Top Tax Attorney: Use Formal Regulations to Change R&D Tax Credit Requirements, Not Casual Legal Memos 

On February 4, a leading tax attorney—Robert J. Kovacev, a tax controversy partner in international law firm Norton Rose Fulbright's Washington, DC and San Francisco offices—argued that it was unfair of the IRS to change stipulations about submitting R&D tax credits via a legal memo, instead of codifying the regulatory change through formal, statutory regulations, calling it an “end-run.”  

Addressing an American Bar Association Section of Taxation virtual meeting, Kovacev said he was concerned that if the new requirements for R&D tax credit claims can be issued in a chief counsel memo, “Why couldn’t any other new requirements for refund claims or any of a number of types of returns or other issues be done just by the expedient of a legal memo?” He added: “There are pretty good incentives [for the IRS] to do an end-run around the Administrative Procedure Act and all the protections for the public and taxpayers it implies.”

IRS Announcement: R&D Tax Credit Requirements

In October 2021, the IRS announced the changed requirements in field attorney advice (in FAA 20214101F), asserting the changes were triggered by the poor quality of R&D tax credit claims the IRS was receiving, which were consuming a lot of the agency’s time.

The field attorney advice dictated that taxpayers are required to provide the following information when applying for research credit refunds:

  • all the business components that form the factual basis for R&D tax credits for the claim year;
  • all research activities performed by business components;
  • the names of all individuals who performed each research activity by business component; 
  • all the information each individual sought to discover by business component; and
  • the total qualified employee wage expenses, supply expenses, and contract research expenses.
R&D Tax Credit Requirements
IRS released interim guidance (LB&I-04-0122-0001)

The IRS began enforcing these changes January 10. Taxpayers have a one-year transition period, during which they’ll have 45 days to perfect research credit claims that failed to provide all required information. In early January 2022, the IRS released interim guidance (in LB&I-04-0122-0001) and an FAQ webpage.

But according to Kovacev, the IRS should issue these changes through formal regulations: “Regulations are similar to statutes on how they are written and how they are construed. The chief counsel memo, no matter how well argued and well written, simply isn’t a statutory regulation, and that gives rise to potential errors in interpretation. I think the process for promulgating regulations is very deliberate, but also provides results that avoid some of the issues that we’re seeing with using a legal memorandum to institute new requirements.” 

The IRS’ position? As a clarification of established law, this shouldn’t be a surprise to practitioners and taxpayers.

Kathryn Meyer of the IRS Office of Chief Counsel (Small Business/Self-Employed) declared that since practitioners have already been working with these requirements for many years, what’s in the memorandum is nothing new.

“You know this criteria, and you know how to write it up,” she commented. “From my perspective, this is not new. [These are] long-standing elements of section 41, and we are simply providing some clarity and transparency as to what we’re really looking for.”

In December 2021, De Lon Harris, commissioner of examinations, IRS Small Business/Self-Employed Division, voiced similar comments; he defended the decision to establish the requirements through a legal memorandum, declaring everything in the memorandum is already established law.

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