D and line 17 of Appendix C.

The taxpayer then determines under IRC 41, the qualifying Upper Level Managers wages (from ASC 730 accounts) in column B, Appendix B. Exam may conduct risk analysis on this amount.

Back to Top

Q3. May the taxpayer claim the remaining Upper Level Managers wages in excess of the limit from Appendix D as QREs in column B, Appendix B?
A3.
No. If the taxpayer claims the limit per Appendix D, the taxpayer does not claim any additional Upper Level Managers wages on Appendix B as part of the ADJ ASC 730 FS R&D.

Back to Top

Q4. How was the 10% Limit for the allocation of Upper Level Managers wages determined?
A4
. During the Industry Issue Resolution process, the team evaluated different ways of capturing the appropriate costs to include in the Directive. Based on the analysis of data from taxpayers who volunteered data, examination results, and the information gained during discussions with externals, the team determined that the 10% limit on the allowed QIC and 1st Level Supervisor Managers wages appropriately limited the allowable Upper Level Managers wages for purposes of the Directive.

Back to Top

Q5. Are indirect wages such as Receptionist wages removed from the ADJ ASC 730 FS R&D?
A5
. Not necessarily. The Directive defines Qualified Individual Contributors as "Employees of the Taxpayer who do not manage any Taxpayer employees and whose wages are charged to U.S. ASC 730 Financial Statement Cost Centers." If the Receptionist's wages, charged to ASC 730 FS cost centers, do not require removal for any of services/activities mentioned on Appendix C lines 5, 7, 8, 9 or 10, the QRES determined under the Directive include these wages. These types of wages are typically not material in amount.

Back to Top


Interaction with Code Sections

Q1. Does the consistency rule under IRC 41(c)(5) apply to the Directive? Is there a requirement for the base years to follow the methodology outlined in the Directive? If so, are certifications required for the prior/base years?
A1
. The Directive is silent regarding the statutory consistency rule. Therefore, in determining QREs, the consistency rule applies. Since the incremental research credit applies only to the increase in research spending over the base amount, accurate measurement of the increase only exists if the taxpayer includes all the same type of expenses in the credit computation for both the base years and the credit year. The consistency rule ensures that there is an accurate determination of the relative increase in research.

IRC 41(c)(5) requires consistent treatment of expenses. QREs considered in computing the fixed-base percentage must be consistent with the determination of the QREs for the credit year. Treas. Reg. 1.41-3(d) further emphasizes that a taxpayer must consistently determine QREs in the fixed-base percentage or base amount on a basis consistent with the definition of QREs for the credit year. When computing the research credit, a taxpayer must consider the same types of QREs included in the credit year as considered in the base or preceding years.

That does not mean that a taxpayer who chooses to follow the Directive must go back to the base years and compute the QREs following the Directive template. However, the taxpayer needs to consider the types of activities and associated costs included in the current year and whether the taxpayer included those same types of activities and associated costs in the base years.

The fact that a taxpayer elects to adopt the Directive methodology to capture QREs in the current year does not necessarily mean that the taxpayer didn’t capture and claim the same type of QREs in the base period using a different methodology.

It’s important for the exam team to discuss with the taxpayer the types of activities and associated costs used in the current year and whether the taxpayer had those same types of costs and activities in the base years.

Back to Top

Q2. May the taxpayer still apply the “substantially all” rule under IRC 41(b)(2)(B) to wages before computing the 95% limitation under Appendix D?
A2.
No, the “substantially all” rule does not apply to the wage QREs determined under the Directive.

IRC 41(b)(2)(B) provides that if substantially all of the services performed by an individual for the taxpayer during the taxable year consist of services meeting the requirements of IRC 41(b)(2)(B)(i) and (ii), then the term "qualified services" means all the services performed by the individual for the taxpayer during the taxable year.

Treas. Reg. 1.41-2(d)(2) provides that services performed under IRC 41(b)(2)(B) constitute substantially all of the services performed by the individual if at least 80% of the wages paid or incurred by the taxpayer for the individual during the taxable year were for services meeting the requirements of IRC 41(b)(2)(B).

However, the Directive specifically states that W-2 wages for employee compensation added to the U.S. ASC 730 FS R&D in Step 4 of Appendix C should not include any amounts relating to the subtractions in Steps 1 - 3.

For example, if the ASC 730 accounts on the Certified Audited Financial Statements include 100% of a QIC’s wages ($50,000), and 15% of those wages ($7,500) were for services performed abroad, then the taxpayer only includes 85% of those W-2 wages ($42,500) in the 95% limitation for QICs, i.e. Step 1 of Appendix D. As a result, only $40,375 (95% of $42,500) versus the $50,000 (100% per the substantially all rule) of the employee’s wages qualify as QREs under the Directive. The taxpayer may not claim any of the remaining 15% as QREs on column B or C of Appendix B.

Back to Top

Q3. How does the Orphan Drug Credit (ODC) impact the Directive?
A3.
A taxpayer may choose to claim a tax credit for qualifying clinical testing expenses that also qualify as QREs either under IRC 45C or under IRC 41 but may not claim both credits for the same expenses.

Back to Top

Q4. Can taxpayers use the Directive to compute their IRC 45C qualified clinical testing expenses?
A4
. No. The Directive only applies to determining QREs under IRC 41, not qualified clinical testing expenses under IRC 45C. Taxpayers may not use the Directive in determining their IRC 45C expenses.

Back to Top

Q5. If the taxpayer chooses to follow the Directive in calculating its QREs, is this a change in their method of accounting?
A5
. No. Changing the methodology to calculate QREs is not a change in accounting method.

Back to Top


Substantiation

Q1. Is the taxpayer required to provide the information identified in the Directive to the exam team upon request? Is this the only information the taxpayer must provide to the exam team?
A1.
To be eligible for the benefits of the Directive, the taxpayer must provide the documents identified in Part IV of the Directive upon request from Exam. This is not an exclusive list. If the taxpayer used additional documents to make the required adjustments on Appendix C or D, the taxpayer must also provide that information to Exam to verify the accuracy of the adjustments.

Back to Top

Q2. What is the meaning of account balance detail?
A2.
The account balance details are the transaction details (i.e. debit and credit entries) recorded in all ASC 730 R&D GL accounts that comprise the ASC 730 FS R&D.

Back to Top

Q3. If the consistency rule applies, what type of substantiation supports the base amount computations?
A3
. Although the consistency rule does apply, (i.e. the Directive does not remove the requirement of IRC 41(c)(5)), it does not mean that a taxpayer who chooses to follow the Directive must go back to the base years and re-compute the QREs following the same template. The taxpayer needs to consider the types of activities and associated costs included in the current year and whether those same types of activities and associated costs occurred in the base years. Exam should discuss with the taxpayer the types of activities and associated costs used in the base years as compared to the current year.

Back to Top

Q4. Are there proforma IDRs available to request the required documents?
A4
. No. Exam can create an IDR from the list of required documents found on pages 3 & 4 of the Directive.

Back to Top


Directive Audit Steps

Q1. Does the use of the term Research & Development, Product Development, Technology and Development, Engineering R&D, etc., on public reporting or independent audited financial statements provide assurance that the amounts represented only include ASC 730 R&D expenses?
A1. ASC 730 has no nomenclature requirement for financial statement reporting. Taxpayers use other terms e.g., Product Development; Technology and Development; Engineering R&D; etc. to report ASC 730 R&D expenses and other similar costs. Costs associated with these terms can also include costs other than ASC 730 R&D costs. The exam team should look to the notes of the financial or independent audit statement to see if the taxpayer is affirming that the amount disclosed (regardless of the terminology) is only the relevant ASC 730 components.

Back to Top 

Q2. What steps can the exam team take to verify the amount of ASC 730 R&D expenses reported on the certified audited financial statements?
A2. Exam teams can request taxpayers to provide a copy of the financial statement auditor’s work paper(s) quantifying the audited ASC 730 R&D expenditures. Following the Information Document Request process, the exam team can also ask taxpayers to provide verification through a signed statement from the auditors that prepared the Certified Audited Financial Statements as to:

  • The amount of expenditures examined and identified as ASC 730 R&D,
  • Where on the Certified Audited Financial Statements the taxpayer reports their ASC 730 R&D expenditures, and
  • Whether the amount of expenditures examined and identified as ASC 730 R&D meet the Disclosure requirements of ASC 730-10-50-1.

Back to Top

Q3. What audit steps should Exam take in reviewing the amounts determined as the ADJ ASC 730 FS R&D QREs?
A3.
Examinations under the Directive involve mechanical reviews of the adjustments made to the taxpayer's ASC 730 R&D costs separately reported on their Certified Audited Financial Statements. Exam should verify the starting point number (ASC 730 FS R&D) and the required adjustments made on each line of Appendices C & D. Exam can request from the taxpayer the information used to compute the adjustments made on Appendix C and D and the other required information outlined in the Directive. Reviewing this information helps verify that the taxpayer made the appropriate adjustments in determining the ADJ ASC 730 FS R&D QREs.

Back to Top

Q4. What audit steps should Exam take in reviewing the amounts determined as QREs outside the ADJ ASC 730 FS R&D QREs, i.e., Appendix B, columns B & C?
A4.
The exam team should risk the QREs in columns B & C of Appendix B to determine the scope of the examination. These QREs are outside of the scope of the Directive and are subject to the same risking as that of other research credit QREs.

Back to Top

Q5. How does Exam verify that the taxpayer correctly identified an employee's job position in the ASC 730 cost centers, i.e., Upper Level managers not recorded as 1st Level Supervisor Managers or QICs?
A5.
The Directive requires the taxpayer to provide a list of employees with the respective W-2 wage amounts the taxpayer reported as additions to U.S. ASC 730 FS R&D in Step 4 of Appendix C. This list should also identify for the applicable taxable year each employee's job title, reporting level, and cost center where each of those employees worked. To verify the accuracy of the reporting levels, the exam team can sample the employees and request supporting documentation.

Back to Top

Q6. Do the MITRE mandatory referral requirements still apply for a taxpayer following the Directive?
A6.
Yes. In general, ASC 730 does not include the costs for developing internal-use software. Therefore, the ASC 730 FS R&D amount typically does not include these software costs.

Since ASC 730 costs rarely include internal-use software development costs, meeting the mandatory referral threshold is unlikely for these software development costs. However, if the taxpayer is reporting sufficient costs outside of ASC 730, (i.e., in column C of Appendix B) involving software development activities that meet the mandatory referral limit, there is a requirement to make a MITRE referral.

Back to Top

Q7. How does management plan to track taxpayers who follow the Directive?
A7.
To aid in measuring the effectiveness of the Directive, exam teams should input the following for each taxable year the taxpayer follows this Directive:

  • Project Code 1511
  • Tracking Code 6750

If the tax return already has a Project and/or Tracking Code on it, keep the project code but override the tracking code and enter 6750 e.g. for Joint Committee Cases, keep the 077-project code but input the Directive tracking code 6750.

Back to Top


Penalties

Q1. Is there any penalty protection for taxpayers who try to follow the Directive?
A1
. No, there is no penalty protection. The same penalty rules apply when following the Directive as for any other examination.

Back to Top