It’s a long-established rule that estimates are a valid method for determining qualification for tax credits, saving the credit when records and documentation are unavailable or incomplete. But even estimates have limitations in the tax realm. In Moore v. Commissioner, the taxpayer tried to wave a magic wand by estimating how much credit they were entitled to for research and development activities. But the the spell failed, and the tax credit was lost.
The taxpayer, Gayla Moore, owned an S corporation that manufactures scoreboards for high school stadiums. The company, Nevco Inc., claimed the R&D credit for 2014 and 2015 based on activities related to developing new products during those years.
The IRS took issue with the wages of the company’s president and chief operating officer, who oversaw the entire company but had assistance with some administrative functions, primarily from Moore and her husband. Moore handled most of the financial responsibilities, and her husband did most of the marketing and sales.
This left the president and COO, referred in court documents only as “Mr. Robert,” with the ability to devote most of his attention to new product development, according to Moore. The engineering department was managed by Dave Paslay, who reported directly to Robert.
During those two years, the company worked on several new products. The court reviewed five:
- Scoreboard Truss, a system manufactured in-house that could withstand winds up to 180 miles per hour;
- Scorbitz, an app to transmit scoreboard information, such as score and time remaining to personal devices;
- New Caney Ribbon Board, a 276-foot-long LED display programmable to show images, scores, and advertisements;
- MPCX-2, a second-generation hand-held device used to operate Nevco’s scoreboards; and
- Slim Shot Clock, a second-generation shot clock designed to be viewed from more angles and is impact-resistant.
Moore came to the court with a substantial lack of documentation. The court would have been willing to overlook this issue if not for Moore’s language, which stated that Robert spent 50% to 65% of his time working on new product development. The opening brief noted that “‘at least some’ of Robert’s work on new product development was qualified research.”
In the truss project, Robert received updates on the project’s progress, specified requirements for the product, and helped identify a design that would perform well. The court held that the first two activities weren’t qualified. While the third was qualified, there was no indication of how long it took Robert to identify an appropriate design.
The court stated that the taxpayer didn’t establish, or even estimate, how much time was spent on qualified activities—not that estimates aren’t allowed or that Robert didn’t perform qualified activities.
On the Scorbitz project, the court wasn’t convinced that Robert’s work in “finding the value for the customer, and [guiding] the concept into something that would be marketable” rose to the level of qualified activity. It acknowledged that Robert’s work with the technical programming details did qualify but was left without a way of estimating the amount of time spent on such activities. Even though there were patents for the work, the court already had been convinced of the qualification of the activity—just not the percentage.
The story repeats itself for the New Caney Ribbon Board, MPCX-2 project, and Slim Shot Clock. As a result, the court felt forced to disqualify all the activities. It found that Robert was a manager of managers and, therefore, not an immediate supervisor of those doing research; he couldn’t provide direct supervision. The court also wasn’t convinced that Robert’s activities aligned with any of the regulatory examples of support activities.
Moore tried to claim the credit by relying on estimates. While this spell is powerful, Moore bumbled the incantation and estimated not the qualified activity, but a broader category that also included unqualified activity. This wouldn’t have happened if Nevco had shown that at least 80% of the estimated activity was qualified.
There were multiple opportunities for Nevco to identify the qualified activity: the initial development, documenting the credit, the exam, and during the trial. But Moore conflated the general activities of the company’s president, with the qualified activities under the statute, the entire time.
Ultimately, the taxpayer has the burden of proving they’re entitled to a credit. This goes beyond just showing that there was qualified activity—it also also requires proof of the amount of activity. While estimates are permissible, it isn’t the court’s responsibility to create them.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Holland King runs a tax litigation firm focused on credits and incentives in Atlanta. He has 15 years of experience representing clients before the IRS and litigating matters before the US Tax Court.
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