On January 17, 2019, a district court ruled that a taxpayer was not entitled to the R&D Credits claimed in tax years 2009 and 2010 because it did not properly establish when qualified research began when calculating the base period for the Start-Up method. Dennis and Linda Quebe owned Quebe Holdings, Inc. (QHI), which operated three separate electrical contracting companies: Chapel Electric, Romanoff Electric, and CRT Technologies. The three companies designed and developed electrical systems for large commercial complexes. QHI was founded in 2002 and acquired Chapel and Romanoff in that year. CRT was founded by Dennis Quebe in 2003.
QHI engaged a third party to conduct an R&D study and amended the 2009 and 2010 tax returns to claim the R&D credits, which was examined by the IRS and eventually went to court. Although QHI was established in 2002, the IRS contended that the taxpayer incurred qualified research expenditures (QREs) in the 1984 through 1988 tax years through the acquired Chapel and Romanoff companies, which were in existence during that timeframe. The IRS argued that because similar projects and activities were conducted in the 80’s as during the years in examination, then QHI was required to use the Standard methodology and was not entitled to use Start-up. Although Dennis Quebe asserted that Chapel and Romanoff were engaged in time-and-material contracts (indicating non-qualified, funded research) in the 80’s and that the prefabrication division which performed the majority of the research for the 2009 and 2010 years did not exist during the 80’s, there was no proof to corroborate these claims. The district court ultimately decided the judgement in favor of the IRS.
This case demonstrates that establishing the proper base period and qualified research expenses can be difficult due to the amount of documentation required. Furthermore, although taxpayers and their representatives traditionally defend R&D credit claims by substantiating the existence of qualified research activities and expenses, they may also need to prove that qualified research activities were not conducted and that qualified expenses were not incurred during certain periods of time. Documenting and proving a negative presents unique challenges to taxpayers claiming the R&D credit. However, proper contemporaneous documentation combined with the adoption of the appropriate calculation methodology should put taxpayers in an excellent position to successfully claim and defend the R&D credit.