We are writing to call your attention to Jeff Moeller’s recent Tax Notes article on the section 41 research credit, Giving Developers the Research Credit They Deserve. It provides an in-depth look at the so-called “substantial rights” rule governing research performed under contract for a customer. A highly peculiar rule, it was applied in an unfortunate way in the recent Tax Court case Tangel v. Commissioner, T.C. Memo. 2021-1 (Jan 11, 2021).
The Tangel case should be of particular concern for companies that conduct custom development and/or manufacturing. Such companies may be able to make relatively minor changes to their contractual arrangements that can be the difference between qualifying and not qualifying for the research credit. Jeff has extensive experience in this regard.
We also wanted to remind you that our firm has substantial expertise battling IRS challenges to research credits, exemplified by our handling of Bayer v. United States, Case no. 09-351 (W.D. Pa.), in which we negotiated a favorable settlement of the largest research credit case ever filed. We have also done a significant amount of R&E credit planning in evaluating the eligibility of expenditures for the research credit, with a particular expertise in the recent pilot model regulations. If you need assistance in this area, please feel free to contact Jeff Moeller.
On a related point, we have recently been doing a lot of work for clients developing ideas that might avoid the application of the unfavorable provisions for sourcing section 174 expenses under Treas. Reg. 1.861-17, including the recently-issued proposed regulations on that subject. Many of the ideas are novel and are not on the list of tax planning ideas that the Big Four is promoting. If you are interested in discussing these ideas, please feel free to contact either Les Schneider or Pat Smith.