The IRS has issued a revised draft Form 6765, "Credit for Increasing Research Activities," which taxpayers must file to claim the research credit under IRC Section 41.

Background

On September 15, 2023, the IRS issued a preview of proposed changes to Form 6765 (the Preview Form) and requested taxpayer feedback (see Tax Alert 2023-1575 for an in-depth look at the originally proposed changes). According to the June 21, 2024 press release announcing the revised draft Form 6765 (the Revised Form), comments from various external stakeholders informed several revisions made to the form. The IRS believes these revisions will "alleviate taxpayer burden, provide taxpayers with a consistent and predefined format and improve the information received for tax administration." The IRS also indicated that completing Section G (discussed further below) will be optional for all taxpayers for tax year 2024, but that Section G will be effective for tax year 2025. Although the draft Form was published on June 21, draft instructions will be released at a later date.

Proposed changes

Updated Sections A and B

The Revised Form updates Sections A and B by moving the IRC Section 280C "reduced credit" election question to the top of the form. The Revised Form also adds a question about being a "member of a controlled group or business under common control" to the top of the form. Additionally, the individual lines for reporting total wages, supplies, contract research and computer rental expenses have been moved from Sections A and B to a new Section F, Qualified Research Expenses Summary, and the totals from Section F will now be reported in Section A or B, whichever is applicable. This revision eliminates duplication of the reporting of this information that existed in the Preview Form, which required this information in both Sections A and B and in lines 58-64.

New Section E

Consistent with the Preview Form, the Revised Form adds new Section E with five questions seeking information on:

• The number of business components generating the credit
• The amount of the officers' wages included in wages for qualified services
• Whether the taxpayer acquired or disposed of any major portion of a trade or business
• Whether the taxpayer identified any new categories of expenditures included in the current qualified research expenses (QREs)
• Whether the taxpayer determined any of the QREs following the Accounting Standards Codification (ASC) 730 Directive

EY insight:

Commentors were concerned with the request to separately identify officers' wages included in QREs, as different business types may use different terms to identify "officers" or executives of the business, and questioned whether the amount of officers' wages included as QREs would provide a reliable indication of risk (selecting the highest risk cases was one objective identified in the Preview Form's press release). See further discussion of this concern in Tax Alert 2023-1575. In the press release accompanying the Revised Form, the IRS indicated that the definition of "officers" will be included in the forthcoming instructions to the Revised Form but did not appear to address the concern regarding the relevance of officer wages.

Similarly, neither the Preview Form nor the Revised Form included a definition for the term "new categories of expenditures" for a question contained in new Section E. The Preview Form stated that the request was "being considered because of consistency requirements." Commentators pointed out that the phrase is vague and open to different interpretations, which will result in inconsistent responses. The IRS did not specifically indicate in the Revised Form's press release that a definition of "new categories of expenditures" will be provided in the forthcoming instructions, so it may remain open to interpretation.

New Section G

As discussed above, the Revised Form added a new Section F, Qualified Research Expenses Summary, and in doing so redesignated the Preview Form's Section F, Business Component Information, as Section G.

Reduced reporting requirements

The Revised Form's press release indicates that the IRS has limited the number of business components taxpayers must report in Section G. Taxpayers should report 80% of total QREs in descending order by the amount of total QREs per business component. New Section G limits the number of business components taxpayers must report to no more than 50. The press release indicates that there will be special instructions for taxpayers using the ASC 730 Directive, who can report ASC 730 QREs as a single line item.

EY insight: In light of its reduced reporting burden for business components (to be confirmed in the forthcoming instructions), taxpayers may want to consider following the ASC 730 Directive as it will provide a less burdensome method for both calculating and reporting the research credit. See Tax Alert 2020-2323 relating to the ASC 730 Directive.

The IRS also reduced the amount of information taxpayers must provide for the business components. Consistent with the Preview Form's Section F, the Revised Form's Section G would require the following information for each identified business component:

• The business component's name
• The Preview Form would have required a "descriptive" name, and the Revised Form's press release indicates that business component descriptive names will be clarified in the instructions.
• The business component type
• The Revised Form's press release indicates the categories of business component types have been reduced from what was originally proposed in the Preview Form (responses were product, process, computer software, technique, formula or invention).
• If the business component is computer software, identification of the computer software category
• The Preview Form included a list of categories to characterize the software (e.g., internal use software (IUS), non-IUS, dual function software or software excepted from IUS treatment), which is not included in the Revised Form.
• A description of the information sought to be discovered
• Note that, until instructions are published, it is unclear whether this description will be required for credits claimed on original returns. The Revised Form's press release indicates that the IRS eliminated "the narrative requirement (for original returns) that describes the information sought to be discovered."
• Identification of wage QREs, by business component, based on whether they are direct research wages, direct supervision wages or direct support wages for qualified services by business component
• Neither the Preview Form nor the Revised Form indicate the purpose for the differentiation of wage QREs.
• Identification of supply costs, rental or lease of computer costs and contract research expenses by business component

In a departure from the Preview Form, the Revised Form will not require:

• The identification of one or more alternatives evaluated in the process of experimentation for the business component
• Whether the business component is new or improved
• The business component's use (e.g., sale, lease, or license or used by the taxpayer in a trade or business)

Optional reporting of Section G

While the Revised Form will be applicable for 2024 tax years, the press release indicates that Section G will be optional for all taxpayers in the 2024 tax year and will be effective beginning in the 2025 tax year.

Additionally, Section G will always be optional for the following two categories of taxpayers (even after the 2024 tax year):

• Qualified Small Business (QSB) taxpayers, defined under IRC Section 41(h)(1) & (2), who check the box to claim a reduced payroll tax credit
• Taxpayers claiming a research credit on an original return that meets the following criteria:
• Total QREs equal to or less than $1.5 million, determined at the controlled group level
• Gross receipts equal to or less than $50 million, as determined under IRC Section 448(c)(3) (without regard to subparagraph (A) thereof)

Finalization of the Revised Form

The Revised Form's press release did not specifically request comments on the Revised Form (although the cover page for the Revised Form included a generic invitation to submit comments), and it is likely that when the revised Form 6765 is finalized, it will very closely match the Revised Form.

Implications

The IRS notes in its press release that the Revised Form was changed from the Preview Form in response to comments from external stakeholders, and that certainly appears to be the case. There are numerous taxpayer-friendly departures from the Preview Form, including:

• The clear limit on the number of business components that must be reported (either the number reflecting 80% of QREs or 50, whichever is higher)
• The elimination of certain information that would be overly burdensome to provide on the return (e.g., details of the process of experimentation by business component) or unlikely to be relevant for an initial risk review (e.g., the business component's use or whether it is new or improved)

The optionality of Section G for certain smaller taxpayers, as well as all taxpayers in the 2024 tax year, is welcome and will alleviate the burden on small taxpayers going forward. The delayed effective date will enable larger taxpayers time to transition to the new reporting requirements, which remain a vast departure from historic reporting requirements and will likely require significant operational changes by taxpayers and their tax preparers.

There are certain open questions that the press release indicates will be addressed in the forthcoming instructions, and we will update this Tax Alert at the time the instructions are published to provide further insights. These open questions include:

• The reporting requirements for taxpayers using the ASC 730 Directive
• The definition of "officers," controlled group reporting and business component descriptive names
• The categories of business component types
• Whether it is necessary to describe the information sought to be discovered by business component on an original return

The Revised Form's press release, however, fails to mention other items that are unclear, and it is currently unknown whether the instructions will address them. These outstanding questions include:

• How a taxpayer that uses statistical sampling that complies with the requirements of Revenue Procedure 2011-42 would report all the requested information for business components and the amount of officers' wages included in wage QREs
• A definition for the term "new categories of expenditures"
• Insights into the significance of requiring business component wages by direct research, direct support and direct supervision (particularly in light of the Seventh Circuit decision in Little Sandy Coal v. Commissioner, see Tax Alert 2023-0708)

Additionally, even with the changes made to the Preview Form, the Revised Form will increase the compliance burden on most taxpayers (including small taxpayers, who must still complete Section E) from the current version of Form 6765. The initial taxpayer concerns with the increased reporting requirements have not been fully alleviated by the Revised Form, as there will still be a significant increase in the amount of data that a taxpayer must compile and include with its tax return. It remains unclear whether the extensive information requested in the Revised Form is appropriate or necessary for a tax credit filing generally, or an initial risk review of a research credit claim specifically.

Members of the EY National Tax Department will discuss the Revised Form in detail in an upcoming webcast.