The IRS Large Business and International Division (LB&I) has added two new active compliance campaigns concerning: (1) fuel mixture credits under IRC Section 6426 and (2) research credits under IRC Section 41 and research and experimental expenditures under IRC Section 174.

Fuel credits

IRC Section 6426 allows excise tax credits for alcohol fuel, biodiesel, and alternative fuel mixtures sold or used by a taxpayer. Some of these credits were extended by The Further Consolidated Appropriations Act, 2020 through at least the end of 2020. In Notice 2020-08, the IRS instructed blenders of biodiesel and alternative fuel and sellers and users of alternative fuel on how to make a claim for retroactively extended incentives, including the biodiesel mixture credit, alternative fuel credit, and alternative fuel mixture credit (See Tax Alert 2020-0134).

LB&I said the fuel credit campaign is directed at taxpayers that received fuel mixture credits under IRC Section 6426 but did not treat the credits as a reduction in their excise tax liability under IRC Section 4081. LB&I cited Sunoco Inc. v. United States,¹ in which the U.S. Court of Appeals for the Federal Circuit, sustaining the IRS's denial of a $300 million refund claim based on fuel mixture credits, found that the credits must first be applied to reduce the taxpayer's excise tax liability, with any remaining credit amount treated as a tax-free payment. The Supreme Court denied certiorari on the question of whether the credits should be treated as a payment of taxes owed or as a reduction of the tax liability.

LB&I said the goal of this campaign is to use issue-based examinations to bring into compliance taxpayers claiming that the fuel mixture credits they received are merely refundable credits, and do not have to be used first to reduce their excise tax liability.

Research credits

LB&I said the research issues campaign will focus on issues such as the research credit under IRC Section 41 and research and experimental expenditures under IRC Section 174. The IRS characterized these two issues as "some of the most prevalent tax issues within [LB&I], utilizing significant examination and taxpayer resources."

LB&I said the campaign will include issue-based examinations, form updates, and requests for guidance, in addition to other treatment streams as the campaign progresses. "The campaign objective is to promote voluntary compliance, focus resources on the highest risk research issues and increase consistency of examinations," LB&I said.

Implications

The fuel credits compliance campaign focuses on those taxpayers that previously took the position that the IRC Section 6426 incentives are merely refundable credits and do not need to reduce a taxpayer's excise tax liability. Taxpayers making claims under IRC Section 6426 should anticipate greater scrutiny of their claims from the IRS, regardless of whether the taxpayer takes the position that these are merely refundable credits or should first reduce their excise tax liability.

The IRS's announcement of the campaign on research credits provides little insight as to what will be the focus of IRS issue-based examinations. There has been a long history of LB&I focus on issues under IRC Sections 41 and 174. The campaign may result in more examinations and possible changes in how the examinations are handled (e.g., new standardized information document requests, new personnel involved in the examination process, etc.). Recent examination experience suggests that the IRS may focus on taxpayers' documentation of qualifying research and costs and the treatment of items as "pilot models," as under the IRC Section 174 regulations. Thus, taxpayers should consider the adequacy of their substantiation for deductions under IRC Section 174 and research credits under IRC Section 41.

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¹ Sunoco Inc. v. United States, 908 F.3d 710 (Fed. Cir. 2018), cert. denied, Sup. Ct. Dkt. No. 18-1474 (2019).