09 January 2025 Newly released draft instructions reveal how IRS expects taxpayers to complete Form 6765
The IRS has issued draft instructions for Form 6765, "Credit for Increasing Research Activities," which taxpayers must file to claim the research credit under IRC Section 41. This Alert summarizes the instructions' requirements, while also comparing the instructions to the draft Form 6765 to help identify similarities and differences. On June 21, 2024, the IRS issued a draft Form 6765 (the Draft Form), with revisions to a September 15, 2023 preview of the form in response to comments from various external stakeholders (see Tax Alert 2024-1365). Nearly six months later, draft instructions (Draft Instructions) followed on December 20, 2024. A press release (IR-2024-313) accompanying the Draft Instructions stated: "Improvements to Form 6765 are intended to make tax reporting more consistent, improve the information received for tax administration and build an ongoing effort to manage resources in a more effective and efficient way." The current Form 6765 (revised December 2023) is two pages long, with 44 lines. The Draft Form is four pages long, with 64 lines total (including sub-lines and unnumbered questions). The current instructions (revised January 2024) have five pages of instructions. The Draft Instructions have more than 10 pages of instructions. New instructions for members of a controlled group of corporations or businesses under common control The Draft Instructions require taxpayers to include an attachment that "reports QREs and additional information needed to compute each group member's credit," and requests the following information for "each line item" (which may be understood as each member):
The Draft Instructions also request that the last line of the attachment include the total QREs of the controlled group and the total credit for the controlled group. In addition, the Draft Instructions request the following information on the attachment: (1) the number of controlled group members for both the current tax year and previous tax year and (2) whether the QREs are being claimed on one consolidated group return, or on separate returns. Unlike the Form 6765 for tax years before 2024, the Draft Form updates Sections A and B by moving the IRC Section 280C "reduced credit" election question to the top of the form. The Draft 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 applies. For the total QREs to be reported on Draft Form Section A, line 5 and Section B, line 20, the Draft Instructions refer taxpayers to Section F, line 48, and the instructions for Sections F and G. The Draft Instructions reflect that members of a controlled group of corporations or businesses under common control report total QREs for Section A, line 5 or Section B, line 20 for the group. For members of a controlled group of corporations or businesses under common control, and consistent with the instructions for the current version of Form 6765, the Draft Instructions state that Section A or B is used to compute the credit for the entire group (even if a member files a separate tax return), but the member reports only the member's allocable share of the group credit on line 13 or line 26, whichever applies. Observation: The Section B Draft Instructions include an instruction that does not appear to be relevant to Section B (instructing group members filing separate tax returns to enter the average annual gross receipts for the controlled group). This instruction may be meant to be part of the instructions for Section A, line 7 (relating to the regular credit). In Draft Form Section C, taxpayers report information about the current-year credit, particularly credits from pass-through entities. Draft Form Section D is for reporting information under IRC Section 41(h), the qualified small-business payroll tax election. The Draft Form made one addition to Sections C and D of the current Form 6765, other than references to appropriate lines on the form. Section D, line 33b of the Draft Form includes a check box to indicate if the payroll tax (for which an election to apply the research credit as a payroll tax credit is being made) "is reported on a different EIN." The Draft Instructions for Section D, line 33b, include a brief instruction to check the box if that is the case. Despite this addition, the Draft Instructions are generally consistent with the current instructions. The Draft Instructions indicate that Section E's purpose is "to provide additional details or information about the total QREs reported in Section F." Observation: The Draft Instructions for Section E do not explicitly indicate whether responses should be reported only for a controlled group member or for the entire controlled group. Because the purpose of Section E, as stated in the Draft Instructions, is to provide additional information about the total QREs reported in Section F (on which a controlled group member filing a separate tax return reports only the member's QREs and not the controlled group's QREs), it may be presumed that the responses on Section E should reflect the member's information (and not the controlled group's information). The Draft Instructions explain how to answer the five new questions in lines 37-41 of Section E, Other Information, of the Draft Form, which seek information on:
Unlike the Draft Form's line 37 request for the number of business components generating the QREs on line 5 or 20, the Draft Instruction for line 37 requests the taxpayer to identify the number of business components generating the QREs shown on line 48. The Draft Instruction for line 37 states that the number of business components is not limited to the number of business components reported in Section G (if applicable). Observation: For controlled group members, the number of business components generating the QREs may differ because the QREs reported on line 5 or line 20 are the controlled group's total QREs, but the QREs reported on line 48 are only the member's QREs. It is unclear whether a taxpayer should report the controlled group's total number of business components (generating QREs on line 5 or line 20) or just the member's total number of business components (generating QREs on line 48). Clarification is needed to achieve consistent reporting among taxpayers that are members of a controlled group, as the Draft Instructions are not consistent with line 37 of the Draft Form. The Draft Instruction for line 38 (amount of officers' wages included in line 42) does not define "officers"; instead, it directs corporations to check the law in their state of incorporation for a definition of the term. According to the Draft Instruction for line 38, the reporting requirement applies even if the "officer" is also a shareholder. The Draft Form and the Draft Instruction for line 38 indicate that the amount of officers' wages to be reported is computed only for a controlled group member, and not the entire controlled group. Observation: The Draft Instruction for line 38 references "the corporation" and "corporate officers." For taxpayers that are not corporations, the Draft Instructions do not explain which employees are considered "officers." Relying on state law to determine who is an officer of a corporation seems antithetical to the IRS's stated goals for the Draft Form, which aim to make tax reporting more consistent and improve the information received for tax administration purposes. Using state law to determine who is an officer of a corporation may be even more complex for a taxpayer that files a consolidated tax return (as the consolidated group members may be incorporated in different states, with various definitions of "officer"). Furthermore, taxpayers using statistical sampling to determine QREs may be unable to identify the amount of officers' wages in a population item that is not a sample unit because only sample units are evaluated. The Draft Instruction for line 38 does not provide any guidance for taxpayers using statistical sampling to determine QREs. Section E, line 39 of the Draft Form provides "Yes" and "No" check boxes to respond to the question, "Did you acquire or dispose of any major portion of a trade or business in the tax year?" Under the Draft Instruction for Section E, line 39, the question is only answered affirmatively if any of the QREs reported on line 48 relate to "an acquisition or disposition made during the current tax year." Observation: There appears to be some disparity between the question on the Draft Form and the information sought in the Draft Instructions. The phrasing of line 39 implies that a taxpayer must determine if there is an acquisition or disposition of a major portion of a trade or business, but the Draft Instruction for line 39 does not appear to require that determination. The Draft Instruction for line 39 does not define any of the line 39 terms. In the controlled group context, is also unclear whether an affirmative response to line 39 is required only if there was an acquisition or disposition by the group member (as is suggested by line 39's location in Section E and the instruction's cross-reference to line 48). Furthermore, the phrase "if any QREs … are related to an acquisition or disposition" could be interpreted to require an affirmative response only if activities constituting qualified research are conducted with respect to the acquisition or disposition. Additional clarity would be useful to taxpayers if the IRS wants to achieve consistency in the answers reported on line 39. Section E, line 40 of the Draft Form provides "Yes" and "No" check boxes to respond to the question, "Did you include any new categories of expenses as current year QREs?" The Draft Instruction for Section E, Line 40, requires taxpayers to check "Yes" if they identified any new categories of expense included in line 48. The Draft Instruction does not define the term "new categories of expenses." Observation: The lack of a definition, or explanation of the purpose, for the term "new categories of expenses" is likely to lead to inconsistent responses by taxpayers., even if "categories" is interpreted consistently with the definition of qualified research expenses in IRC Section 41(b) (i.e., wages, supplies, contract research expenses). A taxpayer could interpret "new" to mean (1) a category that it never included for any project in any year or (2) a category that it included for the first time for a specific project in the current year but was included for other projects in the previous year. A taxpayer could also conclude, however, that a category that was included for some projects (but not all projects) in the previous year is not "new." The Draft Instructions do not identify what a "category" of expenses is (e.g., are officers' wages a different "category" than non-officers' wages?), which will also likely lead to confusion and inconsistent reporting. The Draft Instruction for line 40 indicates that line 40 is relevant for determining if a consistency adjustment is required for the taxpayer's base-period expenses. However, an affirmative response to line 40 could include circumstances for which a consistency adjustment is not required (i.e., the taxpayer did not previously incur the category of expenses for the project in the past). Because the Draft Instruction for line 40 does not define or explain line 40's purpose, it is likely to lead to inconsistent responses by taxpayers. Additionally, taxpayers using statistical sampling to determine QREs may be unable to identify if any "new categories of expenses" are included in QREs for a population item that is not a sample unit because only sample units are evaluated. The Draft Instruction for line 40 does not include any guidance for taxpayers using statistical sampling to determine QREs. Section E, line 41 of the Draft Form provides "Yes" and "No" check boxes to respond to the question, "Did you determine any of the QREs on line 5 or line 20 following the ASC 730 Directive?" The Draft Instruction to Section E, line 41, indicates that taxpayers should answer "yes" if they determine any QREs reported on line 48 under the ASC 730 Directive. The Draft Instructions require a taxpayer answering the question on line 41 affirmatively to report only the amount from ASC 730 Directive, Appendix C, line 19 (the Adjusted ASC 730 Financial Statement R&D amount), on line 41. Therefore, amounts reported in columns B or C on Appendix B, the Reconciliation of Form 6765 QREs to Adjusted ASC 7030 Financial Statement R&D, are not included in the amount reported on line 41. Unlike the Draft Form's line 41 reference to QREs on line 5 or 20, the Draft Instruction for line 41 refers to the QREs on line 48. Observation: Because the QREs reported on line 5 or line 20 are the controlled group's total QREs, but the QREs reported on line 48 are only the member's QREs, the response to the question of whether any of the QREs are determined following the ASC 730 Directive may be different. In other words, the QREs reported on line 5 or line 20 (the controlled group's total QREs) could include QREs determined following the ASC 730 Directive, but the controlled group member's QREs (reported on line 48) may not include any QREs determined following the ASC 730 Directive. It is unclear whether a taxpayer should answer the question by referencing the controlled group's QREs on line 5 or line 20 or the member's QREs on line 48. Clarification is needed to achieve consistent reporting among taxpayers that are members of a controlled group, because the Draft Instructions for line 41 are not consistent with the Draft Form. Furthermore, the Draft Instructions do not exempt taxpayers claiming QREs determined under the ASC 730 Directive from responding to questions in Section E for ASC 730 Directive QREs. Because QREs determined under the ASC 730 Directive are not identified for business components, do not distinguish officers' wages from other employee wages, and are not likely to reveal whether any "new categories of expenses" are included, additional guidance is needed for Section E, lines 37, 38, and 40 for taxpayers that respond "Yes" to Section E, line 41. Section F of the Draft Form, Qualified Research Expenses Summary, replaces the lines in Sections A and B of the current Form 6765 on which a taxpayer reported totals for categories of qualified research expenses (e.g., wages, supplies, contract research) for purposes of calculating the research credit. A specific Draft Instruction applies to basic research payments, which are reported on line 46. If a taxpayer must complete Section G, Section F's Draft Instruction asks taxpayers to first complete Section G, as the totals from Section G will be listed in Section F, summed on line 48 and generally recorded in Section A on line 5 or Section B on line 20, whichever applies. Under the Draft Instructions for Section F, a controlled group member filing a separate tax return reports only the member's QREs and not the controlled group's QREs. The Draft Instruction for Section F, line 48, states that the total from line 48 is entered on line 5 or line 20, as applicable. The Draft Instructions for lines 5 and 20, however, indicate that a controlled group member must enter the controlled group's total QREs, referring taxpayers to instructions for Section F and G for reporting QREs by group members that file separate tax returns. Observation: The Section F Draft Instructions for controlled group members appear to be inconsistent with the Draft Instructions for Lines 5 and 20 and may be confusing to taxpayers. Clarification in the final instructions on controlled group member reporting of Section F items in Sections A and B (i.e., whether lines 5 and 20 should reflect controlled group's QREs or only the member's QREs) would be helpful to achieving reporting consistency among taxpayers. The Draft Form added new Section G, Business Component Information. This section seeks details about the business components for which QREs are claimed for the current credit year. Taxpayers are not required to complete Section G for tax years beginning before 2025. The Draft Instructions require taxpayers to complete Section G for tax years beginning after 2024, unless they are:
Observation: The exception based on QREs and gross receipts states that QREs are determined at the controlled group level; however, it references line 48, which reflects the member's QREs only. Clarification is needed as to whether this instruction should reference the controlled group's QREs on line 5 or line 20 or the member's QREs on line 48. The Draft Instructions limit the number of business components for which taxpayers must report information in Section G to 80% of total QREs in descending order by the total QREs per business component, with a maximum of 50 business components (even if the total QREs for the 50 business components is less than 80% of total QREs). The Draft Instructions require the 80% and 50 business components to be determined at the controlled group level "unless noted below." The Draft Instructions require a controlled group member that files a separate tax return and must complete Section G to report at least 80% of its QREs (not the group's QREs) by business component (but not more than 50 of the member's business components). For all business components not reflected in the 80% of total QREs or 50 business components, the Draft Instructions request that the taxpayer aggregate the QRE information in columns 50-56 (leaving all other columns blank, other than column 49c, which is to report a business component named "Aggregate BCs"). Taxpayer required to complete Section G must enter the totals from Section G on the applicable lines of Section F. Taxpayers using the ASC 730 Directive to determine QREs must report ASC 730 QREs as a single business component (the "ASC 730 Directive business component"), but do not need to provide information on the business component type, the information sought to be discovered, the category of employee qualified services (i.e., direct, support or supervision) or the amount of contract research expenses. The QREs reported for the ASC 730 Directive business component are based on information that the taxpayer must retain (ASC 730 Directive Appendix B, column A), and report in columns 53-56. In determining 80% of QREs or the 50 business components to be reported in Section G, the Draft Instructions state that taxpayers do not count QREs computed under the ASC 730 Directive. If the ASC 730 Directive business component is at least 80% of total QREs reported on line 48, however, the Draft Instructions do not require taxpayers to report any additional business components. Presumably, this would excuse a taxpayer reporting an ASC 730 Directive business component that is at least 80% of total QREs reported on line 48 from having to include an "Aggregate BCs" business component in Section G (which is required for all other taxpayers with business components remaining after reporting 80% of QREs or 50 business components). If the ASC 730 Directive business component is not at least 80% of total QREs reported on line 48, the taxpayer must report additional business components to meet the 80%-QRE-or-50-business-component threshold and report any remaining business components in aggregate, as discussed previously. Observation: The Draft Instruction prohibiting taxpayers from counting the ASC 730 Directive business component in determining the 80% of QREs or the 50 business components seems to contradict the instruction allowing taxpayers to forgo reporting additional business components if their ASC 730 Directive business component QREs are at least 80% of the total QREs reported on line 48. To achieve consistent reporting by taxpayers, clarification would be helpful on (1) whether to take the ASC 730 Directive business component into account in determining 80% of the taxpayer's QREs or 50 business components and (2) whether a taxpayer with an ASC 730 Directive business component that is at least 80% of its total QREs reported on line 48 must report an "Aggregate BCs" business component. The Draft Instructions provide guidance for taxpayers that determine QREs using statistical sampling that complies with the requirements of Revenue Procedure 2011-42. Those taxpayers must report business component information, as is generally required for all taxpayers. The Draft Instructions require a taxpayer using statistical sampling to report 80% of total QREs or 50 business components "irrespective of which business components were used for [the] statistical sample," and report any remaining business components in aggregate, as discussed previously. The Draft Instructions state that a taxpayer should add the word "sample" to the end of any business component name or identifier in column 49(c) for any business components that "are among [the] selected samples" and attach the statistical sampling plan. A specific name for the attachment is provided in the Draft Instructions. Observation: Statistical sampling is a reliable evaluative and estimation tool used to reduce both taxpayer and IRS examiner burdens. Taxpayers using statistical sampling to determine QREs evaluate only the sample units selected from the total population of items and extrapolate the results of the sample units' evaluation to the other population items. Taxpayers using statistical sampling to determine QREs cannot provide all the business component information requested in Section G for the entire population, as the information requested in Section G is not collected for non-sample units under statistical sampling methodologies. Requiring taxpayers using statistical sampling to report, on Section G, items that are not sample units defeats the purpose of statistical sampling (to reduce burden). To achieve the IRS's stated goal of managing resources more effectively and efficiently, additional consideration should be given to the Section G reporting requirements for taxpayers using statistical sampling to determine QREs. Column 49(a). Section G, column 49(a) requests the EIN of the controlled group member conducting the research activities on the business component reported. The Draft Instructions require taxpayers to report "the EIN for the entity associated with the business component and conducting the research activities." Observation: Section G instructions generally indicate that a taxpayer that is a member of a controlled group and files a separate tax return reports only its own QREs (and not the group's QREs). Because of those instructions, column 49(a) is likely to reflect the EIN of the taxpayer claiming the QREs for the business component, even though there could be more than one entity in a controlled group "associated with the business component" or "conducting the research activities." For a controlled group member that is a consolidated tax return filer, it is unclear whether the Draft Form and Draft Instructions are requesting the consolidated group parent's EIN or the consolidated group member's EIN for column 49(a). Additional clarification for reporting EINs would be helpful to achieve consistent reporting by taxpayers. Column 49(b). Section G, column 49(b) requests the controlled group member's principal business activity (PBA) code. The Draft Instructions for column 49(b) request the PBA that best describes the activities of the entity listed in column 49(a). Observation: As the Draft Instructions to column 49(b) seemingly contemplate the listing of only one entity in column 49(a), column 49(b) is likely to reflect the PBA of the taxpayer that is claiming the QREs for the business component. If, however, the IRS expects a different response, additional clarification is needed for column 49(b). Column 49(c). Section G, column 49(c) requests the business component's name or unique alphanumeric identifier. The Draft Instructions state that the "field should be populated with an identifier that is consistent with how you maintain the books and records that substantiate the qualified research activities and associated QREs." Column 49(d). Section G, column 49(d) requires taxpayers to identify the business component type from an option provided. The Draft Instructions list the following options from which a taxpayer must select: "Product," "Process," "All Others" (a category which includes computer software, technique, formula or invention). Column 49(e). If the business component is computer software, Section G, column 49(e) requests the taxpayer to identify the type of computer software by selecting from one of the following four options: "IUS-internal use software," "DFS-dual function software," "Non-IUS," and "Excepted from IUS treatment." The Draft Instructions refer taxpayers to a section of the Draft Instructions titled "Research With Respect to Software," which offers, for the first time in Form 6765 instructions, the IRS's summary of the IRC Section 41 rules on computer software and explanations of the Draft Instructions' categories of computer software. Column 49(f). Section G, column 49(f) asks taxpayers to describe the information sought to be discovered (regarding the business component). The Draft Instructions for column 49(f) require taxpayers to report the information sought to be discovered for the business component(s) to which the research credit claim relates for the year only if they are claiming a refund or credit on an amended return with an IRC Section 41 credit that (1) was either not reported on the original return, or (2) is larger than the credit reported on the original return. Therefore, taxpayers do not include the information in a timely-filed (including extensions) return. Observation: Taxpayers claiming a refund or credit on an amended return with an IRC Section 41 credit that was either not reported on the original return or is larger than the credit reported on the original return should review FAA20214101F (Sept. 17, 2021) and related IRS administrative guidance. See Tax Alert 2024-1261. The Draft Instructions provide a specific name for the attachment required by the administrative guidance on amended-return refund claims for an IRC Section 41 credit. Columns 50-52. Section G, columns 50-52 require taxpayers to report in-house wage QREs segregated by the category of the employees' qualified services for each business component (i.e., direct research wages, direct supervision wages, and direct support wages). Section G, column 53 is the total of the qualified wages reported in columns 50-52 for each business component, the sum of which is reported on Section F, line 42 (total wages for qualified services for all business components). The Draft Instructions include examples of the types of activities that may be considered direct research, direct supervision or direct support. Observation: Wages for qualified services (wage QREs) have historically been reported on one line of the Form 6765. Requiring taxpayers to bifurcate wage QREs into employee activity categories for each business component reported on the Form 6765 will significantly increase the burden on taxpayers. Taxpayers are unlikely to have information to segregate activities into direct research, direct supervision or direct support categories for any current business purpose, as these terms are not common nomenclature for a taxpayer's books and records, including time-tracking systems. The absence of an explanation for requiring this segregation is also troublesome, given that the connection to determining IRC Section 41 qualification is not obvious. Column 54. Taxpayers must report in Section G, column 54, the total qualified cost of supplies used in conducting the research for each business component. The total qualified cost of supplies for all business components is summed and reported on Section F, line 43. Column 55. Section G, column 55 requires taxpayers to report the amount of rental or lease cost of computers used in conducting qualified research. The Draft Instructions summarize the rules relating to qualified use of computers. The total qualified costs for all business components is summed and reported on Section F, line 44. Column 56. In Section G, column 56, taxpayers must report the applicable qualified contract research expenses paid or incurred for the business component. The Draft Instructions include specific rules for reporting qualified basic research payments, which are reported separately on Section F, line 46 (not Section G, column 56). The total qualified contract research expenses for all business components is summed and reported on Section F, line 45. The Paperwork Reduction Act Notice section of the Draft Instructions estimates the time needed to complete and file Form 6765 as follows:
Observation: These burden estimates are unchanged from the current Form 6765 instructions, although the Draft Form is twice as long as the current Form 6765, and the Draft Instruction are twice as long as the current Form 6765 instructions. In comparison, the instructions for Form 3115, Application for Change in Accounting Method, estimate the time needed to complete and file Form 3115 as follows: The instructions for Form 4562, Depreciation and Amortization, estimate the time needed to complete and file Form 4562 as follows:
Given the IRS's public recognition of IRC Section 41's complexity, such low estimates are puzzling, particularly when compared to the time estimated to complete other common forms that are much more familiar to taxpayers. The Draft Instructions and the Draft Form are expected to be finalized for the 2024 tax year in January 2025. According to the accompanying press release, the IRS is seeking feedback on the Draft Instructions, specifically about Section G reporting for controlled groups and business component detail, the ASC 730 Directive business component and statistical sampling. Feedback can be submitted to the following email: lbi.rt.team@irs.gov through June 30, 2025 using the subject line "Instructions for Form 6765." Comments will be considered for purposes of updating instructions for tax year 2025. The new reporting requirements, including an expanded controlled group reporting requirement, depart significantly from historic reporting requirements and will likely require significant operational changes by taxpayers and their tax preparers. The Draft Instructions addressed several open questions on the Section G reporting requirements for taxpayers using the ASC 730 Directive and taxpayers using statistical sampling. They also addressed the definition of "officers," controlled group reporting and business component descriptive names, the categories of business component types and whether it is necessary to describe the information sought to be discovered by business component on an original return. The Draft Instructions left unanswered questions too, which will likely lead to confusion and inconsistent reporting among similarly-situated taxpayers unless the instructions are clarified. For example, the Draft Instructions did not define the term "new categories of expenditures," which could lead to inconsistent reporting depending on how taxpayers interpret "new" or "categories." Additionally, the Draft Instructions did not explain why taxpayers must report business component wages by employee activity category (direct research, direct support and direct supervision). The Draft Instructions also do not include guidance for Section E, lines 37, 38 and 40 for taxpayers using the ASC 730 Directive to determine QREs. The Draft Instructions often do not reflect the information sought on the Draft Form. Reconsideration of the Draft Instructions related to statistical sampling business component reporting would be welcome, as the Draft Instructions do not appear to take into account typical statistical sampling methodologies. The Draft Form and Draft Instructions will likely increase the compliance burden on most taxpayers (including small businesses, which must still complete Section E). Much of the information sought on the Draft Form is not collected in the normal course of a taxpayer's business nor is it collected on a "business component" basis. Taxpayers' initial concerns with the increased reporting requirements have not been fully alleviated by the Draft Form or the Draft Instructions, as the data that a taxpayer must compile and include with its tax return will likely increase.
Document ID: 2025-0191 | ||||||
