Tax court affirms what we already knew…
Smaller-scale manufacturers and fabricators used to get the short end of the stick from the IRS in regards to the Research and Development (R&D) Credit. A rule known as “The Discovery Rule” basically stated that if someone else had already made something, no one else could make it and claim the R&D Credit because the product had already been discovered.
Until about five years ago, this rule wreaked havoc on smaller manufacturers because even though they were trying to design and develop products in competition with much larger organizations, the playing field was not even. They were overcoming the same obstacles and difficulties, but with fewer resources, fewer funds and then, fewer tax benefits.
Rebuffing the IRS
Besides being plainly unfair, the Discovery Rule had other problems. It ignored the fact that while a large company had successfully developed a product, that company did not turn around and tell everyone else in the industry how to successfully produce it. Therefore, smaller companies literally had to reinvent the wheel without the tax savings reaped by their larger competitors. Primarily for those reasons, the tax court put the Discovery Rule out to pasture in 2009.
In Eric G. Suder, et al. v. Commissioner, the tax court rebuffed the IRS’ position that developing similar, competing products is routine and not eligible for the credit. Instead, it found that the activities of every company must be examined on a case-by-case basis. In this case, a small manufacturer of phone equipment had claimed credits for designing and building various pieces of phone system equipment.
The IRS took the position that no R&D took place because the company was merely recreating cheaper, competing products from much larger companies (e.g., Cisco). This was the IRS’ attempt to breathe life back into the draconian Discovery Rule: Cisco already made it; therefore it’s now easy to make. The tax court was not persuaded. The fact that someone else made a similar product had no bearing on its creation by a new company, it found, affirming that every company’s activities should be examined in its own context.
Every Company Is Different
While this case continues to signal the court’s willingness to keep the R&D Credit on a course away from the Discovery Rule, many small and medium-sized businesses still believe they live under its tyranny. This is simply not the case anymore: small and medium-sized businesses still can reap significant rewards by taking advantage of the R&D Credit.
What is commonly heard from clients who don’t think they qualify:
- We make the same things over and over again;
- We manufacture many products, but they are too simple to be R&D;
- We don’t have any scientists;
- We aren’t a big company, and only the big guys get R&D credits;
- We looked into the credit a few years ago, and we don’t qualify.
Every company is different, with its own products, processes and people. The latest court decision highlights the importance of evaluating each company individually, and why finding an experienced tax specialist is imperative in ensuring your company gets the best benefit available. iBi
Saqib Dhanani, JD and Joel Norris, JD are attorneys at HIREtech, an international consulting firm specializing in complex federal and state tax and funding incentives. For more information, visit hiretech.com.