Firm Seeks R&D Guidance for Architecture, Engineering Shops

May 27, 2021

Internal Revenue Service
Attn:CC:PA:LPD:PR (Notice 2021-28) Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Recommendation for the 2021-2022 Priority Guidance Plan Pursuant to Notice 2021-28

To Whom It May Concern:

In accordance with Notice 2021-28, I respectfully recommend the 2021-2022 Priority Guidance Plan include guidance for computing and substantiating the credit for increasing research activities under I.R.C. § 41 for qualifying research and development activities performed by architecture and engineering firms.

Research tax credits reported by architecture and engineering firms are facing increased and inconsistent scrutiny by the IRS exam function. Activities that have historically qualified for the research tax credit are being challenged by IRS resulting in conflicting audit outcomes and uncertainty for firms that should qualify for research credits. This negates the very incentive effect Congress intended for the research tax credit.

While the recent IRS's rationale for challenging research tax credits has varied from case to case, one common thread is the IRS's claim that service providers, such as architecture and engineering firms, cannot meet the Qualified Purpose (Business Component) portion of the four-part test because there is no identifiable “business component.”

The Code clearly defines the term “business component” as a product, process, computer software, technique, formula, or invention. In the past, the IRS exam function has allowed "design drawings" to qualify as the business component (the term technique is synonymous with the term “blueprint” or “design drawing”). However, in many recent audits, the IRS is ignoring the terms “technique” and “formula” in research claims for service providers altogether. While no court cases have addressed this issue directly, there are cases involving service firms taking the research credit in which neither the IRS nor the courts took any issue with the fact that service providers do qualify for the credit — further confirming services are not inherently disqualified.

By its own statistics, the IRS has reported that nearly one-third of taxpayers that claim the credit are "service providers." Importantly, most service providers claiming this important credit are small businesses in the fields of architecture, engineering, and computer science software design providing research activities that are critical to achieving the U.S.'s goals and standards for modernized and safe infrastructure, clean energy, and healthy workplace design and engineering improvements.

The IRS exam function's position is very concerning given the fact that since the credit's inception in 1981, service providers, including architecture and engineering small business activities, have been eligible for the research tax credit.

The IRS exam function is spending a considerable amount of time and resources auditing research tax credits for architect and engineering firms. Audits involving even smaller research tax credits can span several years. These audits are often left unresolved for significant periods of time — often lasting several years, contributing to the IRS exam function's workload and resulting in high examiner turnover, which often negatively impacts the competency of the audit outcome.

These lengthy audits result in many cases being sent to the IRS Office of Appeals and, in some cases, on to litigation. The IRS Office of Appeals is not agreeing with many of the positions raised by the IRS exam function. For example, Appeals has consistently rejected the “business component” position described above. This is the primary reason why the IRS exam function is closing cases out to Appeals. Thus, research tax credits being disallowed by the IRS exam function and, after several years of waiting, are being allowed by the IRS appeals function. The considerable amount of time and energy spent by the IRS on these cases is not a productive use of taxpayer dollars and guidance could allow the IRS to free up these audit resources for other important issues.

We respectfully request the IRS issue industry-specific guidance for the architecture and engineering industry modeled after IRS Guidance for Computing and Substantiating the Credit for Increasing Research Activities Under Section 41 of the IRS Code for Activities in Developing New Pharmaceutical Drugs and Therapeutic Biologics.

Under this proposal, guidance could be developed that creates a "checklist" and certification of activities conducted by taxpayers in the architecture and engineering field that qualify for the research credit and that are subsequently certified to appropriately compute the research credit. By way of example, the qualifying activities list could address the business component and process of experimentation requirements. If a taxpayer meets the criteria and makes the appropriate certification with their tax returns, the guidance could ensure that taxpayer positions would not be challenged by the IRS on audit similar to the guidance provided for the pharmaceutical industry.

The request to prioritize industry-specific guidance for the architecture and engineering industry in this manner is in the best interest of the U.S. Government and taxpayers. This approach would ensure the research tax credit is consistently and fairly applied to a critical industry conducting significant research activities that benefit important U.S. goals. Importantly, this approach would alleviate significant IRS audit caseload volume, examiner turnover, and ensure this important credit is applied in accordance with longstanding Congressional intent.

I deeply appreciate your time to consider this request. Thank you in advance for your consideration of this request for priority guidance. If you have any questions about this request, I welcome the opportunity to meet with you to discuss this important issue.

Sincerely,

Shannon Scott-Paul, Partner
O'Brien, Gentry & Scott, LLC
Washington, DC