April 22nd, 2011

The Internal Revenue Service April 21 offered guidance on how taxpayers should report their research and experimentation expenses when filling out the Schedule M-3, which the nation’s largest taxpayers must use to reconcile their tax and book income.

In general, IRS said that taxpayers who use a current deduction method of accounting for these expenses under tax code Section 174(a) do not need to provide detail on a project-by-project or product-by-product basis in the M-3 supporting schedules.

However, those who account for R&D expenditures under the deferral and amortization method of Section 174(b) must offer detail on that project-by-project basis, IRS said in a frequently asked question and answer (FAQ) posted to its website April 21.

Recordkeeping Required

Whether or not taxpayers are required to break down expenses by project or product, they all must maintain sufficient records to verify the costs are qualified under Section 174, IRS said. The records need to identify the product, the uncertainty related to the product, and the costs related to resolving such uncertainty.

IRS noted that if an entity adopts the current expense treatment under Section 174(a), this treatment applies to all research projects or products as defined under Section 174. Therefore, taxpayers do not need to go project-by-project when detailing their research and development costs for the Schedule M-3.

However, the agency stressed that these taxpayers still must keep records to verify the amount of expenditures deducted as Section 174(a) expenses.

Those who use the deferral and amortization method under Section 174(b) must take the more detailed approach, the agency said. Taxpayers must include the type and amount for each project or product and a description of each specific project or product to which the qualified expenditures relate, IRS noted.