New GAO Report on R&D Tax Credit – Key Changes and Additional Clarity

The General Accountability Office (GAO) recently released a report of its findings regarding the Research & Development (R&D) Tax Credit.

Congress periodically asks the GAO to provide a report on the R&D tax credit. As Congress considers making the R&D Tax Credit permanent, this report provides input and conclusions derived from both the IRS and independent sources with the goal of making the credit more fair and more effective in its intended goal of encouraging domestic research and development activity. This year’s 119-page report to the Senate Finance Committee, which includes much detail and illustrative material, focuses on the efficacy of the R&D credit and areas where improvements and guidance are needed.

The GAO reviewed the various methodologies used to calculate the R&D credit (i.e. the Alternative Simplified Credit (ASC) and the regular credit), along with the issues surrounding the definition of gross receipts for a controlled group, recordkeeping, and substantiation of the R&D credit and issues relating to the definition of qualified research expenses. The report also stated that the Treasury intends to issue further guidance on the complex rules that currently govern the qualification of internal-use software development for the R&D Tax Credit. The resulting report includes significant conclusions and recommendations.

The conclusions presented in the GAO report focus on the ASC. Currently, the ASC can only be elected on an original tax return. The GAO commentators state that taxpayers should be allowed to elect the ASC on either an original or an amended return. Specifically, the report reads “there appears to be no reason to prohibit taxpayers from electing either the ASC or AIRC method of credit computation on an amended return.”

Furthermore, The GAO reports that commentators “believe that taxpayers should be allowed to change their election if, as a result of an audit, the IRS adjusts the amount of QREs or base QREs in a manner which would make an alternative election more advantageous to the taxpayer.” This could have a huge impact on taxpayers in audit situations wherein the base amount minimizes the credit.

The GAO report also recommends an organized dialogue among the Treasury, IRS, taxpayers, and tax practitioners in order to reduce some uncertainty as to the types of research documentation which are acceptable.