In a Directive dated September 11, 2017, the IRS Large Business and International Division (LB&I) issued new guidance for examinations of research credit claims. The Directive outlines new procedures “intended to provide an efficient manner of determining qualified research expenses (QRE’s) for LB&I taxpayers that meet the requirements of the Directive and to more efficiently manage LB&I’s audit resources.” Under the Directive, certain taxpayers may qualify for a safe harbor for their QRE’s claimed for the research credit – the safe harbored QRE’s will not be subject to the normal project based documentation standards under audit and will not be challenged by the IRS if the requirements of the Directive are followed.

The Directive and safe harbor is available to taxpayers who

  1. fall under the LB&I audit jurisdiction, meaning taxpayers with assets of $10,000,000 or more;
  2. issue certified, audited financial statements following US GAAP; and
  3. show on a separate line of the financial statements or in a separately stated note included with the financial statements, the amount of the currently expensed R&D costs under ASC 730 Financial Statement R&D.

The Directive applies to original timely filed tax returns (including extensions) filed on or after September 11, 2017. A superseding return can be filed by the extended due date if the taxpayer has an extended due date that has not passed and the return has already been filed. For example, a calendar year C corporation with an extended due date of December 15, 2017 that already filed its 2016 return in June can file a superseding return by December 15, 2017. Amended returns are not available to add the certification and disclosures (discussed below) to the return.

To calculate the deduction, start with the ASC 730 Financial Statement R&D amount from the audited financial statement, and then adjustments are made to arrive at “Adjusted ASC 730 Financial Statement R&D Costs.” The Adjusted ASC Financial Statement R&D Costs are safe-harbored if calculated in accordance with the Directive.

The adjustments include reductions for amounts that are generally included as GAAP research costs that are not qualified expenses for the credit: costs related to quality control testing and other specifically excluded activities, costs that don’t qualify for the credit (such as shipping, travel, overhead, G&A, etc.), research performed outside the U.S., and patent expenses. Then the costs are further reduced by all amounts related to foreign entities and all contract research, and finally, wages are limited to 95% of the original amount.   Specifics on the calculation can be found in the Directive.

The taxpayer can attach a signed certification and schedules showing the calculation of the Adjusted ASC 730 Financial Statement R&D and a reconciliation from that amount to the amount of QRE’s claimed for the credit. Additional qualified amounts not covered under the safe harbor can be claimed for the credit – the credit does not limit or reduce total credit eligible QRE’s – QRE’s not under the safe harbor will be subject to the usual audit documentation standards and may by reviewed by the IRS. These disclosures are voluntary at the time of filing; the taxpayer will have an opportunity to present them under audit. Along with the disclosures, the taxpayer must have supporting documentation for the ASC 730 costs included in the audited financial statement.


Finally, there are a number of unanswered questions surrounding the Directive, including timing and base period issues, so there may be more developments to come. The calculation and analysis required is complex, and feasibility analysis should be done to see if the safe harbor is worth pursuing for your clients. In summary, if the taxpayer has a solid R&D methodology and project-based documentation, there may be minimal benefit from this safe harbor and the extra calculations and documentation that comes with it.

We are here to help – please reach out to a member of the Bonadio R&D Credit Team with questions or for assistance.

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