In addition to the Research and Development (R&D) Tax Credit’s IRS requirements and guidelines, the IRS also requires the “consistency rule” be used as a basis to request and collect financial and technical information for current and open tax years. The “consistency rule” states that the qualified research expenses (QREs) that are taken into account to compute the base amount should be determined consistently with the QREs used to calculate the credit. This rule avoids an overstatement or understatement of the R&D tax credit by not allowing manipulation of the base years’ QREs.
Under Section 41(c)(5)(A), the “consistency rule” states, that in order to “accurately calculate a credit, the taxpayer is required to define qualified research expenditures the same from year to year.” The IRS adds that the taxpayer must show consistency between the QREs in the credit year and the QREs in the base year. The gross receipts in the base years also have to agree with the prior four years’ average.
This rule is designed to ensure accuracy in the determination of the increase in QREs over the amount regularly spent by the taxpayer relative to its gross receipts. The Research and Development tax credit is an incremental credit, thus, the taxpayer has to prove there has been an increase in QREs relative to its base period. Taxpayers can’t rely on an estimate to support the calculation of the fixed-based percentage. Thus, base year records should be analyzed to determine the correct amount of expenses.
The IRS recommends asking the following questions to make sure, as a taxpayer, you abide by the consistency rule:
- Is the fixed-base percentage in the base years substantially lower than the current research ratios? If so, why?
- Do past annual reports or 10Ks support the reported base years’ QREs?
- If the research credit was claimed in prior years, were the same base years’ attributes used? If not, why not?
- Was there a prior research credit examination? Did it cover one or more of the base years?