Few fields so narrow and technical as the Section 41 Qualified Research Expenses (QRE) have generated so much blogfodder. Today it’s Ramesh C. Kapur and Chandra Kapur, T. C. Memo. 2024-28, filed 3/12/24, fighting over a $186K deficiency and $7K of chops for four (count ’em, four) separate years.

All Judge Cary Douglas Pugh has for today is whether to limit discovery to the two biggest items of a random sample of the 2K -3K projects Ramesh’s Sub S and its couple hundred employees worked on (hi, Judge Holmes), or whether to allow IRS to grill 16 of Ramesh’s employees and go through the whole frame. The employees’ wages are the subject of the deficiency.

It comes down to the third leg in the Section 41 table, the “business component” of the claimed additional research. “We note that entitlement to research credits is based on evaluation of each ‘business component.’ § 41(d)(2)(A); Treas. Reg. § 1.41-4(b). A ‘business component’ generally is defined as a product or process that the taxpayer either holds for sale, lease, or license or uses in its trade or business. § 41(d)(2)(B).” T. C. Memo. 2024-28, at p. 2, footnote 3.

IRS says they can’t evaluate the random sample without knowing what business components the research generated, and Judge Pugh buys that.

Now sampling is a generally-applied method when many projects are involved, and a review of every one of them would cost disproportionate time and  money. While this is an unusual case, in that the parties can’t even agree to use a sample at all, here “…petitioners have not given respondent, or us, enough information about all of the projects to determine whether a sample of two to four projects would be a representative sample.” T. C. Memo. 2024-28, at p. 5.

Ramesh claims the two biggest of the sample projects amount to 72% of all the QRE, but that’s not good enough for Judge Pugh.

“Evaluating compliance with section 41 necessarily involves consideration of the underlying business components. And petitioners agree that they have the burden of showing entitlement to the claimed research credits. See Feigh, 152 T.C. at 270. As we have said previously, ‘[a]bsent an agreement between the parties, project sampling improperly relieves the taxpayer of its burden of proving entitlement to the research credit claimed.’” Betz v. Commissioner, T.C. Memo. 2023-84, at *77 n.30 (citing Bayer, 850 F. Supp. 2d at 538, 545–46).” T. C. Memo. 2024-28, at p. 5.

For Feigh, see my blogpost “The Golden Gophers vs Scholar John – Part Deux,” 5/15/19; for Betz, a/k/a Lincoln, see my blogpost “Uncertainty, Investigation, Experimentation,” 7/6/23.

Of course, there’s always a Plan B, and Judge Pugh has got it.

“to the extent that petitioners believe that the expense is disproportionate they can limit their claim to research credits for QREs relating to the two projects they represent should be the sample. But if they claim more research credits, they must be prepared to substantiate QREs. And nothing bars petitioners from identifying information regarding business components in the sampling frame that then might allow respondent to agree to a representative sample.” T. C. Memo. 2024=28, at p. 6.

So while y’all are sorting out the sample, chaps, file some status reports.