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Tax Point to present on recent R&D Court cases at Boston tax Institute seminar

jfeingold — Mon, 28 May 2012 00:05:03 +0000

This March, the US Tax Court clarified acceptable versus unacceptable documentation with regard to time spent by owners/officers in qualified research and development activities included in calculation of the Federal R&D tax credit. You can see the decision from Basim Shami and Rania Ardah, Et Al v. Commission at http://www.taxpointadvisors.com/blog/?p=691 (or just go to www.taxpointadvisors.com and click on NEWS).

In summary, the court looked at estimates provided by the petitioners and determined that they were unacceptable because they lacked any basis other than oral testimony made by those petitioners. Roughly $30m in wages were disallowed, meaning about $2m in claimed credits were denied by the Court. What does this mean for taxpayers using estimates of their employees, owners, and officers’ time spent in qualified R&D efforts? Simply that having credible evidence (not SOLELY oral testimony) and a basis for estimates can make the difference if audited.

One challenge taxpayers, and their CPAs, have when looking at an R&D tax credit is the type of documentation necessary to substantiate the time and effort spent to develop new or improved products or processes. While the I.R.C. and Treasury Regulations don’t in themselves provide sufficient stand-alone guidance, court cases have given taxpayers direction, and with Shami and several other recent Court decisions, clarity has increased with regard to qualifying R&D activities and the essential required documentation. In the Shami case, company owners estimated time spent on qualified activities which were documented through an interview process. According to the court documents, no other basis was provided and additional interviews with witnesses even contradicted statements made by the petitioners, Shami and McCall. The court concluded that testimony provided “was insufficient to establish the time Mr. Shami or Mr. McCall spent performing any specific service.”

Important message for taxpayers: while companies of all sizes take advantage of the research tax credit and derive benefits that are important to their finances, small and mid-sized businesses are most at risk for not developing the right documentation. As a company grows, so do processes and documentation; small and mid-sized businesses, however, are at risk because the development necessary to create structure and standards may not have been implemented. What should a business glean from this case? Simply that creating a process for documenting time and effort of all individuals involved in the R&D process is important and could save thousands of dollars – or millions, in the case or Shami – if the R&D tax credit is later audited.

How to properly document an R&D tax credit claim, in light of the Shami case and other recent Court rulings, will be covered in depth at Tax Point Advisors’ upcoming R&D seminar at The Boston Tax Institute, June 11, 2012, at the Hyatt Summerfield Suites, Waltham, MA. Contact the Boston Tax Institute for registration and other details: http://bostontaxinstitute.com/

GA State R&D Tax Credit Enhanced

jfeingold — Tue, 15 May 2012 15:51:07 +0000

On May 8, 2012, Georgia Governor Nathan Deal signed into law Georgia House Bill 868 expanding the research and development tax credit available to Georgia businesses. In addition to offsetting their Georgia income tax liability, the new law will allow all Georgia companies to potentially claim a tax credit against Georgia payroll tax withholding obligations.
The R&D Tax Credit generally permits a company to offset up to 50% of its Georgia income tax liability based upon increased spending on research and development activities. Prior to the enactment of this legislation, emerging businesses that have operated in Georgia for five years or less were permitted to use the tax credit against not only 50% of their income tax liability, but could use any excess credit to offset their Georgia payroll withholding tax obligations. This incentive allowed start-up companies with little or no income tax liability to nevertheless take advantage of the R&D Tax Credit. House Bill 868 removes the five years or less qualification and extends this ability to use excess R&D credits to offset payroll tax withholdings to all Georgia businesses.

The R&D Tax Credit amount is 10% of the amount by which qualified research and development expenses in a year exceed a base amount. The base amount is the gross receipts for the year multiplied by a ratio of R&D expenses in each of the prior 3 years compared to gross receipts in those years. Beginning in 2012, if the credit exceeds 50% of the business’ Georgia income tax liability, it may be applied to the business’ quarterly or monthly Georgia payroll withholdings, regardless of the old five year limitation. Notably, this new development allows any Georgia company which may have little or no income tax liability to take advantage of the R&D Tax Credit by offsetting their Georgia payroll tax withholding obligations.

Contact the tax credit experts at Tax Point Advisors, Inc., for further details. 1 (800) 260-4138, info@taxpointadvisors.com

Tax Court decision disallows $1.5m R&D tax credit due to insufficient documentation (tax credit study done by a different tax consulting firm).

jfeingold — Thu, 22 Mar 2012 23:41:06 +0000

Tax Point Advisors has always required clients to have a sufficient amount of written, documentary evidence to support their R&D claims – to establish a nexus between the employees working on the R&D projects and those qualifying projects – and not to rely solely upon the testimony of company owners (oral testimony, in and of itself, is insufficient under audit scrutiny, in the absence of additional written, supporting documentation). This current TC Memo rejects R&D credits claimed by a taxpayer because, the TC states, the taxpayer was a very highly-compensated owner whose only support for his 80% allocation of his wages to the R&D credit was his own testimony. The Court noted that the taxpayer, and the R&D service firm he worked with (not Tax Point Advisors, Inc.), provided no written, documentary evidence, other than this owner’s own testimony, which, the TC claims, was contradicted even by some of the owner’s own colleagues. Tax Point Advisors has always required clients to have documentation (other than and/or in addition to oral testimony) supporting wage allocations to R&D, and this approach is proven by our 100% success rate (and further supported by this TC Memo): we have never had a client’s R&D claim denied, at either the state of Federal level. The TC Memo in entirety is shown below:

Shami v. Commissioner
T.C.
No. 28666-08 T.C. Memo. 2012-78 March 21, 2012
T.C. Memo. 2012-78 UNITED STATES TAX COURT
BASIM SHAMI AND RANIA ARDAH, ET AL. 1 , Petitioners
1 This case is consolidated for purposes of trial, briefing and opinion with the cases of Arthur J. Goertz and Jo McCall Goertz, Docket No. 28667-08; Farouk Shami and Izziah Shami, Docket No. 28673-08; Shaukat Gulamani, Docket No. 28687-08; Rami Shami and Najat Badran, Docket Nos. 28688-08 and 5671-09; and John McCall and Kathy McCall, Docket Nos. 28692-08 and 13408-09.
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 28666-08, 28667-08, 28673-08, 28687-08,
28688-08, 28692-08,
5671-09, 13408-09.
Filed March 21, 2012.
Jeremy M. Fingeret, Michael A. Thompson, and Robert G. Wonish II, for petitioners. Sara W. Dalton, Joshua Smeltzer, and Derek Matta, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined deficiencies in these consolidated cases as follows:
Dkt. No.
28666-08 28667-08 28673-08
Petitioners
Basim Shami and Rania Ardah Arthur J. and Jo McCall Goertz Farouk and Izziah Shami

Activities were spread across departments, but activities involving scientific knowledge and experimentation were conducted by the research and development department or were outsourced. The research and development department staff ranged from 18 to 27 employees during the relevant years. The staff included chemists, technicians and a vice president of research and development, who supervised the department. FS is most known for developing the BioSilk, CHI hair coloring systems and flat irons, Color Vision, SunGlitz and Deep Brilliance product lines.

Mr. Shami founded FS in 1986 after coming to the United States in the 1960′s from Palestine on an academic scholarship, eschewing his father’s desires that he follow him into teaching, and began working part time as a hair stylist. Mr. Shami was FS’s chief executive officer, president and secretary for 2003 and 2004. He also served as the chairman of FS’s board of directors and as the sole member of FS’s manufacturing and operations committee.

Mr. McCall was a principal for many years of Armstrong McCall, a wholesale distributor that marketed and sold FS products. Mr. McCall became a shareholder, officer and director of FS in the 1990s. Mr. McCall was FS’s executive vice president and the sole member of its sales and marketing committee for 2003 and 2004. Mr. McCall was paid wages of $5,722,699 and $1,839,581 for 2003 and 2004, respectively.
Neither Mr. Shami nor Mr. McCall have formal education or training in any physical or biological science or engineering.

FS contracted with alliantgroup, LP (alliantgroup) to conduct research and development tax credit studies covering the relevant years. 3 The studies concluded that FS was eligible to claim the research credit based, in part, upon wages paid to Mr. Shami and Mr. McCall. The results of the studies formed the basis for FS claiming the research credit for the relevant years.

The attorneys representing petitioners are alliantgroup employees. The Court is satisfied that the attorneys’ representation of petitioners did not create a conflict of interest under Rule 24(g) as they obtained the necessary informed consent.
FS filed Form 1120S, U.S. Income Tax Return for an S Corporation, claiming the research credit for each year at issue. Petitioners filed tax returns claiming their respective portions of the research credits. Respondent issued petitioners deficiency notices disallowing the claimed research credits. Petitioners filed timely petitions for redetermination with this Court.

OPINION
We are asked to decide whether certain wages FS paid to Mr. Shami and Mr. McCall qualify for the research credit. We begin with the burden of proof. The Commissioner’s determinations in a deficiency notice are presumed correct, and taxpayers bear the burden of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Tax credits are a matter of legislative grace, and taxpayers bear the burden of proving they are entitled to claim tax credits. See, e.g., INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). The burden to disprove a claimed credit may shift to the Commissioner if the taxpayers prove that they have satisfied certain conditions. Sec. 7491(a); Gaitan v. Commissioner, T.C. Memo. 2012-3. Petitioners have not shown that they complied with the requirements of section 7491(a). The burden of proof, therefore, remains with petitioners. See Rule 142(a).

We now address whether certain wages FS paid to Mr. Shami and Mr. McCall qualify for the research credit. A taxpayer is allowed a credit against income taxes equal to 20% of the excess (if any) of the qualified research expenses (QREs) for the taxable year over the base amount. 4 Sec. 41(a)(1). QREs include, among other things, wages paid or incurred to an employee for performing qualified services. Sec. 41(b)(1) and (2). Qualified services means engaging in qualified research or engaging in the direct supervision of research activities that constitute qualified research. Sec. 41(b)(2)(B). The term “engaging in qualified research” as used in section 41(b)(2)(B) means the actual conduct of qualified research (as in a scientist conducting laboratory experiments). Sec. 1.41-2(c)(1), Income Tax Regs. Direct supervision of qualified research means immediate supervision (first-line management) of qualified research (as in a research scientist who directly supervises laboratory research). Sec. 1.41-2 (c)(2), Income Tax Regs. Direct supervision does not include supervision by a higher level manager to whom first-line managers report, even if the manager is a qualified research scientist. Id.

In 1986 Congress created stricter eligibility requirements for claiming the research credit out of concern that taxpayers were interpreting the research credit too broadly and that “some taxpayers * * * claimed the credit for virtually any expenses relating to product development.” S. Rept. No. 99-313, at 694-695 (1986), 1986-3 C.B. (Vol. 3) 1, 694-695; see also Union Carbide Corp. & Subs. v. Commissioner, T.C. Memo. 2009-50; H. Rept. No. 99-426, at 178 (1985), 1986-3 C.B. (Vol. 2) 1, 178.

If an employee has performed both qualified services and nonqualified services, only the amount of wages allocated to the performance of qualified services constitutes QREs. Sec. 1.41-2(d)(1), Income Tax Regs. All wages paid to an employee, however, are allocable to qualified services and constitute QREs if at least 80% of the employee’s wages are attributable to qualified services for a taxable year. Sec. 1.41-2(d)(2), Income Tax Regs.

The amount of wages properly allocable to qualified services is determined by multiplying the total amount of wages paid to or incurred for the employee during the taxable year by the ratio of the total time actually spent by the employee in the performance of qualified services for the employer to the total time spent by the employee in the performance of all services for the employer during the taxable year. Sec. 1.41-2(d)(1), Income Tax Regs. Another allocation method may be used if the taxpayer demonstrates the alternative method is more appropriate. Id.
A taxpayer claiming a credit under section 41 must retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.

Sec. 1.41-4(d), Income Tax
Regs. Petitioners did not demonstrate a more appropriate method than the one the regulations prescribe for apportioning the wages between qualified services and nonqualified services. Accordingly, while petitioners are not required to show that Mr. Shami and Mr. McCall wore lab coats, petitioners must substantiate the time Mr. Shami and Mr. McCall spent performing qualified services and the total time they spent performing all other services. We now turn to this issue.
Petitioners claim that Mr. Shami and Mr. McCall spent 80% of their time performing certain services related to FS product research and development (research and development services) that constitute qualified services for 2003 and 2004 and that Mr. Shami spent 35% of his time performing such services for 2005. Respondent argues that petitioners failed to adequately substantiate the wage allocations for Mr. Shami and Mr. McCall. We agree.

FS’s product research and development was conducted across numerous departments and by many employees. Petitioners failed to provide any documentation that establishes how much time, if any, Mr. Shami or Mr. McCall spent performing research and development services during the relevant years. Moreover, testimony petitioners offered to substantiate the time Mr. Shami and Mr. McCall spent performing purported qualified services was inadequate. Petitioners offered the testimony of Mr. Shami, Mr. McCall and two FS employees, Jason Yates and Tai Pham. Several witnesses contradicted Mr. Shami’s testimony, and no witnesses corroborated Mr. McCall’s testimony. The testimony of the two FS employees was general, vague, conclusory and insufficient to establish the time Mr. Shami or Mr. McCall spent performing any specific service. In sum, we found all of their testimony self-serving and unreliable. We need not and do not accept any of their testimony. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We hold that the inadequate substantiation prevents any amount of the relevant wages from qualifying for the research credit.

Petitioners argue that we must estimate the amount of wages allocable to qualified services if we find either Mr. Shami or Mr. McCall performed qualified services. We disagree. If a taxpayer establishes that he or she paid or incurred an expense but does not establish the amount of the expense, this Court may approximate the amount of the expense, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). For the Cohan rule to apply, however, a reasonable basis must exist on which this Court can make an estimate. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). Without such a basis, any allowance would amount to unguided largesse. Williams, 245 F.2d at 560.

Petitioners failed to satisfy the Court that there is sufficient evidence to estimate the appropriate allocation of wages between qualified services and nonqualified services for Mr. Shami and Mr. McCall. The Cohan rule, therefore, does not allow this Court to make an estimate, and we decline to do so. See, e.g., Union Carbide Corp. & Subs. v. Commissioner, T.C. Memo. 2009-50; Eustace v. Commissioner, T.C. Memo. 2001-66, aff’d, 312 F.3d 905 (7th Cir. 2002); Fudim v. Commissioner, T.C. Memo. 1994-235.
Petitioners rely on United States v. McFerrin, 570 F.3d 672 (5th Cir. 2009), in arguing that this Court must make an estimate. We follow a Court of Appeals decision squarely on point when appeal from our decision would lie to that court absent stipulation by the parties to the contrary. Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). McFerrin is inapposite to the present case.

In McFerrin, the Commissioner argued that even if qualified research occurred, the taxpayer failed to provide adequate documentation to substantiate the costs associated with the research. McFerrin, 570 F.3d at 679. The Court of Appeals, applying the Cohan rule, held that if the taxpayer can show activities that were qualified research, then the court should estimate the expenses associated with those activities. Id. 5 The Court of Appeals for the Fifth Circuit did not overrule, or even address, the basic requirement under Cohan that a court must have a reasonable basis upon which to make an estimate. See, e.g., Trinity Indus., Inc. v. United States, 691 F. Supp. 2d 688, 693 (N.D. Tex. 2010). Moreover, the Court of Appeals for the Fifth Circuit upheld the requirement that a court must have a reasonable basis upon which to make an estimate in Williams. Accordingly, the Court of Appeal’s decision does not require this Court to estimate the amounts of Mr. Shami’s or Mr. McCall’s wages that are allocable to qualified services given our finding that we lack a reasonable basis upon which to make such an estimate. We reject, therefore, petitioners’ argument.

We note that the U.S. District Court for the Southern District of Texas decision from which the taxpayer appealed in McFerrin denied the taxpayer the research credit because the
taxpayer failed to adequately substantiate the claimed QREs. See United States v. McFerrin, 102 A.F.T.R.2d 2008-6269 (S.D. Tex. 2008). The District Court did not apply, however, the Cohan rule because the taxpayer failed to prove that it actually engaged in qualified research activities. Id. Accordingly, the District Court never determined whether it could make an estimate. Id.

We have considered all arguments made in reaching our decision and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing and the parties’ concessions, Decisions will be entered under Rule 155.

New Guidance on CA R&D Tax Credit and Differences From Federal Credit

jfeingold — Wed, 21 Mar 2012 14:56:35 +0000

March, 2012 – the CA Franchise Tax Board or FTB has issued guidance pertaining to the CA state R&D tax credit for service firms and software developers. For CA R&D tax credit purposes, such companies sales – even CA sales – are not considered CA “gross receipts,” and CA gross receipts are a requirement for claiming the CA R&D credit; however, the recent guidance from the FTB provides a clear opportunity for service firms and software developers to still claim their CA R&D credits. Under the regular state R&D credit calculation method (e.g., for manufacturers versus service firms), R&D expenditures for the year of an R&D credit claim are reduced by a certain “fixed base amount,” which is a percentage of average gross receipts for the four years prior to the year of the credit (same treatment as the Federal credit). Since service firms and software developers are considered not to have CA gross receipts, they of course can’t calculate a fixed base and therefore, ostensibly, can’t claim the CA credit; however, the recent FTB guidance makes it clear that such companies can now utilize a minimum fixed base, equal to 50% of their R&D expenditures in the year of the credit claim. So, again, even absent any gross CA receipts, service firms and software developers can calculate a fixed base and claim a CA R&D credit.

State R&D tax credit rules change frequently, are complex, and vary widely across the nearly 40 states with such credits. For assistance with your state as well as Federal credit claims, call the tax credit experts at Tax Point Advisors, Inc., (800) 260-4183, or email us at info@taxpointadvisors.com. A copy of the CA FTB’s guidance is available at:

https://www.ftb.ca.gov/law/Guidance/2012/2012_03_01.pdf

Tax Point Advisors Supports Passage of R&D Credit by House in Alaska

jfeingold — Sat, 10 Mar 2012 17:47:59 +0000

http://www.cbsnews.com/8301-505245_162-57388611/alaska-house-passes-r-d-tax-credit-bill/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CBSNewsGamecore+%28GameCore%3A+CBSnews.com%29

Tax Point founder quoted by CNBC

jfeingold — Fri, 02 Mar 2012 15:01:31 +0000

Tax Point Advisor’s founder and managing partner, Jeffrey Feingold, was quoted as an expert resource for a recent article by CBNC: http://www.cnbc.com/id/46222439

R&D Credits available for architecture, engineering, and contracting companies.

jfeingold — Sun, 22 Jan 2012 12:31:23 +0000

R&D tax credits are often available to companies in the design and construction industries. Typically qualifying activities for R&D credits for contracting, engineering or architecture industries:
Design for LEED/Green Initiatives
LEED certification
Improving acoustical qualities of structure
Developing alternative water flow / plumbing systems
Developing alternative electricity conduction systems
Developing or improving lighting within a structure
Improving or developing alternative ventilation for a structure
Improving or determining alternative heating and cooling systems
Determining alternative structural design
Designing building shape and form
Building Information Modeling
HVAC design
Mechanical system design and testing
Structure and facility design for constructability
Value engineering
Contact Tax Point Advisors, Inc. for more details.

R&D Credit Coalition Report Supports Stronger U.S. R&D Credit

jfeingold — Sun, 22 Jan 2012 11:49:45 +0000

A recent study conducted by the R&D Credit Coalition concluded that the U.S. Federal R&D tax credit increases research spending and creates jobs in the U.S.. The report also suggested that the effectiveness of the credit would be more significant if the government strengthens the credit and makes it a permanent part of U.S. Tax Code. Among the findings of the study are:

The current credit is estimated to increase annual private research spending by $10-Billion in the short-term and by $22-Billion in the long-term; the benefit being substantially greater in comparison to the credit’s approximately $8-Billion cost against annual federal revenue.

It is estimated that, by increasing the alternative simplified credit (ASC) from a net benefit of 7% to 10%, the annual private research spending in the U.S. would increase by an additional $5 Billion to $15 Billion in the short-term, and that long-term spending would increase to about $33 Billion.

The report also states that research-related jobs would increase in the U.S. by about 130,000 in the near-term and by another 300,000 in the long-term as a result of extending the credit and strengthening the alternative simplified credit.

The coalition’s report submits that the research and development tax credit encourages businesses to make long-term investments in technology that ultimately creates new jobs, boosting the economy and encouraging further innovation development.

Jan., 2012 – NY Credit Expiring: Now Is Time to Claim

jfeingold — Thu, 19 Jan 2012 06:31:12 +0000

New York State’s fully refundable tax credit, the “QETC” program – ended at 12/31/2011 (though can still be claimed for 2011 and earlier years). It appears that some of the components (e.g., the $1K hiring part, and the benefit for investors/investments) will continue, but the $250K per year for up to 4 years $1m maximum refundable aspect of the program – essentially, the R&D part – ended 12/31/2011. NY companies meeting the QETC requirements, can still apply for up to four prior years at the max of $250K per year. The “Excelsior” program, which is a new program now available in NY, has four fully refundable components, but nevertheless is much more limited than the QETC in some key aspects.

PROS (Excelsior):
1) raises $1K hiring credit (in QETC) to $5K, which could be quite significant for growing companies.
2) is NOT limited to small companies like QETC is, and so doesn’t have the limits of 100 or fewer employees and less than $10m in product sales,
3) still includes many industries, including sw development, manufacturing, agriculture, high tech, even financial services.
4) has 4 fully refundable components (i.e., the $5K hiring, an investment piece, a property tax piece, and an R&D credit part)

CONS (Excelsior):
1) The R&D credit part – though refundable, as noted – is a mere 10% of a company’s Federal R&D credit, on in-state expenditures.
2) much more involved application process (u can submit a simple two page form to NY to see if you can pre-qualify for the QETC).

For more information about the QETC tax credit, call Tax Point Advisors, Inc., at 800-260-4138.

Tax Point Advisors, Inc. to continue to assist CPAs and clients in Illinois with 5 year extension of R&D credit.

jfeingold — Wed, 28 Dec 2011 06:21:42 +0000

December 26, 2011, Illinois signed a five year extension of their state research and development tax credit program earlier this month, a boon to companies across the state, including Tax Point Advisors clients. “We will continue to assist CPAs and their clients file for this great program, ” commented Tax Point’s Managing Partner, Jeffrey Feingold, “now that the state has had the wisdom to continue the program until 2016.”