Tax Blog/Blawg

Under section 41 of the Internal Revenue Code, certain taxpayers are eligible to claim a credit for expenses incurred for the performance of qualified research and development activities. Although the research credit is not limited to specific industries or types of taxpayers, taxpayers in manufacturing, information technology, and professional, scientific, and technical services are often the main beneficiaries of this credit.

US-based taxpayers who meet the following four-part test may be eligible for the credit. First, the business component test requires that the activity seek to improve a specific component of the taxpayer’s trade or business and can include improvements to the functionality, reliability, performance, or quality of a product, process, software, technique or invention. Second, the technological information test requires that the taxpayer utilize existing “principles of the physical or biological sciences, engineering, or computer science” as part of its improvement process. Treas. Reg. § 1.41-4(a)(4). The third test, whereby the taxpayer must meet additional requirements found under section 174, requires the taxpayer to establish that uncertainty exists, and that the taxpayer’s experimentation was intended to resolve that uncertainty. Finally, under the process of experimentation test, taxpayers must evaluate alternatives that achieve a result that is uncertain at the outset of the research activity. Treas. Reg. § 1.41-4(a)(5)(i).

Perhaps as a result of the IRS’s 93 percent success rate in research credit litigation, tax professionals have become increasingly concerned with the IRS’s pursuit of research credit examinations and litigation. The research credit is now the “single largest domestic examination issue” for the IRS’s Large Business & International division. In a Letter from the American Bar Association, tax professionals asked the IRS to issue a Revenue Ruling clarifying requirements to claim the credit and expressed its concerns that increased examination activity may disincentivize US investment and economic development.

Not only is the IRS increasingly examining taxpayers who claimed the research credit, but it also recently revised Form 6765, Credit for Increasing Research Activities, in February 2025. The revised Form 6765 greatly expanded the amount of information taxpayers were required to provide to claim the credit.

Taxpayers who are interested in claiming the research credit should consider seeking proactive legal advice from an attorney who can assist them in navigating the legal intricacies of the research credit including gathering the information necessary for filing the revised Form 6765. Experienced tax professionals can also ensure taxpayers are keeping adequate, contemporaneous business records sufficient to withstand any future IRS examination. Similarly, taxpayers who have already claimed the research credit should consider consulting with an experienced tax controversy attorney to ensure they have sufficient evidence and substantiation to support their claimed credit.

Taxpayers who are already under examination should seek out a tax controversy attorney with IRS examination experience to help them successfully navigate the process and minimize any IRS adjustments and penalties. This is especially imperative in research credit examinations where the IRS often does not allow a taxpayer to substantiate their entitlement to the research credit based on statistical sampling or documentation created during the normal course of business. Both of which are permitted by courts who have considered research credit issues. A recent example of this was in George v. Commissioner where the Tax Court disagreed with the IRS’s decision to disallow all of taxpayers’ research expenses based on a lack of substantiation. The Court noted that taxpayers are not required to keep any particular type of record and permitted taxpayers to rely on witness testimony and records kept in the ordinary course of business operations.