1. IRS Practice & Procedure: Research Credit
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
IRS Practice & Procedure: Research Credit
SJSU-TEI High Tech Tax Institute
November 6, 2006
Mallorie Jeong-
Research Credit Technical Advisor

2. RC ATG and Examination Tools
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
RC ATG and Examination Tools
Last update June 2005
Consistent case handling
Save time
Scope and materiality assessed more effectively

3. Aggregation / Allocation Temp.Reg. 1.41-6T
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
Aggregation / Allocation Temp.Reg T
Single TP computation
Allocation of group credit among members
Base on the relative amount of each individual member’s “stand-alone” entity credit
No special allocation rule for consolidated groups
Temporary regs released under TD 9205 in May 2005.
Contains guidelines for the “allocation” of the credit for a controlled group of corporations.
Applies a “single taxpayer” computation rule to members of a controlled group
Control = 50%
Start-up
Stand-alone comp-Cannot allocation more than what the member would be entitle to if not a member of the group
Consolidated group
Designated member (makes elections on behalf of…)
Disclosure of group activities on the return ??? and requesting supporting WPs
FAQ can be secure on the RC website.

4. Guidance Priority Issue: Handling of intragroup transactions
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
Guidance Priority Issue: Handling of intragroup transactions
Should receipts from controlled foreign corporations be excluded for the purpose of determining Gross Receipts?
CCA (2/14/06)– General Memorandum –exclusion NOT allowed.
What type of receipts are included?
ILM GR exclusion was allowed.

5. RC Coordinated Issues:
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
RC Coordinated Issues:
NEW (5/06)-Extraordinary utilities supply interpretation
Overhead cost for self-constructed supplies are not QREs
IU SW (3-prong test)
Technical Writers’ wages are not qualified wages
401(k) benefits are not qualified wages
2 new issues which I mentioned earlier

6. LMSB Initiatives
RC Methodology Prefiling Agreements
CAP-Compliance Assurance Program
Fast-track

7. HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
RC Claims
Significant compliance challenge for IRS
Re-emphasis on Notice
Focus on due diligence in preparation of RC Study

8. Directive RE: Retroactive IRC 280C Elections
Financial Services Industry Directive 7/26/04, reissued Aug 2005
References Notice
Retroactive 280C election NOT allowed.
Election MUST be made on an ORIGINAL return, otherwise, lower 13% rate is not available when claims or amended returns are filed.
Protective election OK?

9. Mandatory MITRE Referral:
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
Mandatory MITRE Referral:
IUSW cases with over $1.5M in research credit at issue per audit cycle
Commercial SW cases…
Critical to breakout QREs associated with IUSW to determine if a referral is required.

10. 3 Main Compliance Categories
COMPUTATIONS, IRC 41(c)
QUANTIFICATION, IRC 41(b)
QUALIFICATION, IRC 41(d)

11. HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
Computations
Correct?
QREs
Proper?
Activities
Qualify?

12. ALL RC Examinations will address the following:
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
ALL RC Examinations will address the following:
Procedural issues (e.g. claim filing procedures Notice , proper elections)
Computational issues
Methodology assessments
Record adequacy assessments
Quantification issues
Qualification issues

13. Qualified ACTIVITIES, IRC 41(d) Meets qualification criteria?
Identify business component
What is “qualified purpose?”
Substantially all POE or shrink back
Any excluded activities?
Qualified research EXPENSE, IRC 41(b)
Supplies
Consumed ??
Not depreciable
Contract research
Service vs Purch goods
Wages
Directly engaging in
Direct supervision
Direct support

14. Recordkeeping
Reg requires the keeping of records “sufficient to establish the amount of …credits,… required to be shown…”
The consequence of failing to keep sufficient records substantiating a claimed credit may be denial of the credit.

15. Cross Industry General Issue Areas
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
Cross Industry General Issue Areas
11/6/06
Admin., marketing & sales activities
Manufacturing activities (e.g. prototypes)
General IT maintenance activities
Legal fees
Technology acquired thru business acquisition
Research conducted overseas
Fringe benefits (e.g. 401(k), stock option exercise)
Direct supervision / direct support
Supplies (e.g.prototype materials, xtra utilities)
Contract Services (e.g. cascading credit)

16. High Tech Mfgrs - Issues:
HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
High Tech Mfgrs - Issues:
Properly defining the R&D cycle vs. MFG
Prototypes
What activities are R&D?
What costs incl?
Process R&D
Testing (Design v. Quality Control)
Technical Marketing
Supplies (e.g. mask tools, computers, prototype materials, xtra utilities)
Quantification methods (e.g. dept/cost center allocations)
Intragroup Gross Receipts from CFCs
Aggregation & Allocation rules
IRC 174 vs. 263(a)

17. Guidance paper for Commercial & Internal use Software, 2/4/05

18. Issue Coordination
Software claimed as supplies
Self-constructed assets (incl. equipment, tooling, prototypes), which may be “asset of a character…”

19. HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
ANY QUESTIONS ?
Mallorie Jeong
San Jose, CA

20. HIGH TECH TX INSTITUTE: IRS PRAC&PRO- RESEARCH CREDIT
11/6/06
IRC Section 41
IRC Section
Reg Section
Original FR Reference
41(a)-General Rule
1.41-1, General
TD /17/89
41(b)-Qualified Research Expense
1.41-2, Qualified Research Expense
41(c)-Base Amount
1.41-3, incl. definition Gross Receipts
TD /3/01
41(d)-Qualified Activities
1.41-4, Qualified Research, Recordkeeping
TD /2/04, ANPRMM 12/26/03 (IUSW)
41(e)-Basic Research
1.41-5, Basic Research (12/31/86)
41(f)-Special Rules
1.41-6T, Aggregation of Expenditures
TD /24/05 (Agg & Alloc)
41(g)-Pass-thru of Credit
1.41-5A, Special Rules
41(h)-Termination
1.41-8T, Special Rules applicable after 1/3/01, AIRC election