Tax- Section 41 of the Internal Revenue Code

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7^th Circuit Court of Appeals

Case Name: Little Sandy Coal Company, Inc v. CIR

Case No.: 21-3145

Officials: Rovner, Hamilton, and Brennan, Circuit Judges.

Focus: Tax- Section 41 of the Internal Revenue Code

The court needs to interpret the research tax credit under Section 41 of the Internal Revenue Code. To claim the credit, a taxpayer must demonstrate that at least 80% of its research activities for a business component constituted elements of a process of experimentation.

Taxpayer Little Sandy Coal Company, Inc., the parent of a shipbuilding company, claimed expenses for 11 vessels under the tax credit. But the Commissioner of Internal Revenue disallowed the credit and assessed a tax deficiency. Taxpayer unsuccessfully challenged that decision in tax court.

Taxpayer did claim more tax credit than it could prove. Taxpayer did not offer a principled way to determine what portion of the employee activities for each vessel constituted elements of a process of experimentation, much less research activities. Instead, Taxpayer offered arbitrary allocations for nonproduction employee wages that estimate the portion of the employee’s time spent on qualified research. These allocations were not broken out by vessel and did not adequately document that nonproduction employees performed research activities which constitute elements of a process of experimentation. Taxpayer also claimed production employee wages, but similarly failed to show that the production activities accounted for by these wages were elements of a process of experimentation—even less, research activities.

Affirmed.

Decided 03/07/23

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