Executive Summary
The Notice of Claim Disallowance (NOCD) is a critical juncture in the R&D Tax Credit lifecycle. It represents the IRS's formal rejection of a refund claim. Understanding this document is vital because it triggers strict legal deadlines. This dashboard breaks down the complexity of the NOCD into actionable insights.
📍 Where does NOCD fit in the Process?
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Meaning & Importance
The Meaning: A Notice of Claim Disallowance (often issued as Letter 105C) is the formal administrative conclusion of the IRS regarding a taxpayer's request for a refund or credit. In the context of R&D tax credits, this usually occurs after a taxpayer files an amended return (Form 1040-X or 1120-X) claiming the credit, and the IRS audit team has determined the claim does not meet the requirements of IRC Section 41. It is not merely a preliminary proposal; it is a final determination that closes the door on internal IRS appeals for that specific claim.
The Importance: The issuance of an NOCD is legally pivotal because it starts a "ticking clock." Under IRC Section 6532, a taxpayer has exactly two years from the date the Notice is mailed to file a refund suit in either a U.S. District Court or the U.S. Court of Federal Claims. If the taxpayer ignores this notice or fails to act within this statutory window, they permanently forfeit their right to challenge the IRS's decision in court, effectively losing the claimed credit revenue forever. It is the bridge between administrative tax procedure and federal litigation.
The "Ticking Clock" Implication
Visualizing the 2-Year Statute of Limitations triggered by Letter 105C.
IRC § 6532(a)(1)
Real-World Scenario: TechNovation Inc.
Explore how an NOCD impacts a hypothetical software company claiming the R&D credit. Click the stages below to unfold the story.
The Claim
TechNovation Inc. identifies $150,000 in missed R&D tax credits for software development done three years ago. They file an amended return (Form 1120-X) to claim a refund. They believe their internal time tracking supports the "Qualified Research Activities."
Suggested Next Steps
How to clarify the notice and proceed strategically.
1. Immediate Review & Preservation
📂Identify the specific date on the Letter 105C. This date is legally binding for the 2-year statute. Preserve the envelope and the letter itself. Do not discard any R&D documentation (project notes, timesheets, payroll).
2. Request Administrative File
📝To clarify why the claim was disallowed, file a FOIA request or ask for the Exam Team's workpapers. Understanding if the denial was due to substantiation (lack of proof) or legal interpretation (eligibility) is crucial.
3. Consult Tax Controversy Counsel
⚖️A CPA prepared the return, but an attorney handles litigation. Engage counsel to evaluate the "Litigation Hazards" vs. the value of the credit. Is the $150k credit worth $50k in legal fees?
4. Tolling Agreements
🤝In rare cases, if you and the IRS are still negotiating, you may request a Form 907 Agreement to Extend the Time to Bring Suit. This stops the 2-year clock temporarily, but the IRS must agree to sign it.
The Legal Mandate and Procedural Urgency of the Notice of Claim Disallowance in Research and Development Tax Controversy
I. Executive Summary: The Activation of the Statutory Clock
The Notice of Claim Disallowance (NOCD), typically issued by the Internal Revenue Service (IRS) as Letter 105C or Letter 106C, is the formal, non-negotiable legal mechanism utilized by the Service to deny a previously claimed tax credit or refund.1 For corporate taxpayers asserting entitlement to the Credit for Increasing Research Activities (the R&D Tax Credit) under Internal Revenue Code (IRC) § 41, the receipt of the NOCD is a high-stakes event that immediately transforms an administrative disagreement into a time-sensitive legal controversy. The letter serves as a final administrative declaration, detailing the reason for the Service’s adverse decision, specifying the date of the decision, and identifying the tax year or period affected.1 While the underlying basis for disallowance—whether technical ineligibility or substantiation failure—remains critical, the overriding importance of the NOCD resides in its immediate procedural effect: the activation of a non-extendable statute of limitations for judicial review.
The receipt of the NOCD mandates an immediate shift in strategic planning toward litigation readiness. Specifically, the letter initiates the critical two-year period, as dictated by IRC § 6532(a)(1), during which the taxpayer must commence a refund suit in either the appropriate United States District Court or the Court of Federal Claims.2 This jurisdictional deadline dictates all subsequent actions, compelling tax counsel to prioritize the safeguarding of judicial rights above administrative engagement. The high dollar values and inherent complexity of R&D tax credit claims—which often involve intricate issues of documentation traceability and the application of complex technical standards—mean that they frequently face rigorous examination and subsequent disallowance based on inadequate substantiation or procedural failures.3 The universal application of the NOCD framework (Letters 105C/106C) across various types of credits (such as the R&D Credit and the Employee Retention Credit (ERC) 4) standardizes the resulting legal risk, emphasizing that the primary focus must be procedural compliance with the two-year judicial clock, regardless of the technical merits of the claim itself.
II. The Notice of Claim Disallowance: Definition and Function
A. Formal Designation and Content Requirements
The Notice of Claim Disallowance functions as the formal administrative barrier that must be crossed before a taxpayer can seek relief through the judicial system. It satisfies the statutory prerequisite that a claim must either be formally denied by the Secretary or left unaddressed for a minimum of six months before a refund suit may be filed. The NOCD letters (105C or 106C) are designed to provide the taxpayer with all the necessary legal data points to initiate a challenge. These letters unequivocally communicate the disallowance of the claimed refund or credit.1
Beyond the basic denial, the formal NOCD must include the specific reason for the IRS decision, the precise date the decision was made, and the affected tax year or period.1 Critically, the letter provides a specific timeframe—the aforementioned two-year window—in which the taxpayer must file suit if they intend to challenge the denial in court.1 This information is the foundation upon which all subsequent legal and financial planning must be built. The integrity of the notice and its accurate mailing date are central to determining the deadline for maintaining jurisdictional viability.
B. Stated Reasons for Disallowance: Procedural vs. Substantive Denial
The stated reason for disallowance dictates the appropriate response strategy. These reasons generally fall into two categories: procedural jurisdictional defects and substantive technical disagreements. The most dangerous disallowance reason is procedural untimeliness. To be considered timely, a claim for credit or refund must generally be filed within the later of three years from when the original return was filed or two years from the date the tax was paid, pursuant to guidelines such as those found in Publication 556.1 If the claim itself was determined to have been untimely filed, the controversy often terminates immediately, as IRC § 6514(a) considers a refund of any portion of tax filed outside the proper time limitations to be erroneous and void.5 If the claim is based on untimeliness 2, proving the original claim date becomes paramount, superseding any technical argument about the R&D activities themselves.
In contrast, if the disallowance is based on the merits—for instance, the IRS determined the R&D activity did not meet the four-part test, or the Qualified Research Expenses (QREs) were not sufficiently substantiated—the taxpayer retains the ability to pursue litigation, assuming the NOCD deadline is respected. For R&D claims, such substantive denials frequently hinge upon documentation insufficiency, a common reason the IRS cites when claims are disallowed.3 The focus for the taxpayer then shifts to assembling comprehensive documentation and expert testimony to rebut the Service’s finding on the underlying tax law, but always within the shadow of the statutory deadline.
III. The Immediacy of IRC § 6532: Statute of Limitations for Suit
A. The Two-Year Jurisdictional Clock
The provision codified in IRC § 6532(a)(1) establishes the rigid two-year period for commencing a tax refund suit, measured from the date the Notice of Disallowance is mailed by certified or registered mail. This period is not merely administrative; it is jurisdictional. If a taxpayer fails to file a complaint in the appropriate judicial forum—the United States District Court or the Court of Federal Claims—prior to the expiration of this two-year window, they are permanently and irrevocably barred from challenging the disallowance in court.2 This limitation is critical, especially since these forums typically require the full payment of the disputed tax amount (the Flora rule) as a prerequisite for jurisdiction, contrasting sharply with the deficiency jurisdiction of the U.S. Tax Court.
B. The Critical Procedural Hazard: The Appeal Trap
Perhaps the most common and professionally hazardous pitfall associated with the NOCD is the so-called “Appeal Trap,” which is directly addressed by IRC § 6532(a)(4). This provision explicitly states that any administrative consideration, reconsideration, or action taken by the Secretary following the mailing of the notice of disallowance—even if the claim is formally submitted to the Independent Office of Appeals for review—does not operate to extend the statutory two-year period within which suit must be begun.6
This statutory constraint compels R&D controversy counsel to adopt a mandatory dual-track defense strategy. While utilizing the Appeals process may offer a cost-effective path to settlement, the administrative negotiation must be subordinate to the litigation deadline. Taxpayers cannot afford to rely on the administrative process to resolve the claim, as engaging in negotiation or submitting voluminous new documentation does nothing to toll or pause the judicial clock. Failure to recognize the absolute nature of IRC § 6532(a)(4) can result in the catastrophic loss of the right to judicial review. Consequently, litigation planning must proceed simultaneously with Appeals negotiation, effectively serving as an insurance policy to preserve the right to challenge the NOCD.
C. The Only Safe Mechanisms for Extension
Given the rigidity of the two-year statute, the only permissible mechanism for extending the period to commence a tax refund suit is through a formal, written agreement between the taxpayer and the IRS. This agreement is executed by filing IRS Form 907, Agreement to Extend the Time to Bring Suit.5 Crucially, the agreement must be executed by both parties before the original two-year period has expired.6
The IRS may agree to a Form 907 extension for several reasons, including requiring additional time for internal processing of the claim, the necessity of rectifying internal failures that adversely affected the taxpayer (such as a case being lost between functions), or when the Taxpayer Advocate Service (TAS) is engaged in working the case.5 The existence and use of Form 907 underscore the fact that the two-year deadline established in IRC § 6532 is fundamentally non-negotiable without a formal, mutual stipulation.
The following table summarizes the legal limitations imposed by the mailing of the Notice of Claim Disallowance:
Statutory Deadlines Associated with IRS Notice of Claim Disallowance (NOCD)
| IRS Action/Event | Statutory Trigger | Limitation Period | Relevant IRC Section |
| Mailing of NOCD (Letter 105C/106C) | Decision to disallow claim for refund/credit | 2 years to file suit in court | IRC § 6532(a)(1) |
| Filing of Form 907 | Mutual agreement between taxpayer and IRS | Extension of the 2-year period | IRC § 6532(a)(2) |
| Requesting Appeals Reconsideration after NOCD | Taxpayer action following disallowance notice | Does NOT extend the 2-year period | IRC § 6532(a)(4) |
IV. Disallowance in the Context of Research & Experimentation (R&E) Credits
A. The High Burden of R&D Substantiation
R&D tax credits require one of the highest burdens of substantiation in the U.S. tax code. Taxpayers must provide rigorous documentation that verifies QREs were incurred for activities meeting the four-part test—specifically, demonstrating efforts to eliminate technical uncertainty through a process of experimentation. Because R&D claims often involve high-dollar amounts and complex calculations across multiple business units, the majority of claims leading to a NOCD are traceable not to a failure of technical eligibility, but to systemic failures in documentation and financial traceability.
B. Example: Disallowance due to Failure to Substantiate QRE Samples
A common and illustrative pathway to the issuance of a NOCD in the R&D context involves the failure to substantiate the statistical basis for the claimed QRE calculation. Large corporations often employ statistical sampling to extrapolate qualified expenses from a large universe of employee wages and supply costs. The IRS, however, imposes stringent audit requirements designed to test the financial and statistical rigor of this methodology.
The NOCD may specifically result from the taxpayer’s inability to satisfy the IRS demand to replicate or recreate the estimated QREs.3 For example, the IRS may have issued the disallowance citing the taxpayer’s failure to furnish all the requisite reports and computer files used during the initial “population refinement process,” or the failure to reconcile the claimed QREs back to the company’s underlying financial books and records.3 Furthermore, the NOCD might specify that the taxpayer failed to provide a written explanation for missing documentation related to certain sample units, or lacked a justifiable statistical basis for applying re-scaling factors to the extrapolated QRE dollars.3 This lack of financial and statistical traceability permits the IRS examiner, often supported by internal Subject Matter Experts (SMEs), to conclude that the calculation of the QRE amount is arbitrary, thereby justifying the full disallowance of the claimed credit. This demonstrates that in R&D controversy, the disagreement frequently shifts from an interpretation of tax law (eligibility) to a forensic accounting methodology dispute (measurability).
C. Recourse Against Negligent Advisors
When a NOCD is issued based on substantiation failures, particularly those arising from poorly executed statistical methodologies or a generalized lack of contemporaneous documentation, the event may establish a separate claim for professional liability. If the company relied on a professional advisor whose counsel or preparation was negligent, leading directly to the IRS challenge or disallowance, the company may have grounds to seek damages against the advisor.9 Such a claim could enable the company to recoup penalties and interest imposed by the IRS that would have been avoided had competent advice been provided. Immediate evidence gathering, including all correspondence and claim documentation demonstrating the advisor’s guidance, is a critical step following the NOCD to determine the viability of professional action.9
V. Taxpayer Response Strategies Following NOCD Receipt
A. Immediate Triage and Deadline Confirmation
The receipt of a Notice of Claim Disallowance necessitates immediate, disciplined action. The primary duty of counsel is to confirm the exact two-year jurisdictional deadline by verifying the mailing date of the Letter 105C or 106C. As established by IRC § 6532(a)(4), this deadline cannot be compromised by subsequent administrative actions.7 Concurrently, the firm must undertake an urgent internal assessment: a review of the procedural posture of the claim to confirm it was timely filed under IRC § 6511 1, and a thorough evaluation of the technical and documentation strengths of the underlying R&D claim to determine the likelihood of success on the merits.
B. The Strategic Decision Matrix
Upon completing the internal assessment, the taxpayer faces a stark strategic choice among three primary paths, which must be selected and acted upon swiftly due to the time constraint:
- Agree and Accept: If the NOCD is based on an irrefutable jurisdictional defect, such as untimeliness under IRC § 6511, or if the documentation deficit is deemed fatal and prohibitively costly to litigate, accepting the disallowance may be the most financially prudent course.4
- Administrative Appeal: The taxpayer may request that the claim be sent to the Independent Office of Appeals.2 This track is attractive as it offers a non-judicial pathway to settlement and potential compromise, often involving less immediate cost than litigation. However, this decision must be managed with extreme caution, as engaging in Appeals negotiations does not toll the two-year clock.
- Judicial Litigation: The taxpayer may elect to bypass Appeals entirely or proceed to litigation simultaneously with Appeals. This requires filing a tax refund suit in the U.S. District Court or the Court of Federal Claims before the IRC § 6532 deadline expires.8 For high-value R&D claims, the judicial path is the primary goal, and litigation preparation should begin immediately upon NOCD receipt to allow ample time for drafting the complaint, ensuring proper venue selection, and meeting the complex procedural requirements.
C. Securing Rights via Form 907
If the administrative Appeals track is chosen, legal counsel must immediately seek to negotiate and execute Form 907, Agreement to Extend the Time to Bring Suit. This action is paramount because the statutory architecture of IRC § 6532 mandates that the taxpayer secure this extension to create sufficient time for meaningful settlement negotiations without sacrificing the ultimate right to judicial review. If the IRS declines to sign Form 907, the presumption must be that the Appeals process will not be concluded within the statutory two-year period, necessitating an acceleration of judicial filing preparations, often resulting in a protective suit to preserve jurisdictional access.
VI. Next Steps: Proactive Measures for Clarification and Full Explanation
A comprehensive understanding of the NOCD process requires acknowledging the systemic pressure points and implementing strategies to mitigate exposure.
A. Mandating Perpetual Litigation Readiness
To fully clarify and explain the use of the Notice of Claim Disallowance, clients must be advised to operate under a standard of perpetual litigation readiness for their R&D claims. Receipt of Letter 105C/106C demands immediate engagement of litigation counsel to secure all relevant evidence, draft the judicial complaint, and determine the optimal venue well within the 24-month window. The primary objective is either to file a timely suit or, at minimum, secure a Form 907 extension prior to the expiration of the deadline.8 This strategic posture views administrative processes, such as Appeals, as tools for settlement leverage rather than ultimate means of resolution, eliminating the risk inherent in relying on reconsideration that does not extend the statutory clock.
B. Implementing Rigorous R&D Audit Controls
The most effective method for navigating the NOCD process is preventative—ensuring future R&D claims withstand the rigor of an IRS examination focused on substantiation and replicability. Given that R&D disallowances often stem from failures of accounting methodology rather than tax law interpretation, internal controls must be enhanced to satisfy the demand that the IRS be able to “recreate the sample”.3 Specific recommendations include:
- Traceability Systems: Implementation of robust financial systems that precisely tag Qualified Research Expenses (QREs), especially employee wages, back to specific documented qualified projects with contemporaneous technical narratives and project calendars.
- Statistical Validation: For large claims utilizing extrapolation, ensuring the methodology is vetted and validated by an independent statistical firm to meet the IRS’s demand for a justifiable statistical basis and replicability.3
- Contemporaneous Documentation: Moving away from reliance on retrospective studies, mandating that all technical and financial documentation essential to the claim be captured concurrently with the research activities to satisfy the highest burden of proof required in tax controversy.
C. Advocacy for Legislative Reform of Procedural Traps
A complete explanation of the NOCD must address the inefficiency created by the Appeal Trap codified in IRC § 6532(a)(4). The need for taxpayers to file a Form 907 extension 5 or a costly protective suit while actively negotiating with Appeals demonstrates that the current statute compels taxpayers to incur litigation costs merely to preserve a statutory right, rather than encouraging the efficient administrative resolution of the core tax dispute. Therefore, a constructive step forward involves advocating for legislative reform. This would entail suggesting to Congressional committees that IRC § 6532 be amended to formally toll the two-year statute of limitations during the period of a formal, timely review by the IRS Independent Office of Appeals. Such a systemic change would promote efficiency, reduce unnecessary litigation, and align the procedural rules with the administrative goal of dispute resolution.
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What is the R&D Tax Credit?
The Research & Experimentation Tax Credit (or R&D Tax Credit), is a general business tax credit under Internal Revenue Code section 41 for companies that incur research and development (R&D) costs in the United States. The credits are a tax incentive for performing qualified research in the United States, resulting in a credit to a tax return. For the first three years of R&D claims, 6% of the total qualified research expenses (QRE) form the gross credit. In the 4th year of claims and beyond, a base amount is calculated, and an adjusted expense line is multiplied times 14%. Click here to learn more.
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