Meyer, Borgman & Johnson, Inc. v. Commissioner, No. 23-1523 (8th Cir. May 6, 2024). Full decision of the 8th Circuit available here.

The U.S. Court of Appeals for the Eighth Circuit affirmed a decision of the Tax Court that the taxpayer was not entitled to research tax credits because the taxpayer’s research was “funded” within the meaning of section 41(d)(4)(H).

Background

Meyer, Borgman, & Johnson, Inc., a structural engineering firm, sought R&D tax credits for its expenses incurred in creating documents for the structural design of building projects. The taxpayer claimed approximately $190,000 in tax credits for the years ending September 30, 2010, 2011, and 2013. The credits were denied by the Commissioner on the basis that the research was “funded”. The Tax Court ruled that the taxpayer had no financial risk as payment was to be made regardless.

The taxpayer argued that the Tax Court erred as payment for their research was in fact contingent on the success of its research. Furthermore, they argued that their contracts have a fixed price which is not generally considered to be funded work – statement supported by Case Law: Populous Holdings, Inc. v. Commissioner 2019 WL 130325266, at *2 (T.C. Dec. 6, 2019) (non-precedential order by Tax Ct. R. 50(f)). 

Legislation

 26 U.S.C. § 41(d)(4)(H) states that “Any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity)” is not qualified research. The legislation clarifies that taxpayers who are paid to conduct research – such as through a contract – must have rights to use the IP and must be paid on a basis that indicates payment for the research is contingent on the success of the research.

This specification is essential as it clarifies who is at financial risk for the research taking place. If a taxpayer is paid regardless of the outcome or success of the research, there is no financial risk involved. However, if payment is contingent on the success of the research, financial risk falls on that taxpayer.

Outcome

The Eighth Circuit affirmed the Tax Court’s decision and stated that the Taxpayer’s contracts lacked the specificity required to prove financial risk. In particular, they specified that the contracts lack the express terms that courts have identified as important to establish payment was contingent on the success of the research and highlighted Dynetics, 121 Fed. Cl. at 505 and Little Sandy Coal Co., Inc. v. Commissioner, 62 F.4th 287, 298 (7th Cir. 2023).

Dynetics was used as an example because the Taxpayer’s contracts did not include rejection language nor did it limit payment to work that was accepted. Little Sandy Coal Co was used as this case law provides a description of qualified research, (holding that “qualified research” does not include “testing to determine if the design of the product is appropriate,” cannot just be “any design or modification to meet customer specifications,” but must remove uncertainty “related to the ‘development or improvement’ of the product”

In summary, the Taxpayer’s contracts had verbiage outlining general economic risk of investing resources without a commitment to be paid, but that the risk was not contingent on the success of the research itself. Requirements to comply with pertinent codes and regulations or to perform pursuant to a general standard of care does “not mandate success” (citing Geosyntec Consultants, Inc. v. United States, 776 F.3d 1330, 1341 (11th Cir. 2015)). 

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

United Therapeutics Corp. v. Commissioner, case number 23-1718, in the Court of Appeals for the Fourth Circuit.

Background

United Therapeutics Corp, a biotechnology company, has brought their case to the Fourth Circuit of Appeals, where they aimed to appeal a decision passed by the US Tax Court. According to the Tax Court, the company’s computation methods resulted in an R&D claim inflated by $1.2 million.

The company first received a notice of deficiency from the IRS in 2021 for an R&D tax credit claim made for the 2014 tax year. The deficiency specified an income tax deficiency of $1,212,655. In 2023, the Tax Court upheld the deficiency. This decision is now being appealed. The issue at hand pertains to the calculation used when claiming both the R&D tax credit (IRC 41) and the Orphan Drug Credit (IRC 45).

The taxpayer used the alternative simplified credit method (ASC) for computing their research credit, which provides a credit equal to 14% of qualified research expenses (QRE) that exceed 50% of the “average qualified research expenses for the 3 taxable years preceding the taxable year for which the credit is being determined.”

Some of the QREs crossover and qualify as clinical testing expenses for the orphan drug credit. When claiming both credits, a coordinating provision in IRC 45C(c)(2) mandates that any qualified clinical testing expenses that are also QREs “shall be taken into account in determining base period research expenses for purposes of applying section 41 to subsequent taxable years”.

The Court of Appeals is reviewing the Tax Court’s opinion that the taxpayer did not appropriately address the coordinating provision under IRC 45C(c)(2). 

Approach Used

The taxpayer incurred expenses that qualified under both credits in the baseline period of 2011-2013. The taxpayer claimed the orphan drug credit in tax years 2011-2014 and elected to claim the R&D credit in tax year 2014 using the ASC method. However, in calculating the average QREs for the 3-year base period, the taxpayer excluded the qualified clinical testing expenses incurred in 2011-2013. These expenses would also be QREs. By excluding these expenses, the resulting average QREs for 2011-2013 were $22,605,492 and resulted in an R&D tax credit of $2,799,129 for the 2014 tax year. 

IRS’ Stance

The IRS disagreed with this method, stating these expenses should have been included in the baseline. If the IRS’s take is correct, the base period QRE should be $49,257,244 and the correct R&D credit would be $1,586,474.

Arguments

The taxpayer argued that the term “base period research expenses” in IRC 45C(c)(2) was a statutorily-defined term that Congress used in the 1980s version of the IRC 41 research credit (JA.51, 54) that no longer had any meaning in the applicable 2014 version of § 41 (JA.59). 

The Commissioner disagreed, arguing that even though Congress eliminated the term “base period research expenses” from IRC 41, that term continued to operate through IRC 45C(c)(2) to coordinate the two credits. (JA.114, 123.) 

The taxpayer told the Fourth Circuit that the Tax Court was wrong to look at dictionary definitions to establish a base period for the credit calculation. The term “base period” is defined in IRC Section 41, which governs scientific research credits separately from those for clinical testing, as a term that applies only in the calculating of basic research credits, which the company did not apply for, according to its brief.

The Commissioner argued that United Therapeutics has ignored the part of IRC Section 41(e) that says only basic research credits are relevant to the base period. Under the plain meaning of the law, that provision does not extend to IRC Section 45C, which requires all expenses to be included in the credit calculation, the government said.

Appeal Result

The Tax Court sustained the Commissioner’s tax deficiencies, agreeing that IRC 45C(c)(2) should be applied according to its ordinary meaning. Since “base period research expenses” was not a defined term in the 2014 versions of either IRC 41 or IRC 45C, one should turn to the contemporary definition, interpreting “base period” as a baseline or reference point.

With this decision in, the Tax Court correctly relied on current dictionary definitions of a base period in holding that United Therapeutics should have included all its qualified research expenses, including those to develop drugs to treat disease, for the three years leading up to its 2014 credit year. As a result, the taxpayer did in fact claim a credit $1.2 million larger than they were eligible for.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

The Internal Revenue Code (IRC) Section 174 historically allowed taxpayers to deduct research and experimentation (R&E) expenditures in the year they were incurred. The Tax Cuts and Jobs Act of 2017 (TCJA) made a significant change to this allowance, requiring taxpayers to capitalize and amortize these R&E costs for taxable years beginning on or after January 1, 2022. This change has had large backlash from taxpayers as it shows a severe lack of support for companies performing R&D.

Generally, determining state taxable income begins with how a state adopts the IRC and how the state applies federal changes to its taxable income computation. Some states use “rolling conformity,” where they automatically adopt changes to the IRC as they occur. Many others use a “static” or “fixed date” approach and adhere to the IRC as it existed at a specific point in term. Still, others practice selective conformity, picking and choosing federal provisions or definitions in their own tax code. This can often be an indicator of tax provisions that are effective or well accepted, as most states will conform.

For states that have conformed, Section 174 expenditures must be capitalized and amortized over the same period as they are for federal income tax purposes.

The changes to Section 174 from the TCJA have shown a surprising level of nonconformity with 5 states opting out of these changes.

• California

California generally adopts the IRC as of January 1, 2015, which would not include the changes to Section 174.

• Georgia

On May 2, 2023, Georgia enacted S.B. 56 and decoupled from the federal treatment under Section 174. Section 174 must be applied as it was in effect immediately before TCJA was enacted.

• Indiana

On May 4, 2023, Indiana enacted S.B. 419, which requires a deduction for R&E expenditures that were required to be capitalized for federal purposes and an addition for any R&E expenditures deducted for federal purposes — effectively decoupling from the federal capitalization treatment under Section 174.

• Tennessee

For tax years beginning on or after January 1, 2022, Tennessee follows the federal treatment of expenditures under IRC Section 174 as it existed on December 31, 2017.

• Wisconsin

Wisconsin adopts Section 174, but specifically states it is the version that existed prior to TCJA.

Conforming states may well follow suit. Many were waiting for updates regarding Congress potentially repealing the legislation. With recent guidance and tax deadlines come and gone, it is clear that Congress is unlikely to repeal it any time soon. States may need to take some time to determine the fiscal impact of decoupling and and whether it could further entice companies to perform research activities in their states. It is likely that more states could enact decoupling laws in upcoming legislative sessions.

There are a few bills in progress that are looking to repeal this amortization requirement. For now, we must wait and see how they play out in Congress.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/

Leonard L. Grigsby et al. v. The United States (No. 19-00596-BAJ-SDJ)

The United States filed a civil suit against Leonard Grigsby, seeking the return of an erroneously issued tax refund. The Government further moved that the company did not conduct any qualified research activities, and so the credit is ineligible from the start.

The Erroneous Refund

Cajun Industries, LLC & Subsidiaries (Cajun) claimed an R&D tax credit for the tax year 2013, wherein the entity elected to be treated as an S Corporation. During this year, Leonard Grigsby was a member of Cajun. 

Leonard and Barbara Grigsby filed multiple tax returns, including amended returns following Cajun’s amended return. This return filing history is outlined here:

• Leonard and Barbara Grigsby filed a timely filed return for 2013, claiming an overpayment carryforward to tax year 2014 of $239,310;
• Leonard and Barbara Grigsby filed a second joint federal income tax return for 2013, claiming an overpayment carryforward of $259,962 to the 2014 tax year
• Cajun filed an amended federal tax return around October 3, 2016 which claimed $1,341,420 of research credits
• After this, Leonard and Barbara Grigsby filed another amended 2013 federal income tax return, claiming a tax refund in the amount of $576,756.
  • This amount was attributable to the portion of the Cajun R&D tax credit allocable to Leonard Grigsby as a shareholder.

On September 18, 2017, the IRS processed the individual’s second 2013 return as an amended return, allowing the additional overpayment of $20,652 claimed on that return. The IRS then processed the third return, erroneously allowing the $576,756 refund claimed on that return. On September 15, 2017, the IRS erroneously issued to Leonard and Barbara Grigsby a refund in the amount of $671,071.38, which reflected the amount of the refund claimed by the Grigsbys on their Third 2013 Return, plus statutory overpayment interest of $73,663.38. 

Qualified Research

Cajun is a civil construction company which contracts with hundreds of private and public clients to provide a range of construction services in numerous markets. With consultation from AlliantGroup, the company identified 105 research projects in their 2012 tax year, which ended September 30, 2013. They amended their tax return, claiming a tax credit in the amount of $1,341,420.

In review of the credit, Cajun and the Government agreed that a sampling of four of Cajun’s projects for the tax year ending September 2013 would be sufficient to determine the outcome of the dispute. The company provided brief descriptions of each representative project.

Each project was subcontracted work and, upon review of contracts and service agreements, the Government identified the following key contract terms and details:

• Each contract was a fixed-fee with a capped payment; however, each contract also contained provisions wherein Cajun may receive additional compensation in stated circumstances such as if the scope of work is changed or expanded.
• Each contract stated that work was subject to approval by the hiring entity, with different outcomes for how this would impact payment (if at all).
• Three of the contracts outlined IP and Work Product rights, asserting that any IP or Work Product developed is the property of the hiring entity.

Outcomes and Learnings

The devil is in the details, especially when it comes to contracts and service agreements. At first glance, each of these subcontracted projects were fixed-base and the financial risk would be placed on Cajun. However, reading the detailed contract terms highlighted that there were provisions and clauses that would ensure Cajun was compensated in almost every instance that would create financial risk. The contract allowed the taxpayer to receive compensation for “all loss, damages or risks … connected with … the work.” This included unanticipated amounts for inspection and testing.

This level of protection financially favored Cajun, protecting them well in business but ultimately removing the right to the tax credit. What was good for business is not necessarily suitable for tax.

The Government also found, and reinforced, that “Works Made for Hire” are funded. Cajun did not retain rights to the research, work product, or IP in 3 of the 4 representative projects. Since the final product benefitted the hiring entity, it would be considered funded research, again removing Cajun’s eligibility for the credit.

The Government found that Cajun’s credit was ineligible and was denied. Similarly, the court ruled in favor of the US in the civil suit against Grigsby, requiring the erroneous refund to be recollected.

The lesson here is understanding eligibility and financial risk is essential to determining who has rights to the credit. A simple overview of a contract is not always sufficient and diligence is crucial.

The full case can be found here.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

Desert NewCo, LLC, GoDaddy Inc., Tax Matters Partner, V. Commissioner Of Internal Revenue

Desert NewCo LLC, a partnership and the parent company of GoDaddy, has petitioned the U.S. Tax Court for help in securing $16.3 million in research and development tax credits, stating their software and product development expenses qualified for a now-expired tax break.

The company originally made this request more than two years ago but the IRS has since failed to make a decision. In response to this lacking decision, Desert NewCo filed their petition, asking the Tax Court to intervene.

Their claim indicates an expenditure of $174.8 million on research expenses in 2017 which qualified under Section 174 of the Internal Revenue Code (IRC). This resulted in an R&D tax credit claim under Section 41 in the amount of $16,256,374. The claim suggested the following:

• The largest source of research expenses for GoDaddy came from wage, contract expenses, and computer leasing costs
• $1 million in costs came from securing the rights to use computers to conduct qualified research
• GoDaddy had unrealized gains in property due to interest transfers between it and GoDaddy that should have resulted in an additional $37,000 in deductions

Desert NewCo asked the IRS, in December 2020, for an administrative adjustment granting the credits on its amended 2017 return. This request was never allowed nor acted upon.

With the petition filed, the company now awaits a response to determine how these partnership items can be adjusted. The full petition highlights further details pertaining to the partnership and the company’s requests.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

Moore v. Comm’r, T.C. Memo. 2023-20| February 23, 2023 | Colvin, J. | Dkt. No. 18632-19

Summary:

Nevco, Inc (Nevco) had claimed R&D tax credits for both 2014 and 2015 with a total claim of $68,263 and $141,945 in each year respectively. The company manufactures scoreboards for high school and college athletic events, as well as LED video displays, score tables, and other types of equipment for indoor and outdoor sports venues.

Nevco’s president and chief operating officer (COO) during these years and the claim was calculated with his time included. The IRS held that the wages paid to this COO could not be included in computing the R&D tax credit under Section 41 because the taxpayer failed to adequately substantiate time spent on qualified research and did not engage in direct supervision or support.

The company maintains that the COO spent a significant amount of time — approximately 50-65% — on new product development.

Key Points of Law:

Section 41 outlines that staff must be either engaged directly in qualified services or in direct supervision or support of those performing the qualified services:

• 41(b)(1)(A). A taxpayer’s “in-house research expenses” include “any wages paid or incurred to an employee for qualified services performed by such employee.” § 41(b)(2)(A)(i). Section 41(b)(2)(A) includes as wages “all remuneration . . . for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash.” See §§ 41(b)(2)(D)(i), 3401(a). An employee performs “qualified services” by either “(i) engaging in qualified research, or (ii) engaging in the direct supervision or direct support of research activities which constitute qualified research.” § 41(b)(2)(B).

Four Key Criteria

Under section 41(d), four requirements must be met in order for an activity to be “qualified research.” 

1. Research must be eligible to be treated as expenses under section 174
2. Research must be undertaken to discover information which is “technological in nature”
3. Application of the research must be intended to be useful in the development of a new or improved business component of the taxpayer
4. Substantially all of the activities of the research must constitute elements of a process of experimentation for a purpose related to a new or improved function, performance, or reliability or quality.

Details:

The COO had previously been a software engineer, chief information officer at an electronics firm, and vice president at another electronics company. With this history, he had experience with designing and manufacturing various electronics. 

The company failed to keep records of the COO’s time including how much time he spent on any individual project. The company could not present any documents that detailed either the COO or any employee’s responsibilities or duties in 2014 and 2015, making it difficult to substantiate the work performed by the COO. The company contended that other senior officers took care of financial, marketing, and sales initiatives, leaving the COO to oversee operations and new product development.

The company followed a structure where the engineering and product development teams reported to Mr. Paslay, a direct supervisor who then reported to the COO. As such, the COO was the second-level supervisor of the engineering team. 

The COO testified that he spent two thirds or more of his time working on new product development in 2014 and 2015. His testimony was corroborated by the testimony of other employees, including Mr. Paslay. 

The Court’s Decision And Learnings:

The Court agreed with the testimony, as well as the percentage arrived at by the company. Given the company structure leaving operations and product development to the COO while other senior level officers managed the sales and financials, the Court believes a 50-65% estimate of time is reasonable. However, the Court holds that the percentage and time spent are irrelevant as the work conducted by the COO does not meet the definition for qualified services.

An employee’s time must meet four key criteria to be considered eligible. The company’s records provided no proof or detail that distinguished the COO’s time spent on qualified research from the broader category of new product development. 

With the example of one claimed project, the testimony only mentioned the COO specified requirements for the product – which is not qualified as they do not apply technology in an experimental process. While they did mention his work in identifying a design that would perform well in high winds, they could not show how much time was spent on this specific activity. The same pattern repeats for all projects claimed wherein the potentially qualified activity could not be substantiated by records.

Regarding the use of direct supervision under 41(b)(2)(B)(ii) (“engaging in the direct supervision or direct support of research activities which constitute qualified research”). The term direct supervision as used in section 41(b)(2)(B) means the immediate supervision (first-line management) of qualified research (as in the case of a research scientist who directly supervises laboratory experiments, but who may not actually perform experiments). Direct supervision does not include supervision by a higher-level manager to whom first-line managers report, even if that manager is a qualified research scientist. As such, the COO acting as a second-line supervisor negates him from being qualified under this definition.

The Court determined the company could not consider any wages paid to the COO in computing Nevco’s section 41 research credit for 2014 or 2015.

This case highlights the importance of record keeping and maintaining documents or time records to substantiate employee time.

Click here to read the full case.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

Kellett v. Comm’r, T.C. Memo 2022-62 | June 14, 2022 | Greaves, J. | Dkt. No. 21518-18

Summary:

The IRS disallowed a $25,992 business expense deduction resulting in a corresponding deficiency of $6,475 in 2015. 

Kellett ran a business information website which started upon the website’s opening in September 2015. This website compiled demographic, social, and economic data and attempted to make a user-friendly version of Google or Yahoo Finance. The website was developed with engineers who built the desired features and functionality. On a timely filed 1040, the taxpayer claimed expense deductions for these engineers as well as a marketing strategist, cell and internet service cost from his home, and some miscellaneous expenses. The IRS denied all deductions on the grounds that the business had not started.

The Tax Court set out to determine:

• When does a business start for purposes of § 195?
• Can a taxpayer expense the costs of developing software under § 174 before the business technically begins, or is he solely relegated to relief under § 195?
• Can a taxpayer use Rev. Proc. 2000-50 to deduct the costs of developing a website?

Key Points of Law:

• 195 Start-up Expenditures: § 195(a) disallows deductions for start-up costs except for provided in this section. Therefore, under § 195(b), a taxpayer generally can deduct up to $5,000 of start-up expenditures. However, if the costs are in excess of $50,000, then the amount is phased out dollar for dollar until $55,000. § 195(b)(1)(A)(i)-(ii). Any amount phased out, or in the event the costs exceed $55,000, the taxpayer must capitalize the capital outlay and then amortize it ratably over 15 years. § 195(b)(1)(B).
• 174 Research and Development: Taxpayers are granted relief from the harsh capitalization standards for start-up costs under § 174, but it applies only in limited circumstances. However, the general rule is that taxpayers may treat R&D connected with their trade or business as expenses not chargeable to the capital account. § 174(a)(1). § 195(c)(1) excludes from the definition of start-up expenditures any amount which a deduction is allowable under § 174.

The Court’s Decision And Learnings:

The court determined the business began in September of 2015 because that is when it began providing the services for which it was organized. Any expenses incurred before this date must be taken under § 195 and any expenses after this date are taken under § 162.

Further review brought the following decision: the taxpayer is disallowed from taking a § 174 deduction (i.e. R&D Tax Credit) since he merely adapted a widely used software rather than developing it from whole cloth.

This case highlights the importance of understanding the difference between development and experimental development. While website or software development may seem as though it is inherently R&D, developers must carefully consider if their product is novel and faces technical uncertainties. Modification of existing software rarely has significant enough technical uncertainty or experimental development work to pass the IRS’s four part test.

Click here to read the full case.

Are you conducting research and development activities? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.