Fudim: Opinion
CONTENTS:
Procedural Issues
Statute of Limitations
Burden of Proof
Assessment of 1988 Taxes
Other Procedural Matters
Substantive Issues
Losses on Time Share Condominiums
Research Credit
Procedural Issues
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Statute of Limitations
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Burden of Proof
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Assessment of 1988 Taxes
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Other Procedural Matters
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Substantive Issues
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Losses on Time Share Condominiums
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Research Credit
Finally, we must decide whether petitioners are entitled to research credits for 1986, 1987, and 1988. Section 41(a) allows a tax credit equal to 20 percent of the amount by which current qualified research expenses exceed the average of such expenses over the preceding 3 years. For taxable years after 1985, this credit is part of the general business credit allowed under section 38, and thus is subject to the various limitations applicable to that credit. Sec. 38(c).
In general, “qualified research” is defined as research of a type with respect to which expenditures are deductible under section 174, which is undertaken for the purpose of discovering information what is technological in nature, and the application of which is intended to be useful in the development of a new or improved business component of the tax payer. Sec. 41(d)(1); TSR, Inc. v. Commissioner [Dec. 47,426], 96 T.C. 903, 913 (1991). Qualified research expenses are composed of in-house research expenses and contract research expenses paid or incurred by a taxpayer in carrying on any trade or business. Sec. 41(b)(1). “In-house research expenses” include “wages paid or incurred to an employee for qualified services” and amounts paid or incurred for “supplies used in the conduct of qualified research “. Sec 41(b)(2)(A)(i) and (ii). For purposes of this section, “wages” include the net earnings of a self-employed individual reported on Schedule C. Secs. 41(b)(2)(D)(ii); 401(c)(1) and (2).
Qualified services” are services rendered in performing qualified research and in direct supervision or direct support of research activities. Sec. 41(b)(2)(B). “Direct support of research”, as explained in section 1.41-2(c)(3)(ii), Income Tax Regs., includes:
The services of a secretary for typing reports describing laboratory results derived from qualified research, of a laboratory worker for cleaning equipment used in qualified research, of a clerk for compiling research data, and of a machinist for machining a part of an experimental model used in qualified research. Direct support of research activities does not include general administrative services, or other services only indirectly of benefit to research activities. ***
If during the year an employee performed both qualified and nonqualified services, only the amount of wages relating to qualified services constitutes an in-house research expense. Sec. 1.41-2(d)(1), Income Tax Regs. Accordingly,
In the absence of another method of allocation that the taxpayer can demonstrate to be more appropriate, the amount of in-house research expense shall be determined by multiplying the total amount of wages paid or incurred for the employee during the taxable year by the ratio of the total time actually spent by the employee in the performance of qualified services for the taxpayer to the total time spent by the employee in the performance of all services for the taxpayer during the taxable year. [id.]
However, if “substantially all”, i.e., at least 80 percent, of the services of an employee are qualified services, then all of such employee’s services are considered qualified services. Sec. 41(b)(2)(B); sec 1.41-2(d)(2), Income Tax Regs.
Although respondent argues otherwise, we have no doubt that during 1986, 1987, and 1988 petitioner was engaged in research and development for which a research tax credit under section 41 is allowable. His training and background certainly attest to his capability to develop the rapid modeling process. Moreover, the record includes contemporaneous letters and scientific articles acknowledging and describing petitioner’s newly developed rapid modeling process. Most importantly, contemporaneously, petitioner was awarded two patents for the rapid modeling process which reflected the results of his research during 1986, 1987, and 1988. The first patent was granted on June 21, 1988, and the other on January 31, 1989.
We are also satisfied that the supplies petitioner purchases were devoted to research. There is no evidence that petitioner used any supplies (other than the small amounts reflecting the difference between the amounts petitioner deducted and the amounts stipulated in his consulting work, and he derived only a minimal amount of income on the models he made during those years. Consequently, we are convinced such supplies were used in petitioner’s research activity.
Lastly, we must decide how much time petitioner, Mrs. Fudim, and Natalia spent engaged in qualified services during the years in issue. Because petitioner did not produce contemporaneous written records of the time and activities spent by himself, Mrs. Fudim, and Natalia, we must rely on his testimony and other evidence in the record. Based on the record, we have estimated the time spent on research and development under the principles set forth in Cohan v. Commissioner [2 USTC ¶ 489], 39 F.2d 540 (2d Cir. 1930).
We are satisfied that, during 1986, 1987, and 1988, petitioner spent more than 80 percent of the time he worked with Light Sculpting engaged in qualified services. Although during those years petitioner derived a substantial amount of income from consulting work for Sundstrand, he was paid, on average, $1,500 a day. At this rate he worked an estimated 12 days, 36 days and 43 days for Sundstrand in 1986, 1987, and 1988, respectively. He also spent only a small amount of his time writing and reviewing articles during the years in issue. Consequently, even if we assume petitioner worked only a 5-day week (and we are convinced he worked more than that), we find that he spent more than 80 percent of his time performing qualified services.
We also conclude that Mrs. Fudim spent at least 80 percent of her time in 1987 engaged in qualified services. She is a highly trained engineer proficient in computer programming. With this expertise, she had to have been a substantial help to her husband.
On the other hand, we simply do not have sufficient information to determine whether Natalia’s services were so directed. The record fails to reveal Natalia’s age, training, or level of expertise. Petitioner also failed to present any evidence as to what services Natalia rendered. Therefore, we find that petitioner is not entitled to any research credit based on the wages he paid Natalia.
On the basis of our findings, petitioner’s research credit for 1986, 1987, and 1988, and allowable carrybacks must be recomputed. Accordingly,
Decision will be entered under Rule 155.
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