Tax Court Ruling Importance Guidance for R&D Tax Credit Filings

March 23, 2012 - PRLog -- http://www.taxpointadvisors.com/blog/?p=691

Unlike some R&D credit firms, Tax Point 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 doing the R&D work and the qualifying R&D projects – and NOT to rely solely upon the testimony of company owners. The TC Memo supports the rejection of 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), provided no written, documentary evidence, other than this owner’s own testimony, which, the TC claims, was contradicted even by some of his own colleagues. Tax Point has always required clients to have documentation (other than and/or in addition to oral testimony) supporting wage allocations to R&D.  The Tax Point approach is proven by our 100% success rate: we have never had client’s R&D claim denied, at either the state of Federal level.  The TC Memo:

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,
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

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.

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.

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.

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Tax Point Advisors assists CPA's & their clients in identifying & capturing their maximum R&D tax credits. WE HAVE A 100% SUCCESS RATE, NEVER HAVING HAD A CLAIM DENIED. 1 (800) 260-4138, www.taxpointadvisors.com