Expected new reporting requirements for the Research Credit on Form 6765

ARTICLE | December 18, 2024

Authored by RSM US LLP

Executive summary: Proposed Form 6765 will require taxpayers to substantially change approach to Research Credit claim reporting

The IRS has released a new draft Form 6765, Credit for Increasing Research Activities, that would require taxpayers to report additional pertinent information in order to claim the Research Credit on future tax returns.

Most noteworthy changes surround business component reporting that could complicate the process for taxpayers in claiming the Research Credit due to the information required to be reported by business component. With the Business Component Detail reporting to become mandatory beginning in tax year 2025, taxpayers should begin preparing for such changes now.

Proposed Changes to Form 6765

On Sept. 15, 2023, the IRS first provided a preview of proposed changes to certain sections of Form 6765, Credit for Increasing Research Activities, to request feedback from stakeholders before the formal draft release process. On June 21, 2024, the IRS released the revised draft Form 6765 following public comment on the preview of the proposed changes.

The IRS claimed the proposed changes to the Research Credit form are intended to provide taxpayers with a consistent and predefined format for reporting credit claims and to improve the information received for tax administration. Because the Research Credit is frequently reviewed upon examination, the item can consume significant resources for both taxpayers and the IRS.

The most significant change to the proposed Form 6765 is the addition of a new Business Component Detail section for reporting quantitative and qualitative information for each business component included in the credit claim (the new “Section G”). The Business Component Detail section will require taxpayers to provide a substantial amount of information that has not been previously required to claim the Research Credit, hence the concern among stakeholders as to the additional burden this will place on taxpayers with legitimate Research Credit claims.

Examples of the new qualitative information required include the business component type and the information sought to be discovered by the research activities. Yet the burden of additional quantitative reporting could be even more onerous, as taxpayers will be required to report qualified research expenditures (e.g., qualified wages, contract research costs, supply costs, and computer rental costs) by business component within the claim.

Among other adaptations to the form, the IRS added a new Section E with five questions seeking miscellaneous information intended to address consistency requirements in the credit calculation. Examples of such miscellaneous information include the number of business components generating the qualified research expenditures (QRE), the amount of officers’ wages included in the credit claim, and whether the taxpayer acquired or disposed of any major portion of a trade or business in the tax year, among other information.

With the revised draft issued in June 2024, the IRS then made further changes to reduce the new information to be reported on the form and to thus “alleviate taxpayer burden.” However, the vast majority of the additional information required by the new draft Form 6765 did not change, and thus it would appear that taxpayers will need to adapt to these substantial form changes for future tax years. The most notable changes to the updated draft form are summarized below:

• Section G will require taxpayers to report 80% of total QREs in descending order by the amount of total QREs per business component, but no more than 50 business components.
• For tax years after 2024, Section G will be optional for Qualified Small Business (QSB) taxpayers, as defined in section41(h)(1) & (2), who claim a reduced payroll tax credit; or taxpayers with QRE of $1.5 million or less, and $50 million of gross receipts or less (determined at the controlled group level) that are claiming a Research Credit on an original filed return.

Furthermore, Section G will be optional for all filers for tax year 2024; Section G will be effective for tax year 2025 and future tax years.

The Importance of Business Components

With the addition of the Business Component Detail section to Form 6765, it would appear that the IRS is hoping to obtain more transparent information with tax return filings in terms of how taxpayers are determining the business components and the associated qualifying research costs for which they are claiming the section 41 credit.

Section 41(d)(2)(B) defines a “business component” as any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer.

The determination of business components and qualifying research activities have been found at the center of recent case law. Section 41(d)(1)(C) requires that substantially all research activities must constitute elements of a process of experimentation for such activities to meet the definition of qualifying activities for purposes of the Research Credit. Reg. section1.41-4(a)(6) defines “substantially all” as meaning 80% or more. As such, for a business component to qualify for the credit, at least 80% of the research activities must relate to a process of experimentation.

In Little Sandy Coal Company, Inc. v. Commissioner of Internal Revenue, No. 21-3145 (7th Cir. 2023), the US Court of Appeals for the Seventh Circuit held that the taxpayer’s activities failed to meet the substantially all rule under section 41(d)(1)(C), as 80% or more of the taxpayer’s activities for its business components did not consist of a process of experimentation. Had the taxpayer differently identified its business components, the taxpayer could have possibly met the substantially all requirement based upon the courts’ interpretation of the rule.

Furthermore, in Leonard L. Grigsby et al. v. The United States, No. 22-30764 (5th Cir. 2023), the court’s ruling partially focused on the taxpayer’s inability to define a valid business component for the research credit. While the taxpayer had originally defined its business components for the credit as “products,” the IRS argued that the oil refineries and flood control systems built under contract by the taxpayer would not be considered a “product” of the taxpayer. When the taxpayer rebutted that the business components were construction processes, the court noted that the taxpayer had failed to identify even one new or improved process.

Therefore, taxpayers should consider carefully how they define business components within their Research Credit claims, especially when considering the increased reporting requirements proposed by the draft Form 6765. If taxpayers do not ensure that business components as reported on the draft Form 6765 meet the substantially all rule under section 41(d)(1)(C), this could create a significant area of risk upon exam.

Washington National Tax takeaways

Since the June 2024 release, the IRS has not provided any further official updates. However, the IRS is expected to release new instructions for the Form 6765 in the near future. The IRS noted that they will provide certain guidance within the updated instructions, such as clarifying information for the reporting of officers’ wages, controlled group reporting and business component descriptive names.

While the revised draft Form 6765 reduced the additional information required to be reported from the original draft form, the changes to the information required to claim a Research Credit could significantly increase the burden of reporting on taxpayers. Taxpayers claiming a Research Credit should remain aware of these changes that would be implemented and required for claims filed for tax year 2025 and after.

Taxpayers should also carefully evaluate whether the new Section G is optional for them, in which case they could avoid the most burdensome changes proposed in the updated Form 6765 when such changes likely become mandatory in tax year 2025.

RSM US may assist taxpayers in determining which elements of the draft Form 6765 they will be required to complete. If new Section G is not optional for a specific taxpayer, RSM may also assist with determining the most streamlined approach to the new reporting requirements.