Attorney-at-Law

THE PRODUCER

In Uncategorized on 10/20/2011 at 15:22

Or, Research Is Scientific

 So The Heritage Organization, LLC, finds out in The Heritage Organization, LLC, GMK Family Holdings, LLC, Tax Matters Partner, 2011 T.C. Mem. 246, filed 10/19/11.

Heritage was a tax planning promoter, originally a life insurance producer; a producer is a broker which solicits or negotiates insurance contracts on behalf of its customers. It claimed a Section 174 research and development deduction on its Form 1065 for the years at issue, courtesy of a decision by its CFO, a high-school graduate bookkeeper who had been working for Heritage for more than thirty years.

Heritage used a separate legal entity that “…conducted legal and tax research regarding corporate and trust structures that would allow individuals to minimize income and estate tax. It spent hundreds of thousands of dollars for legal advice from estate and tax planning attorneys from around the United States.” 2011 T.C. Mem. 246, at p. 5.

As a result of some of this research, Heritage set up trusts, in each of which Heritage placed corporations which ran a “son-of-BOSS” operation, in which short sales were mismatched with the unrecognized obligation to cover the short, thereby trying to create basis where none in fact existed.

In order to protect the trusts by covering their losses on the deals, Heritage’s CFO issued each a check for $550,000, an amount she derived based upon actual loss in covering the short, plus a gross-up for income taxes due and a rounding figure so the check would be in an even dollar amount. Heritage’s CFO booked the payments as “research and development”, and so deducted the payments on Heritage’s 1065.

No, said IRS.

No, said Judge Paris. “The term ‘research or developmental expenditures’ is defined as ‘expenditures incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense.’ Sec. 1.174-2(a)(1), Income Tax Regs. The term generally includes all such costs incident to the development or improvement of a product. Id.”  2011 T.C. Mem. 246, at p. 15. Those are costs necessary to develop the concept or technique of the product, not the product itself.

Using the plain meanings of “experimental” or “laboratory”, Judge Paris finds “(T)he payoff amounts fail to meet the section 174 requirement that the expenditures be for research in the experimental or laboratory sense. The payments were not made for scientific activities. The payoff amounts consisted of the amount outstanding for each corporation on its loan from Heritage, a tax gross-up amount, and an arbitrary amount to make the payment a round number. While a portion of the loss may have been deductible as a short-term capital loss, the remainder would have been a nondeductible investment expense. Holdings relies on the fact that there were a number of employees of Heritage engaged in researching tax planning strategies and identifying high-net-worth individuals, even though these activities were performed by a different Heritage subsidiary. These activities are irrelevant to determining whether the payoff amounts are research and development expenses. The activities were unrelated to the payoff amounts, and further, any expenses associated with those activities were deducted through a different Heritage subsidiary.” 2011 T. C. Mem. 246, at p. 17.

In short, wrong church, wrong pew, and what you put in the collection plate isn’t deductible.

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