Background

Mendes v. Commissioner T.C. No. 16032-95.

This Tax Court case concerns tax deficiencies and additions to tax for the 1988 taxable year. The IRS denies that Fortunato J. Mendes (Mendes) is entitled to any claimed deduction and dependency exemptions.

Basic Facts

In 1995, the IRS noticed a deficiency in Mendes’ tax returns from 1988 which Mendes did not file until 1997. The Court finds that petitioner lacked reasonable cause for his failure to timely file the 1988 return, it follows that his underpayment was due to negligence as he was incarcerated at the time for a murder he committed.

Because this tax report was filed over 2 years after a notice was issued to the petitioner, he essentially waived his right to the escape from any possible liabilities and thus prohibited from using this amended tax return to calculate the penalty.

Findings

The Court sustains respondent’s inclusion of $40,347 in petitioner’s gross income for the audit year, and hold that
petitioner is not entitled to a deduction for loss of the IBM sale proceeds of $27,573 as an offset to that income inclusion.  The Court further sustains respondent’s determination under section 6654, in which the petitioner is responsible for the addition to tax pursuant.

Click Here to view the full case: Fortunato J. Mendes v. Commissioner of Internal Revenue 121 T.C. 308 (t.C. 2003)

Background

Saykally v. Commissioner T.C. Memo. 2003-152

This tax court memo concerns the Saykally family and the following issues are up for debate:

1. Whether petitioners are entitled to deduct expenses claimed for research and development for taxable years 1995 and
   1996 in the respective amounts of $67,534 and $1,421,645;
2. Whether petitioners are entitled to deduct certain expenses on their Schedules C, Profit and Loss From Business, for
   the taxable years 1994, 1995, and 1996;
3. Whether petitioners are liable for accuracy-related penalties pursuant to section 6662 for the taxable years 1994,
   1995, and 1996.

Basic Facts

Saykally has extensive experience in the computer software industry. After a falling out with a previous marketing company for which research and business had been conducted, research was then solely responsible by Saykally. During 1995 and 1996, CPSG, Inc., by and through its wholly owned subsidiaries, paid $67,543 and $1,361,006 of research and development costs on behalf of petitioner.

Deductions generally have the burden of proof fall on the taxpayer to provide evidence to support these deductions. If the Court finds that Saykally is not entitled then CPSG would be so entitle and because CPSG abdondend this argument, there is no opinion to this issue. The next issue addressed is whether petitioners are entitled to deduct certain expenses. At the time Saykally incurred the R&D expenditures, he did not have the objective intent to enter into a future business of his own with the developed technolog but rather to conduct business with other companies and license this to an existing business and there is no evidence on record that Saykally intended to use this research for his own business.  The last issue is whether petitioners are liable for accuracy related penalties. There is no evidence to support the deductions claimed and for the other deductions in regards to R&D, the petitioner testified that they sought advice from a tax professional so the penalties associated with deductions for this would not be appropriate in this case.

Findings

This Opinion finds that respondent’s imposition of a penalty for an erroneously claimed double deduction was substantially justified, they do not find petitioners’ argument that respondent failed to identify which deductions were denied persuasive and they find that at the time this case was filed, the Saykally’s did not engage in research that had the intention of engaging in their own business with the developed technology from research.

Click Here to view the full case: David M. and Teri L. Saykally v. Commissioner of Internal Revenue. 247 Fed. Appx. 914 (9th Cir. 2007)

Background

Bayer Corporation v. United States Civil No. 09-351

This is in regards to a denial of federal research tax credits from Bayer Corporation and Subsidiaries for 1990-2006.  Bayer presents an Amended Motion based on statistical sampling.

Basic Facts

Qualified Research Expenses (QREs) were established in 1981 to increase productivity.  Bayer Corporation and Subsidiaries employ more than 20,000 employees and have several divisions in its company including healthcare, material science and crop science. Bayer conducts research in the US as well as the United Kingdom, Singapore, Germany and several other countries.  Bayer calculates its QREs through accounting records consisting of Word documents, Excel files, patent applications and substantiates QREs for the purpose of claiming tax credits through evidence provided by former and current employees who performed the research.  After completing the Deloitte study in 1998, Bayer filed a claim for additional QRE credits and the IRS denied this claim and also denied credits for QREs that they had previously agreed upon.

The parties’ Joint Motion for a Hearing on Bayer’s amended Sampling motion was granted and a hearing held in 2011, which would seek clarification in regards to the QREs discussed above.

Bayer spent over 13,000 hours devoted to retrieving documents and evidence pertaining to this case as well as offering testimony and documentation.  The government states that Bayer has not met its burden of identifying business components for which the QREs are claimed and therefor cannot quantify the amount of QRE credits that Bayer is entitled to.

Bayer acknowledges that sampling may have been used in tax cases however the references used in the past have all been rejected.

Court’s Decision

The Court is not persuaded by Bayer’s arguments that denial of the Amended Sampling Motion would create a credit for the QREs they were claiming for the purpose of research credit. In addition, Bayer’s argument regarding bookkeeping and evidence requirements should be directed to the Legislative Branch, not this Court.

Click Here to view the full case: Bayer Corporation and Subsidiaries v. United States, Civil No. 09-351 (W.D. Pa. 2012).

Background

T.C. Memo 1994-235

This tax court memo concerns Efrem V. Fudim (Fudim), who in 1988, the Kansas City Service Center informed petitioner that the amount of research credit they claimed exceeded the amount allowable for that year.  They disallowed $3,222 of the $6,176 research credit and directed the petitioners to explain why they had not erred in their original amount reported.

Basic Facts

Efrem V. Fudim (Fudim) and Margarita L. Fudim (Mrs. Fudim) formed Light Sculpting Co. in 1985 and engaged in research. The rapid modeling procedure utilized ultraviolet lights to fabricate plastic objects and they attempted to perfect this method by trying other models and alternatives. Sculpting Co. obtained two patents on this process that was developed that improved the forming of three dimensional objects.

The petitioners attached a Credit for Increasing Research Activities form as part of their income tax return however they ignored the explanation of the limitation and they erroneously reduced their tax. The respondent sent a second letter detailed what the petitioner owed and the petitioners denied they owed anything.

The petitioner contend that the Tax Court should shift the burden of proof in this case to the respondent because they improperly reopened the case but there is not authority or truth to t his argument. The petitioner also argues that the respondent’s assessment of the disallowed excess portion was erroneous because no notice was given but the law states that the respondent may not access this information until an issuance of a notice of deficiency to the taxpayer has been put through.

Most importantly, research credits must be decided if they are acceptable for the years 1986 -1988. If accepted, only the wages paid related to the qualifying services constitute in-house research expenses.  The Court is satisfied that the petitioner’s subsidiaries spent time engaged in qualified services and that Mrs. Fudim spent at least 80% of her time engaged in qualified services.

Court’s Decision

The Court states that on the basis of these findings, petitioner’s research credits for 1986, 1987 and 1988 and allowable carrybacks must be recomputed accordingly.

Click Here to view the full case: Fudim v. Commissioner, T.C. Memo. 1994-235.

Background

Fairchild Industries Corporation v. United States discusses the regulations in regards to qualified research expenses and the role of “funding”. Qualified Research Expenses (QREs) shall not include the following:

• research conducted outside of the United States
• research in the humanities or social sciences sectors
• research funded by any contract, grant or any other person including a government entity

The research tax credit was established in 1981 to provide incentives to American industries to invest in research.  The main issue in this case is the application and implementation of regulations to Fairchild’s contract with the Air Force. 

Basic Facts

In 1982, Fairchild Industries Incorporated and the Air Force entered into a fixed-price incentive contract where Fairchild would design and produce a “next generation trainer” aircraft intended to train new pilots.  This design included many phases of production, development and testing which also had over 1,000 pages of technical specifications and performance standards that were Fairchild were required to adhere to. For Fairchild’s 1982-1985 federal income tax returns they reported $109.4 million of qualified research expenses related to this project of which the IRS disallowed around $19.6 million not related to this program. Because the Air Force funded 55.8% of Fairchild’s research, the IRS disallowed $5.8 million in research tax credits claimed for those years. The interpretation of the statute and regulation for this case is up for debate and review. The question here is whether Fairchild’s research is considered “funded” by the Air Force in terms of research credits. Fairchild claims that the Air Force “funded” none of its research because their right to pay was considered upon the success of the research project.  The government argues that the determination of whether the research is funded or not does not depend on whether the contract reserves the right to pay for unsuccessful research. Fairchild remained at risk throughout this process time until the research was successfully completed. The Regulation places importance on the fact that in order for the researcher to claim credit, accounts payable under the agreement must be contingent upon success.

Court’s Decision

Fairchild’s QREs were not considered “funded” and they are entitled to the research tax credit.  The decision of the Court of Federal Claims is reversed and further proceedings will determine how much Fairchild is owed.

Click Here to view the full case: Fairchild Industries Incorporated v. United Sates, 71 F.3d 868 (Fed. Circ. 1995).

Background

U.S. Court of Appeals, 10th circuit. Tax & Accounting Software Corporation v. US 301 F.3d 1254

Tim Kloehr and Sheryl Kloehr own Tax & Accounting Software Corporation which is an Oklahoma corporation that makes and sells computer software for its customers including the four products at issue: EasyACCT, EasyMICR, Professional Tax System, and EasyTEL. They filed a tax refund suit for 1993 and 1994. They acquired research and development credits developing these products and they were denied these credits. Tim Kloehr faced tax deficiencies of $123,764 in 1993 and $192,510 in 1994. The main argument up for debate in this case is what constitutes “qualified research.”

Basic Facts

Qualified research has 5 separate requirements

1. research much qualify as an expense
2. the research must be conducted to acquire and discover information
3. must be technological in nature
4. the application of information must be used to develop or improve a product
5. must have a “process of experimentation”

The government conceded that Tax & Accounting Software Corporation’s projects passed the 1st, 2nd and 4th requirements.  The “process of experimentation” and “discovering information” requirements are up for debate. The “discovering information” requirement means that the taxpayer must show they discovered new information and must be separate from the product that is actually developed.  The evidence presented shows that Tax & Accounting Software Corporation did demonstrate that they passed this “discovering information” test. For the “process of experimentation,” both parties argued in regards to the definitions they thought fit best. The government relied on past legislative history while Tax & Accounting Software Corporation relied on other legislation. The Court found that TAASC could not be allowed this credit because they did not follow all requirements, mainly the feasibility issue, for the “process of experimentation.”

Court’s Decision

The judgment of the district court is REVERSED, and the case REMANDED.

Click Here to view the full case: Tax & Accounting Software Corporation v. United States, 301 F.3d 1254 (10th Cir. 2002).

Background

Nguyen v. Commissioner T.C. Memo (2003-313)

This is a memorandum from the U.S. Tax Court.  Nguyen filed an tax return for the year 2000 and also claimed a tax refund for $4098.  In response to a selection for examination, Nguyen sent various documents to the respondent.  The respondent stated this information was insufficient and issued another letter to Nguyen for more information.

The issues for decision in this case are as follows:

1. Whether the IRS’s position in the administrative and court proceedings was substantially justified.
2. Whether Nguyen unreasonably extended the administrative and court proceedings.
3. Whether the administrative and litigation costs claimed by Nguyen are reasonable.

Basic Facts

Taxpayers are required to provide information in regards to deductions and claims  by maintaining records necessary to establish both the taxpayers’ entitlement to such items and the proper amount.  This case dealt with research credits, child tax credit, income credit and  The Court holds that respondent’s position in the administrative and court proceedings was substantially justified because failed to substantiate their claims with appropriate information. The Opinion has considered other arguments made by petitioner for a contrary result and found those arguments to be without merit.

Findings

Nguyen is not entitled to administrative and litigation costs.

Click Here to view the full case: Nguyen v. Commissioner of Internal Revenue T.C. Memo (2003-313)