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FROM THE OFFICE OF PUBLIC AFFAIRS December 14, 2001PO-871 The Treasury Department and the Internal Revenue Service today issued proposed regulations on the research credit in order to lay to rest many of the disputes about whether research and experimentation expenses qualify for the credit. The proposed regulations eliminate the controversial "discovery test" that was included in the regulations issued on January 3, 2001. Under the discovery test, research and experimentation expenses did not qualify for the credit unless the taxpayer's research advanced the state of knowledge in a particular field, a requirement not found in the statute and difficult for the Internal Revenue Service and taxpayers to apply. The proposed regulations also clarify the internal software use rules. "We need to use every tool available to encourage growth, investment and job creation in our economy," stated Treasury Secretary Paul O'Neill. "The elimination of the discovery test will make it easier for businesses to qualify for the credit in the course of developing new products." On January 3, 2001, Treasury and IRS issued final regulations (in T.D. 8930) implementing the 1986 changes to the definition of qualified research. Taxpayers strongly criticized the regulations , and on January 31, 2001, Treasury and IRS suspended the rules, indicating the changes would be reviewed and requesting additional public comments. The proposed regulations make significant changes to provide rules regarding: Qualified Research The proposed regulations eliminate the "discovery test", which required that qualified research be "undertaken to obtain knowledge that exceeds, expands, or refines the common knowledge of skilled professionals in a particular field of science or engineering." The "discovery test" is the single greatest source of controversy between taxpayers and the IRS. Documentation The proposed regulations eliminate the research credit specific documentation requirement in accord with Congressional direction that the regulations minimize the administrative and record-keeping burden on taxpayers related to the credit. The revised regulation provides flexibility for taxpayers in keeping the records necessary to establish eligibility for the credit. Internal Use Software The proposed regulations also describe when computer software is developed by a taxpayer primarily for the taxpayer's internal use - subjecting the related expenses to a stricter test for credit eligibility - and clarify when such software is eligible for the research credit. Effective Date The proposed regulations, when finalized, will be effective for taxable years ending after the date the proposed regulations are published in the Federal Register. In order to clarify the administration of the credit until final rules are issued, the preamble to the proposed regulations states that the IRS generally will not challenge return positions that are consistent with the proposed regulations. A copy of the proposed regulations that will be published in the Federal Register is attached.
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