Will the new IRS Form 6765 obliterate your R&D credit?

On September 15, 2023, the IRS released a preview of the proposed changes to tax Form 6765, “Credit for Increasing Research Expenses” (a.k.a. “R&D Credit”), which all taxpayers are required to file when computing an R&D credit under IRC 41.

The reality is that the new IRS Form 6765 will obliterate your R&D tax credit if you don’t change your R&D credit provider.

What Happened?

On September 15, 2023, the IRS released a preview of the proposed changes to tax Form 6765, “Credit for Increasing Research Expenses” (a.k.a. “R&D Credit”), which all taxpayers are required to file when computing an R&D credit under IRC 41.

The newly proposed 6765 form represents a big shift from just reporting the numbers, to reporting why the research projects (i.e., “business components”) meet the qualitative requirements.

Significant Changes

There are several changes, but the most significant changes include the following:

1. Every business component must be analyzed. The proposed form does not make accommodation for statistical sampling.

2. Every business component must have a description of the information sought to be discovered and the identification of one or more alternatives evaluated in the process of experimentation.

3. All qualified research expenditures must be allocated to a specific project.

R&D Credit Compliance Costs

Accounting firms spared no time announcing to the world that these changes mean more work and more fees.

When you consider your total R&D credit compliance costs, you have to ask at what point do the costs exceed the benefit?

There are two components to your R&D credit compliance cost. There is the fee the CPA firm charges and your internal costs. Combined these average 59% of the credit.

It’s easy to focus on the CPA portion of the R&D credit compliance cost. Paying for inexperienced staff to enter numbers into spreadsheets and paying for two or three accountants to interview your employees. These inefficient manual tasks comprise 70% of the CPA portion of the R&D credit compliance cost.

The hidden R&D compliance costs are the untracked internal costs of your team working with the accountants. These costs often include gathering costing data, running custom reports, exporting data to spreadsheets, scheduling interviews, participating in interviews and the resulting follow up, answering questions, and managing the entire process. These costs average twice the CPA fees.

Even more frustrating is that fact that there is an inverse relationship between the CPA fee and the internal costs. The more the CPA reduces its cost, the more work shifts to your internal team and the internal costs increase.

No Room for Fee Increases

On average, the net R&D credit a taxpayer receives is 20% of the gross computed credit (100% less 21% for the 280C addback and less 59% for compliance costs). There is no more room for fee increases.

But fee increases are the only solution that accounting firms have to offer. For 30+ years they have relied on exorbitant R&D credit fees and had no incentive to innovate or automate.

Almost every firm follows the same “status quo” process of interviewing employees, manually manipulating spreadsheets and writing short summaries of research projects and activities. Today it is estimated that taxpayers pay $5billion each year to have accountants compute R&D credits.

No wonder why the accountants’ reaction to the change in the Form 6765 is to increase fees. That’s how accounting firms react to any tax change.

This time the increasing fees won’t work. Compliance costs already eat over half of the credit.

The only feasible solution is technology.

Embrace Artificial Intelligence

The only reasonable way to address this change is to automate using artificial intelligence. Artificial intelligence models have a proven track record of performing the core tasks performed during an R&D credit analysis.

· Reading documents: AI models used in the legal profession have been reading, understanding, and interpreting documents.

· Extracting numerical information: AI models used in banking have been reviewing, classifying and extracting transactional data and then creating reports and schedules from that data.

· Predicting outcomes: AI models used in many industries have been analyzing data, identifying historical patterns, and predicting outcomes based on historical patterns.

· Writing: AI models have been writing unique, natural language reports.

· Interpreting rules: AI models have been trained to apply complex rules to data sets and perform computations by applying those rules to the specific data.

These tasks comprise 80% to 90% of an R&D credit analysis. Accordingly, 80% to 90% of the R&D credit analysis tasks can be automated through properly trained artificial intelligence models.

Revised R&D Credit Compliance Costs

Embracing automations through artificial intelligence has a significant impact on the economics of your R&D credit. Taking this simple step can increase your next credit benefit by 230%. Your next credit benefit can jump from $200 per thousand to over $660 per thousand.

Automating the manual tasks performed by accountants is simple. The three largest, most inefficient tasks of manipulating spreadsheets, interviewing employees, and writing project memos can be automated. This alone reduces your compliance costs by about 80%.

Time to Change

The IRS is doing you a favor. By changing the Form 6765 they are incentivizing you to embrace artificial intelligence for your R&D credit preparation. By taking this step, not only will you be complying with the requirements of the new form you will be automating tasks for which you have been overpaying.

The choice is simple, either move to artificial intelligence or stop filing an R&D credit.