Attorney-at-Law

LITTLE SANDY COAL – NO CREDIT

In Uncategorized on 02/11/2021 at 16:55

No, for once it’s not another syndicated conservation easement. Judge James S (“Big Jim”) Halpern goes to sea with Little Sandy Coal Company, Inc., 2021 T. C. Memo. 15, filed 2/11/21. The L’il Sandys build boats; and drydocks. And they claim a bunch Section 38 and 41(a) tax credits (hi, Judge Holmes).

But most of what the L’il Sandys claim is wages for production and supervisory types, and a freelance inspector, but not for experimenters. 80% of the spend has to be for experimenters and researchers, per Section 41(d)(1)(C) and Reg. sec. 1.41-4(a)(6). True, the recordkeeping is not what businesses usually do, but IRS loosened the rules years ago, and the L’il Sandys didn’t even do enough recordkeeping to get to that point.

It’s the usual Judge Big Jim drill-down, measuring each person on the job against what is Qualified Research Expenditure activity, throwing up fractions and percentages in every direction. And in every direction the L’il Sandys miss the 80% cut.

Judge Big Jim does have time to take a shot at a USDJ in USDCNDTX. That Judge (unnamed) reckoned that since all of the ships in the case that Judge had were new, everything was research, and didn’t look at who did what and how much.

“If the court did not make a line-by-line determination of those otherwise qualifying research expenditures that involved a process of experimentation, we do not understand how the court concluded that the 80% test was met. Moreover, the proposition that the court’s finding in regard to the 80% test meant that all costs necessary in the development of the ship were QREs conflicts with the governing regulation. Section 1.41-4(a)(6), Income Tax Regs., makes it clear that ‘the remaining 20 percent (or less) of a taxpayer’s research activities with respect to the business component [that] do not constitute elements of a process of experimentation for a purpose described in section 41(d)(3)’ must ‘satisfy the requirements of section41(d)(1)(A)’–that is, the cost of the activities must be eligible for deduction under section 174. Not all costs necessary in the development of a business component are research or experimental expenditures within the meaning of section 174. (We are hard pressed to see, for example, how the purchase of insurance is an activity ‘intended to discover information that would eliminate uncertainty concerning the development or improvement of a product.’ Sec. 1.174-2(a)(1), Income Tax Regs).

“Because the District Court… did not explain how it arrived at its finding that the taxpayer’s research on two of the vessels in issue satisfied the substantially all test of section 41(d)(1)(C), and because, in each case, the court  stated its finding after a recitation of those aspects of the vessels that were new or redesigned, we can understand how petitioner might have interpreted the court’s substantially all analysis to have turned on an assessment of the proportion of novel elements in each vessel. If that understanding of the court’s analysis is correct, however, we judge the analysis unsupported by the governing regulations and thus decline to follow it.” 2021 T. C. Memo. 15, at pp. 28-29.

Judge, I can imagine the TX USDJ had little idea what was Section 41(a) research, and even less of what has to happen before brand-new steel can go to sea; and wasn’t going to make a career out of figuring it out. And neither did 5 Cir., which affirmed.

But mox nix; the L’il Sandys, being back home in Indiana, are Golsenized to 7 Cir.

Howbeit, the L’il Sandys are out for incomplete records, and taking an “all-or-nothing” approach, rather than shrink-wrapping item by item, per Reg. section1.41-4(b)(2); but shrinking-down wouldn’t help, without records.

 

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