July 2023 / United States

Businesses can benefit from the business credit for increasing research activities, even if the research activities were performed for both qualified and non-qualified purposes under Internal Revenue Code (IRC) section 41(d)(3), according to a recent released technical advice memorandum (TAM) (202327015), issued by the Internal Revenue Service (IRS).

Section 41 provides a research credit to businesses that includes 20% of the excess (if any) of their qualified research expenses over a base amount. Qualified research must, in part, be:

• research undertaken for the purpose of discovering information and the application of which is intended to be useful in the development of a new or improved business component; and
• experimentation research activities conducted for a new or improved function, performance, reliability or quality (i.e. the experimentation test).

However, the statute explicitly excludes from the definition of qualified purposes research related to style, taste, cosmetic or seasonal design factors.

In the present case, the Internal Revenue Service (IRS) initially disallowed a taxpayer's claimed research credits for a business component, in part, because all of the taxpayer's development activities for the business component were considered non-qualified activities undertaken for purposes of style, taste, cosmetics or season design factors.

However, the IRS Independent Office of Appeals concluded that the mere fact that a taxpayer engaged in non-qualified purpose activities with respect to the business component does not preclude the taxpayer from satisfying the experimentation test, provided that substantially all of the activities for business component constitute elements of a process of experimentation.

Note: The IRS will occasionally release a TAM, which is drawn up by the IRS Office of Chief Counsel in the Washington National Office to answer a technical or procedural question posed by an IRS director or an area director. These TAMs are similar to Private Letter Rulings (PLRs) in that they are provided to the public to help guide and advise tax practitioners on applicable rules and procedures through the eyes of the IRS. Like PLRs, TAMs should not be used or cited as precedent.

On 11 July 2023, the Internal Revenue Service (IRS) issued interim guidance on FBAR examination procedures as a result of the Bittner case, in which the United States Supreme Court held that the penalty for non-willful FBAR violations applies on a per form, rather than a per account, basis. The interim guidance takes effect immediately and will be incorporated into the Internal Revenue Manual (IRM) within 2 years.

According to the interim guidance, the IRS is no longer considering mitigation provisions in calculating penalties for non-willful violations of the Report of Foreign Bank and Financial Accounts (FBAR) requirement, following the Supreme Court's landmark decision in Bittner v. United States.

Under previous guidance, the IRS could mitigate penalties for non-willful FBAR violations to:

• USD 500 per non-willful violation (with total non-willful penalties not exceeding USD 5,000 per year), if the maximum aggregate balance for all accounts to which the violations relate did not exceed USD 50,000 at any time during the calendar year;
• USD 5,000 per non-willful violation, if the maximum aggregate balance for all accounts to which the violations relate exceeds USD 50,000 but not USD 250,000 at any time during the calendar year; or
• the statutory maximum per non-willful violation, if the maximum aggregate balance for all accounts to which the violations relate exceeds USD 250,000 at any time during the calendar year.

While the IRS eliminated the above mitigation provisions and amended the IRM provisions related to non-willful FBAR violations to be consistent with the Bittner decision, the IRS guidance highlights that penalties for willful reporting violations still apply on a per-account basis and that the IRM guidance regarding the calculation of such penalties remains unchanged.

Changing tax-exempt government securities to special 90-day certificates of debt doesn't violate the rule for keeping enough money invested for long-term expenses, if certain conditions are met, according to a recent released Office of Chief Council (OCC) memorandum (202326019), issued by the Internal Revenue Service (IRS).

Conversions of these government securities - issued pursuant to the Demand Deposit State and Local Government Series program (i.e. demand deposit SLGS) - to special 90-day certificates of indebtedness (i.e. special 90-day C of I) are governed under Treasury Regulation (Treas. Reg.) section 1.148-1(c)(4)(ii)(C).

Additionally, the OCC memorandum clarified that after such a conversion, an issuer's investment in demand deposit SLGS does not lose its status as a tax exempt bond under Treas. Reg. section 1.150-1(b) if the special 90-day C of I are reinvested in demand deposit SLGS when the issuance of demand deposit SLGS resumes.

Internal Revenue Code (IRC) section 103(a) says that interest earned from state or local bonds is generally not taxable. However, this exemption does not apply to interest earned from arbitrage bonds (as defined under IRC section 148), which are bonds issued with the intention of using the money to invest in higher-yielding investments. A safe harbor rule (under Treas. Reg. 1.148-1(c)(4)(ii)(C)) requires any money invested in eligible tax-exempt bonds (such as demand deposit SLGS) to be continuously invested.

If the money is held for up to 30 days before being reinvested in eligible tax-exempt bonds, it's still considered invested. However, if the money is held for longer than 30 days, the IRS Commissioner can allow an extension under certain circumstances (under Treas. Reg. section 1.148-10(g)).

Conversion of demand deposit SLGS to special 90-day certificates of indebtedness (C of I)

When demand deposit SGLS - meeting the requirements of the Treas. Reg. 1.148-1(c)(4)(ii)(C) safe harbor - were converted, the money that was available for investment was no longer invested in tax-exempt bonds. However, according to the OCC memorandum, the Commissioner could decide to treat the special 90-day C of I as demand deposit SLGS during the period when the issuance of demand deposit SLGS was suspended.

Conversion of demand deposit SLGS to special 90-day C of I replacement funds

Similarly, if replacement funds were invested in demand deposit SLGS to avoid investing in higher-yielding investments, and then converted to special 90-day C of I, the Commissioner could also treat the C of I as demand deposit SLGS during the period when the issuance of demand deposit SLGS was suspended.

Note: The IRS will occasionally release internal memoranda to request information between associate counsel and the IRS Office of Chief Counsel. These memoranda are similar to Private Letter Rulings (PLRs) in that they are provided to the public to help guide and advise tax practitioners on applicable rules and procedures through the eyes of the IRS. Like PLRs, internal memoranda should not be used or cited as precedent.

The Internal Revenue Service (IRS) has released a Private Letter Ruling (PLR-122641-22, 202326015) which allowed a common parent of an affiliated group of corporations to file a consolidated federal tax return election under Treasury Regulation (Treas. Reg.) section 1.1502-75(a)(1) even though the election was not timely made.

The benefit of a consolidated return is that it allows related corporations to file a single return versus a return for each entity as well as combining income and losses of each member of an affiliated group into a single income. Through filing multiple entities on a single consolidated return, a compliance and administrative burden is mitigated considering most corporations have multiple related entities.

The election is made by filing a timely consolidated return as of the filing deadline, including extensions, for the parent. When corporations fail to make a timely election, they must request an extension of time, provided under Treas. Reg. section 301.9100-3, which may be granted if the taxpayer provides satisfactory evidence to the IRS Commissioner that demonstrates the taxpayer acted reasonably and in good faith and granting the relief would not prejudice government interests.

In the PLR, the IRS granted the corporation an extension to file a consolidated return after receiving information, affidavits, and representations by the parent, company official, and the tax professional that demonstrated the taxpayer acted reasonably and in good faith because, as provided under section 301.9100-3, the request for relief was filed before the failure to make the election was discovered by the IRS.

Note 1: A PLR is a written response to a taxpayer's question(s) by the IRS national office located in Washington DC. In order to obtain a PLR, the taxpayer must pay a fee and provide the facts the taxpayer wishes the IRS to address. While a PLR can only be used by the taxpayer requesting it as precedent and other taxpayers cannot, they do help guide and advise tax practitioners on applicable rules and procedures through the eyes of the IRS. PLR procedures and user fees are published annually which are provided in the first revenue procedure of the calendar year. Revenue Procedure 2023-1 provides guidance on 2023 procedures and fees.