A Banner Year for the R&D Tax Credit

RIG — Thu, 26 Aug 2010 05:26:56 +0000

The R&D Tax Credit has long been an attractive tax incentive as it allows taxpayers to claim a credit for current and past operational activities. In addition, the credit is generally available at both the federal and state level. California, for example, offers a very attractive credit that mirrors the federal credit. Credit claims, however, have often been mired in controversy due to the lack of clarity in both the Internal Revenue Code and the underlying Regulations. In 2009, several prominent cases provided additional clarity on key issues and were very taxpayer friendly.

McFerrin v. Commissioner

Documenting the R&D Tax Credit has often been the most challenging aspect of credit claims. In McFerrin, a federal appeals court held that taxpayers are permitted to make a fair estimate of time and expense in order to calculate the credit. This decision is favorable to taxpayers in its application of the law and the evidence needed to support a credit claim. For taxpayers without detailed time records, reasonable estimates based on the longstanding Cohan rule may be allowed.

Union Carbide Corporation v. Commissioner

In order to qualify for the R&D Tax Credit, research must be performed to resolve uncertainties in the development of a product or process. A U.S. Tax Court ruling allowed a taxpayer to defend its claim by permitting uncertainty in the appropriate design of a product although the successful outcome of its product development was not in question. In this case, the IRS also attacked the taxpayer’s method of documenting activities during its base period (1984-1988). The court found that estimates are permissible and a “close approximation” is appropriate while ruling that the Regulations do not require a taxpayer to substantiate its claim with any particular documents.

FedEx v. United States

The U.S. District Court issued a ruling clarifying that a taxpayer may rely on the guidance of internal use software (IUS) found in the 2001 Treasury regulations and was not bound by the “Discovery Test” that required taxpayers to make a discovery new to the world. The discovery need only be new to the taxpayer.

TG Missouri Corp. v. Commissioner

The decision held that supplies are qualified research expenses (QRE’s) even if the supply may have a useful life greater than one year as long as the property is not depreciable in the hands of the taxpayer. The IRS had previously taken the position that if a supply was property eligible for depreciation, then it would not qualify as a QRE. Therefore, taxpayers may rely on this case to include prototypes in the credit calculation.

Your company may be entitled to significant cash refunds. Call or email us for a free consultation to take advantage of this powerful incentive program.

John Langreck, CPA is the Director of R&D Tax Credit Services at Romo Incentives Group in El Dorado Hills, CA.