Last fall, the Internal Revenue Service (“IRS” or the “Service”) published detailed proposed changes to the Form 6765 Credit for Increasing Research Activities, also known as the R&D Tax Credit. The Service asked for comment on the form from stakeholders in advance of the formal draft release process, with the plan for these changes to take effect for tax year 2024. On June 21, 2024, the IRS published IR-2024-171 with an updated Form and details as to how the comments received impacted adjustments to the form and confirming it will go into effect for tax year 2024.
Before the IRS’s proposed changes, the only information necessary to claim the R&D Tax Credit on an originally field return were the categorized qualified research expenses (“QREs”), qualified wages, supplies, rental or lease cost of computers, and contractor costs, and the base period calculation. The draft version of the Form 6765 includes several new and expanded sections including the following.
Section E (required for all taxpayers)
Section E requires answers to a series of questions to further allow the service to evaluate claims, including the number of business components generating the QREs used to calculate the credit, the amount of officers’ wages included as QREs, whether the taxpayer acquired or disposed of any major portion of a trade or business in the tax year, and whether the taxpayer included any new categories of expenditures as current year QREs.
Section G—Business Component Information
This section closely mirrors the information that IRS requires for amended returns claiming a refund based on the R&D Tax Credit. Specifically, it requires the identification and documentation of each business component included the credit calculation.
In order for expenses to be eligible for the R&D Tax Credit, the expenses must be incurred as part of qualified research activities. One prong of determining whether the activities constitute qualified research is that the taxpayer is developing a new or improved business component for sale, lease, or license or used by the taxpayer in its trade or business (Section 41(d)). A business component is defined as a product, process, computer software, technique, formula, or invention.
Thus, the IRS requests the qualitative elements:
- Business component’s name or unique alphanumeric identifier;
- Business component type (product, process, software, technique, invention, or formula);
- Software (if applicable, select from the available options); and
- A description of the information sought be discovered.
Then, the IRS requires a breakout of each expense category (qualified wages, supplies, rental or lease cost of computers, and contractor costs) based on the identified business component. In addition, for the qualified wages, there is a further requirement to distinguish by business component the wages categorized as direct research (ex/scientist performing experiments), direct supervision (ex/ technical lab manager), and direct support (ex/ note taker during lab experiments), see below.
Changes from the Previous Version
Section G, which was labeled “Section F” in the version of the form that the IRS shared last fall, requests the Business Component Detail. The instructions will provide that Section G will be optional for:
- Qualified Small Business (QSB) taxpayers, defined under section 41(h)(1) & (2) who check the box to claim a reduced payroll tax credit; or
- Taxpayers with total qualified research expenditures (QREs) equal to or less than $1.5 million, determined at the control group level, and equal to or less than $50 million of gross receipts, as determined under section 448(c)(3) (without regard to subparagraph (A) thereof), claiming a research credit on an original filed return.
The IRS also reduced the number of business components that must be reported on Section G to 80% of total QREs, in descending order by the amount of total QREs per business component, not to exceed 50 business components. The IRS also decreased the amount of information to be provided by business component.
Revised Section G will be optional for tax year 2024 allowing time to transition to the Section G format. Section G will be effective tax year 2025. All other sections of the form will be required for tax year 2024.
How to Prepare
The new Form 6765 represents a marked change in the requirements for filing the R&D Tax Credit for most taxpayers as well as provides clear communication to everyone claiming the credit as to what level of detail the IRS will expect in an examination. Certain requirements may pose hurdles to taxpayers.
- Section E – New Categories of Expenditures + Acquisitions & Dispositions: These questions are likely aimed at evaluating whether the claim is properly following the consistency requirements in Section 41(c)(5); however, without additional guidance as to what should be categorized as a new category of expenditure and how to account for that change in the credit calculation, these questions could create pitfalls for unaware taxpayers.
- Section G – Identification of Business Components: For many taxpayers claiming the credit, they may not have previously identified discrete business components or understood the requirements for determining qualification and calculating expenses at the business component or project level.
- Section G – Software: The form requires additional information for any software business component, including whether the software was developed for “internal-use”. This is a very nuanced area of the tax code, which requires an additional level of technical review to properly categorize and qualify projects.
This announced shift towards requiring additional information for all filings presents an opportunity for taxpayers to assess their current claims and internal processes to ensure they are in a position to meet the upcoming filing requirements.
Working with a seasoned professional can help ease the burden of these additional requirements. Contact CTI today and let our team of R&D experts work to help you gather, produce, and maintain a substantiation package necessary to support an R&D Tax Credit claim.
