The IRS has issued guidance (LB&I Memorandum  LB&I-04-0917-005) that allows certain large taxpayers to adopt a simplified method of determining qualified research expenditures (QREs) to be used in computing the credit for increasing research activities under IRC §41.  The method makes use of the entity’s audited financial statement’s amount of research and development expenditures reported as an expense under the provisions found in Financial Accounting Standards Codification ASC 730, Research and Development.

To be eligible to use this method the organization must initially meet the following three criteria:

• Must have assets greater than or equal to $10 million (that is, taxpayers whose exams are conducted by the IRS Large Business & International Division);
• Must follow U.S. GAAP for financial reporting purposes;
• Must have obtained an audit report on a GAAP financial statement that is either
  • A clean opinion;
  • A subject to opinion that does not involve a contingency related to ASC 730;
  • A except for opinion that covers a method of accounting the outside auditor disagrees with that does not involve ASC 730; or
  • An adverse opinion not related to ASC 730, but only if the auditor discloses the  amount of disagreement with the statement
• The financial statement must report, either as a line item or in disclosures to the financial statement, the amount of ASC 730 expenses.

The amount of QREs will be determined by starting with ASC 730 expenses per the financial statements, and then adjusting that number based on adjustments found in the Appendix C worksheet found in the memorandum.  The resulting number is referred to in the guidance as “Adjusted ASC 730 Financial Statement R&D.”

An eligible taxpayer may opt in to using this method by attaching the disclosure statements found in the referenced appendix of this procedure to the taxpayer’s tax return.

• Appendix A – Certification Statement Claiming Adjusted ASC 730 Financial Statement R&D as QREs
• Appendix B – Reconciliation of Form 6765 QREs to Adjusted ASC 730 Financial Statement R&D.  (Reconciliation should include a breakdown of costs as detailed in Appendix B).
• Appendix C – Computation of Adjusted ASC 730 Financial Statement R&D
• Appendix D - Adjusted ASC 730 Financial Statement R&D Wage Detail

The Appendix A certification noted above reads as follows:

Taxpayer Name:

Taxpayer EIN:

Taxable Year Ending:

Relevant Period(s) of Applicable Certified Audited Financial Statement(s):

CERTIFICATION

By signing this Certification Statement, Taxpayer agrees to readily provide (upon request of the IRS) all relevant data and records to establish to the satisfaction of the IRS that the statements made in this certification statement are true, correct and complete.

I certify, under penalties of perjury, that for the taxable year ending ____________, the computation of Adjusted ASC 730 Financial Statement R&D has been computed in accordance with the definitions and methodology set forth in this Directive and that all information provided in accordance with this Directive, to the best of my knowledge and belief, is true, correct, and complete.

Signature:

Title:

Date:

The other appendices contain worksheets that must be attached to the return to reconcile the financial statement reported numbers to those reported on the tax return, providing specific detail about various computations.

The following documentation must be maintained by the employer and made available to the examiners upon request:

• Certified Audited Financial Statement for the Credit Year including auditor’s certifying opinion;
• Taxpayer’s Chart of Accounts;
• List of U.S. ASC 730 Financial Statement Cost Centers that make up the ASC 730 Financial Statement R&D amount shown in Step 1 of Appendix C.
• All ASC 730 R&D GL Accounts with account balance details that make up the ASC 730 Financial Statement R&D amount shown in Step 1 of Appendix C.
• List of ASC 730 R&D GL Accounts with account balances that make up the adjustments in Steps 2 through 4 of Appendix C.
• Taxpayer’s organization chart showing employees and levels of management for the Credit Year.
• Executed contracts pursuant to which Taxpayer is performing ASC 730 research in order to comply with the terms of the contract.
• Executed contracts pursuant to which persons other than employees of Taxpayer are  performing ASC 730 research on behalf of Taxpayer.  This would include sufficient information to show what research was performed outside the U.S.
• List of employees with their respective W-2 Wage amounts claimed as additions to U.S. ASC 730 Financial Statement R&D in Step 4 of Appendix C, which list would also identify for the applicable taxable year each employee’s job title and reporting level and the cost center where each of those employees worked.

If a taxpayer complies with the requirements in the memorandum, the memorandum provides “LB&I examiners will not challenge QREs which are the Adjusted ASC 730 Financial Statement R&D costs for the Credit Year.”

Though providing a taxpayer is supposed to have attached the documents, the memorandum goes on to provide that a Taxpayer may still be examined under this provision:

If these documents were not voluntarily attached to the return, the audit team at the beginning of the examination of the Research Credit will verify whether the Taxpayer followed or plans to follow the Directive.

The program only applies to original returns timely filed on or after September 11, 2017.