Recent IRS directive for the California research credit February 2018 Tax News

You may be wondering what this directive means for the California research credit

On September 11, 2017, the IRS issued Directive Accounting Standards Codification (ASC) 730, relating to research expenditures, and you may be wondering what this directive means for the California research credit.

What the IRS Directive does

This directive allows certain taxpayers a “safe harbor” with respect to the examination of Qualified Research Expenditures (QREs) included in a federal research credit computation. The “safe harbor” is based on a reconciliation of research expenses reported or footnoted for financial statement reporting and following ASC 730.  The directive applies to original tax returns (including extensions) filed after September 11, 2017. A full text of the directive can be found on the IRS website.

Who is eligible

The directive applies to taxpayers subject to examination by the IRS Large Business and International (LB&I) group that meet both of these requirements:

  • Have assets equal to or in excess of $10 million, and
  • Follow Generally Accepted Accounting Principles (GAAP) to prepare their certified financial statements and show a separate line item or state the amount of expenses ASC 730 research costs.

How California will apply the Directive

For taxpayers that meet the above requirements and file a California tax return, we will follow the IRS directive and guidelines. We will use GAAP expenditures for the calculation of the California Research Tax Credit. During a California research credit audit, taxpayers following the ASC 730 Directive must provide the following information:

  • A copy of the completed and signed Certificate Statement filed with the IRS.
  • All ASC 730 financial statement in-house research and development (R&D) expenses performed outside of California.

Additionally, taxpayers following the IRS directive must make the following adjustment to the federal "safe harbor" when computing the California credit:

  • From the computations of Adjusted ASC 730 Financial Statement R&D, subtract all in-house and contract expenses performed outside of California.

We may also request other relevant documentation to support the credit. Some examples include, but are not limited to:

  • Documentation for any expenses included in the credit in excess of the "safe harbor."
  • Information necessary for the computation of the California Credit.

For additional information, see our web page for California Research Credit.