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IRS Increases Focus on Research Issues

Mar.19.2020

Some taxpayers might have been surprised last month when the IRS announced a campaign focusing on research credit and deduction issues—surprised to learn that there was not already a research credit and deduction campaign. Based on the IRS’s continued focus on research credit and deduction issues during audits and in the Compliance Assurance Process (CAP), it is easy to understand why taxpayers assumed the IRS already had a campaign in place.

Research Campaign

Since 2016, the IRS Large Business and International (LB&I) Division has been focusing its limited audit resources on enforcement “campaigns” with respect to issues having high compliance risk for large groups of taxpayers. There are now more than 50 campaigns.

In February, LB&I announced the Research Issues Campaign. The campaign will focus on Section 41, Credit for Increasing Research Activities, and Section 174, Research and Experimental Expenditures. LB&I said these code sections generate “some of the most prevalent tax issues” in LB&I audits and they use significant IRS and taxpayer resources. The campaign’s objectives are to promote voluntary compliance, focus resources on the highest risk research issues, and increase consistency of examinations. To achieve those objectives, the IRS will use issue-based examinations, form updates, and requests for guidance.

LB&I to Centralize Risk Review

Following the campaign announcement, LB&I issued a directive to its personnel regarding the centralized risk analysis of research issues under IRC Sections 41 and 174. According to the directive, a research risk review team will conduct a comprehensive risk analysis and then provide examination team a proper depth and scope of audit of the research issues. The review team will focus on identifying high risk returns. The review team consists of subject matter experts, engineers, revenue agents, and other specialists. The directive does not apply to CAP cases or Research Issues Campaign Inventory. For all other LB&I cases, the directive is effective for any new research issues identified on or after April 1.

What it Means for Taxpayers

Although corporate taxpayers might already be familiar with the IRS’s focus on research credit and deduction issues in their audits, we may begin seeing increased focus and more centralized management of these audits. This campaign announcement is a good reminder for taxpayers to consider the strength of their research credit computations, if they have sufficient substantiation, and if they want to use the IRS’s safe harbor for taxpayers that expense research and development costs on their financial statements pursuant to ASC 730.

Taxpayers evaluating the strength of the research credits and deductions should review the IRS’s Research Credit website. The website has the IRS’s Research Credit Audit Technique Guide, plus audit guides specifically for the aerospace industry and the pharmaceutical industry, and audit guidelines for research expenses for software development activities. Moreover, taxpayers relying on statistical sampling for substantiating their claims should review the IRS’s field directive regarding such studies. Although these guidelines are several years old, they still reflect the IRS’s current approach to audits involving research credit and deduction issues. It would be beneficial for taxpayers if the new Research Issues Campaign resulted in updated IRS materials.

For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

David B. Blair
Partner – Washington, D.C.
Phone: +1 202.624.2765
Email: dblair@crowell.com
Robert L. Willmore
Partner – Washington, D.C.
Phone: +1 202.624.2915
Email: rwillmore@crowell.com
Teresa Abney
Counsel – Washington, D.C.
Phone: +1 202.624.2667
Email: tabney@crowell.com

Senior Law Clerk John Arszulowicz also contributed to this alert.