Taxpayer Challenges R&D Refund Procedures

Beginning in 2022, it became tougher to claim a refund for R&D credits under Section 41. Under rules set forth in a memorandum that IRS Chief Counsel lawyers wrote, an R&D refund claim no longer would be treated as valid by the IRS unless the taxpayer submitted an incredible amount of granular and detailed information with the refund claim. Without that information, the IRS will not even consider the claim for refund. Under the new rules, the IRS does not simply deny a refund claim because it believes that not enough information has been provided to support the claim. Rather, without the detailed information, the IRS treats the claim as if it was never filed and doesn’t grant or deny the claim, essentially foreclosing the taxpayer from other avenues to get the credit.

Crowe observation

Beginning in the 2025 tax year, additional onerous requirements also will apply to submissions of Form 6765, “Credit for Increasing Research Activities,” filed with an original return.

Recently, a taxpayer filed a complaint in court challenging the IRS’ tougher standard for filing a valid refund claim. In Park-Ohio Holdings Corp. v. United States, the taxpayer filed a timely claim in October 2022 for refund of $1,210,190 for its 2018 tax year based on an increase in R&D credits. The IRS would not accept the claim as filed and instead made two separate requests for additional information, which the taxpayer responded to with additional information. The taxpayer also obtained the assistance of the Taxpayer Advocate Service to get the IRS to process its refund claim. Despite these efforts, on April 21, 2023, the IRS sent the taxpayer a Letter 6424C providing the IRS’ final decision that it would not process the claim because it was deficient and not a valid claim.

The taxpayer filed suit in the District Court for the Northern District of Ohio. In its lawsuit, the taxpayer asked the court to order the IRS to refund the $1,210,190 overpayment and stop the IRS from implementing its new R&D refund procedures. The taxpayer also asked for court costs and fees. The complaint provides the following bases for its request:

• The taxpayer filed a valid refund claim under existing statutes, regulations, and case law and filed suit within the applicable time period and, therefore, the taxpayer is entitled to its refund.
• The IRS’ new R&D refund procedures set forth in an internal IRS Chief Counsel memo are invalid because they did not meet the procedural notice and comment requirements under the Administrative Procedure Act.
• The IRS’ response to the taxpayer that it would not consider the refund claim because it deemed the claim invalid was arbitrary and capricious and an abuse of agency discretion.

Looking ahead

Taxpayers have experienced increasing difficulty claiming R&D credits, with lengthy audits and increasing requests for documentation during the audit. With the refund claim requirements and new onerous disclosure requirements when filing Form 6765 for a current-year claim, the IRS effectively has excluded many taxpayers that otherwise are entitled to R&D credits from being able to claim them. These requirements frustrate the intent of policymakers who support R&D credits to increase U.S. innovation and the use of advanced technology. It will be interesting to see how this latest case proceeds and how the IRS incorporates comments it requested on the Form 6765, which are due on June 30.