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Comments on consistent treatment of qualified research expenditures in the base period for purposes of calculating the research tax credit.

Comments on Consistent Treatment of Qualified Research Expenditures in the Base Period for Purposes of Calculating the Research Tax Credit

In these comments, Tax Executives Institute addresses the question whether, with respect to pre-1990 years, a taxpayer's base-period qualified research expenditures (QRE) should be determined on a basis consistent with the determination of the QRE for the computation year of the research tax credit. The Institute recommends that the Internal Revenue Service issue a revenue ruling answering the question in the affirmative.

BACKGROUND

The Omnibus Budget Reconciliation Act of 1989 contained a provision relating to the consistent treatment of research and experimental (R&E) expenses. As amended, section 41(c)(4)(A) of the Code states:

Notwithstanding whether the period for filing a claim

for credit or refund has expired for any taxable year

taken into account in determining the fixed base percentage,

the qualified research expenses taken into

account in computing such percentage shall be determined

on a basis consistent with the determination of

qualified research expenses for the credit year.

The legislative history of the provision states that "no inference" is intended whether prior law requires a taxpayer, in calculating its credit amount for pre-1990 years, to determine its base-amount by adjusting QRE for an earlier base-period year for which an assessment of a deficiency or refund of the overpayment is barred by the statute of limitations. H.R. Rep. No. 101-247, 101st Cong., 1st Sess. 1202 n.11 (1989).

Notwithstanding the no-inference clause in the legislative history of the 1989 tax act, TEI believes that, with respect to pre-1990 years, the rule prescribed by section 41(c)(4)(A) should apply with respect to all years - both before and after 1990. Thus, a taxpayer's base-period QRE should be determined on a basis consistent with the determination of the QRE for the computation year of the credit. Regrettably, the IRS apparently takes the opposite view. In Letter Ruling No. 9040002 (June 26, 1990), the IRS denied a taxpayer's request to reduce its base-period research expenses attributable to closed years that were similar to those denied by the IRS in the year under audit. Specifically, the IRS ruled that a taxpayer could not recompute its base-period QRE where the base-period years are barred by the statute of limitations and the taxpayer received a "benefit" from the earlier inclusion of certain costs in its QRE.

SUMMARY OF POSITION

We understand that the IRS is preparing a revenue ruling embodying the holding of the private letter ruling. TEI believes the issuance of such a ruling would be a mistake. We submit that sound tax policy requires the consistent treatment of QRE between the base-period years and the computation year, and we believe the case law and other authorities support recomputation of the base period with respect to the R&E credit.(1) Such a recomputation should occur, moreover, without regard to whether a positive or negative adjustment is required in the base period to be consistent with the computation year and without regard to whether the years in the base period are open or closed under the statute of limitations.(2)

In particular, we believe that the reasoning of the private ruling is flawed and that the supposed "duty of consistency" cannot properly be invoked to justify the IRS's position. Indeed, we submit that it is the IRS, not the taxpayer, that seeks inconsistency and skewed results by refusing to permit the computation of base-period QRE on a basis consistent with the determination of QRE in the computation year. What is more, the mitigation provisions of the Code clearly operate to forestall any "gaming" of the system. Indeed, even in the absence of the mitigation provision, it is doubtful that a taxpayer could truly "game" the computation of its R&E credit since it would have to be prescient to know whether to "gamingly" include certain expenditures in, or exclude them from, QRE. Consequently, we strongly recommend that the IRS issue a published ruling repudiating the result reached in Letter Ruling No. 9040002 and confirming that, with respect to pre-1990 years, the taxpayer's base-period QRE will be determined on a basis consistent with the determination of the QRE for the computation year.

TAX POLICY CONSIDERATIONS: DOES

IT MAKE SENSE TO RECOMPUTE

BASE-PERIOD QRE?

TEI believes that it represents unsound tax policy to base the calculation of the R&E credit upon mistaken information from prior years. The policy underlying the R&E credit calculation can best be illustrated by the following examples. In each example, all years are closed except for 1985.

A. Example 1: Positive Adjustment to Base

Period Required

T failed to include attorney wages for patent prosecution in its QRE for the years 1982, 1983, and 1984. Assume that these wages are properly QRE. In 1985, T does include the wages in its QRE and the IRS allows the expense. The amounts are, as follows:
Year QRE other Patent Total
 than Patent Prosecution QRE
 Prosecution Wages


Wages
1982 2000,000 20,000 220,000
1983 200,000 20,000 220,000
1984 200,000 20,000 220,000
1985 200,000 20,000 220,000


If T is not required to adjust its base period, the computation of T's R&E credit for 1985 would be as shown in column 1 below:
 Column 1 Column 2
 (unadjusted (adjusted
 base period) base period)


1. QRE in base period
 (1982-1984) $600,000 $660,000
2. Divided by 3 $200,000 $220,000
3. QRE in tax year (1985) $220,000 $220,000
4. Incremental QRE (3-2) $ 20,000 0
5. R&E credit @ 25% $ 5,000 0


The column 1 computation clearly produces the wrong result. In 1985, T has not increased its QRE over its base-period QRE and, therefore, is not entitled to receive an R&E credit in 1985 merely because it failed to report all of its QRE on its tax returns for the base-period years. The correct computation is set forth in column 2, and T should receive no R&E credit in 1985.

B. Example 2: Negative Adjustment to Base Period

Required - Level Costs

T included certain utility expenditures in QRE for the years 1982 through 1985. In its audit of T's 1985 tax return, the IRS determines that those expenditures were not QRE. The amounts involved are, as follows:
Year QRE other than Utility Total
 Utility Expenditures


Expenditures
1982 $200,000 $15,000 $215,000
1983 $220,000 $15,000 $235,000
1984 $240,000 $15,000 $255,000
1985 $320,000 $15,000 $335,000


Since T claimed the utility expenditures as QRE on its return in 1985, it calculated its R&E credit as shown in column 1:

[Tabular Data Omitted]

If the IRS disallows as QRE the $15,000 utility expenditures in 1985 without adjusting the base period, T's R&E credit will be computed as shown in column 2.

Again, this is clearly the wrong result. As shown by columns 1 and 3, T's R&E 1985 credit is not increased by the inclusion of the utility expenditures. Extension of this example will demonstrate that similar results will occur in prior years that include utility expenditures. The proper computation of T's 1985 R&E credit should be as shown in column 3.

Example 2 exposes the flaw in the IRS's argument that there should be no negative adjustment to the base period because the taxpayer has somehow received a "benefit from including the costs in its QRE. In the example, T received no benefit from the inclusion.

C. Example 3: Negative Adjustment to Base

Period Required - Declining Expenditures

T included utility expenditures in QRE for the years 1980(3) through 1985. In its audit of T's 1985 tax return, the IRS determines that these expenditures were not QRE. The amounts are, as follows:
Year QRE other Utility Total
 than Utility Expenditures


Expenditures
1980 $150,000 $60,000 $210,000
1981 $180,000 $50,000 $230,000
1982 $210,000 $40,000 $250,000
1983 $220,000 $20,000 $240,000
1984 $250,000 $10,000 $260,000
1985 $330,000 $10,000 $340,000


T calculated its R&E credit in 1981[sup.4]-1985, as follows:

1981 1982 1983 1984 1985

1. QRE in

base period 210,000 440,00 690,000 720,000 750,000

2. Divided by

1, 2, or 3 as 3. QRE in tax 4. Incremental

QRE (3-2) 20,000 30,000 10,000 20,000 90,000

5. R&E credit

@ 25% 5,000 7,500 2,500 5,000 22,500

If T had computed its R&E credit correctly in all years, its R&E credit would have been, as follows:

1981 1982 1983 1984 1985

1. QRE in

base period 150,000 330,000 540,000 610,000 680,000

2. Divided by

1, 2, or 3 as

appropriate 150,000 165,000 180,000 203,333 226,667

3. QRE in tax

year 180,000 210,000 220,000 250,000 330,000

4. Incremental

QRE (3-2) 30,000 45,000 40,000 46,667 103,333

5. R&E credit

@ 25% 7,500 11,250 10,000 11,667 25,833

Thus, T's "mistake" (including utility expenditures in QRE in all affected years) caused it to understate its R&E credit in 1981 by $2,500, in 1982 by $3,750, in 1983 by $7,500, and in 1984 by $6,667 - a total understatement of $20,417. The same "mistake" caused T to understate its R&E credit in 1985 by $3,333. Under the IRS's position in Letter Ruling No. 9040002, T's 1985 R&E credit is to be computed, as follows:
 1. QRE in base period (1982-1984) $750,000
 2. Divided by 3 $250,000


3. QRE in tax year (after audit
 adjustment) $330,000
 4. Incremental QRE (3-2) $ 80,000
 5. R&E credit @ 25 percent $ 20,000


The failure to adjust the base period will result in an unjustified reduction in T's 1985 R&E claimed credit of $2,500 ($22,500 less $20,000), even though the mistake had already produced an understatement of the credit by $3,333. In other words, the difference between the right calculation and the IRS's calculation is $5,833. T can never recoup the credit it lost during 1981-1984. It seems unduly harsh to penalize T again in 1985 for the prior years' mistakes by disallowing a base-period adjustment.5 D. Example 4: Negative Adjustment to Base Period

Required - Increasing Costs

T included certain utility expenditures in QRE for the years 1980(6) through 1985. In its audit of T's 1985 tax return, the IRS determines that these expenditures were not QRE. The amounts are, as follows:

Year QRE other than Utility Total

Utility Expenditures

Expenditures
1980 $150,000 $10,000 $160,000
1981 $180,000 $20,000 $200,000
1982 $210,000 $30,000 $240,000
1983 $220,000 $40,000 $260,000
1984 $250,000 $50,000 $300,000
1985 $330,000 $60,000 $390,000


T calculated its R&E credit in 1981(7)-1985, as follows:

1981 1982 1983 1984 1985

1. QRE in

base period 160,000 360,000 600,000 700,000 800,000

2. Divided by

1, 2, or 3

as appropriate 160,000 180,000 200,000 233,333 266,667

3. QRE in tax

year 200,000 40,000 260,000 300,000 390,000

4. Incremental

QRE (3-2) 40,000 60,000 60,000 66,667 123,333

5. R&E credit

@ 25% 10,000 15,000 15,000 16,667 30,833

If T had computed its R&E credit correctly in all years, its R&E credit would have been, as follows:

1981 1982 1983 1984 1985

1. QRE in

base period 150,000 330,000 540,000 610,000 680,000

2. Divided by

1, 2, or 3

as appropriate 150,000 165,000 180,000 203,333 226,667

3. QRE in tax

year 180,000 210,000 220,000 250,000 330,000

4. Incremental

QRE (3-2) 30,000 45,000 40,000 46,667 103,333

5. R&E credit

@ 25% 7,500 11,250 10,000 11,667 25,833

Thus, T's "mistake" (including utility expenditures in QRE in all affected years) caused it to overstate its R&E credit in 1981 by $2,500, in 1982 by $3,750, in 1983 by $5,000, and in 1984 by $5,000 - a total overstatement of $16,250. The same "mistake" caused T to overstate its R&E credit in 1985 by $5,000. Under the IRS's position in Letter Ruling No. 9040002, T's 1985 R&E credit is to be computed, as follows:
 1. QRE in base period (1982-1984) $800,000
 2. Divided by 3 $266,667


3. QRE in tax year (after
 audit adjustment) $330,000
 4. Incremental QRE (3-2) $ 63,333
 5. R&E credit @ 25 percent $ 15,833


The failure to adjust the base period will result in an unjustified reduction of T's 1985 R&E claimed credit of $15,000 ($30,833-$15,833), even though the mistake had alredy produced an overstatement of the credit of only $5,000. In other words, the difference between the right calculation and the IRS's calculation is $10,000.

LETTER RULING NO. 9040002 IS FLAWED

In Letter Ruling No. 9040002, the IRS denied a taxpayer's request to reduce its base-period research expenses attributable to closed years that were similar to those denied by the IRS in the year under audit. Support for this position was found in the "duty of consistency," which the IRS concluded prevented a taxpayer receiving a tax benefit from its treatment of an item in a closed year from claiming that the original treatment was incorrect and thus obtaining a tax advantage in a later year. There are at least three flaws in the IRS's reliance on this supposed "duty of consistency."

A. The "Duty of Consistency" Has No Application

in This Case

In Letter Ruling No. 9040002, the IRS correctly cites Beltzer v. United States, 495 F.2d 211 (8th Cir. 1974), as holding that the "duty of consistency" arises when:

* the taxpayer has made a representation or reported

an item for tax purposes;

* the Commissioner has acquiesced in or relied on that

fact for that year; and

* the taxpayer wishes to change the representation in

a later year after the statute of limitations on assessment

bars adjustments for the initial tax year in

such a way as to harm the Commissioner.

Even assuming the first two factors are present in respect of the computation of base-period QRE, the third prerequisite to the IRS's "duty of consistency" is missing. Thus, in the private ruling, it was the IRS, not the taxpayer, that desired to change the characterization of certain expenditures as QRE. The taxpayer had consistently contended that these expenditures were QRE. In responding to the IRS's changes, however, the taxpayer sought consistency from year-to-year - not to obtain a tax benefit through its change, but rather to prevent a tax penalty.

We submit that the "duty of consistency" more appropriately applies in the following circumstance:

Assume the taxpayer claims certain design modifications

to a product as QRE in the three base years and

claims a credit in each of those years. In the current

year, the taxpayer does not incur any of those design

modification expenditures and, for purposes of computing

its incremental QRE in the current year,

claims that the design modification expenditures in

the base-period years were not really QRE.

Adopting such a position allows the taxpayer to claim incremental QRE on other expenditures in the current year. The IRS, invoking a "duty of consistency," could properly claim that the taxpayer is bound to the QRE it reported in the base-period years if those years are barred by the statute of limitations. See Herrington v. Commissioner, 854 F.2d 755 (5th Cir.), cert. denied, 109 S.Ct. 2062 (1989).

This is not the case in Letter Ruling No. 9040002, where the taxpayer had consistently maintained that the expenditures were QRE. Again, it was the IRS that claimed such expenditures were no longer QRE. Consequently, the taxpayer should be permitted to adjust the QRE in the base-period years.

B. The Tax Benefit May Be Illusory

As demonstrated in Examples 1 through 4, a taxpayer does not necessarily obtain a tax benefit from characterizing expenditures as QRE. Absent the showing of such a benefit (by the party asserting the duty), the "duty of consistency" should be irrelevant.

C. The Item Can Be Corrected

In Letter Ruling No. 9040002, the IRS acknowledged that the "duty of consistency" can be invoked only where the taxpayer obtained a benefit in a year that cannot be corrected. See Johnson v. Commissioner, 162 F.2d 844, 846 (5th Cir. 1947). The mitigation provisions of the Code, however, provide the IRS with ample protection in such circumstances and therefore vitiate the potential application of the "duty of consistency."

In specified circumstances when an error has been made in the inclusion or exclusion of an item of income or credit, sections 1311-1314 of the Code permit a correction even though the statute of limitations has run for that year. For the mitigation provisions to apply, the following conditions must be met:

(1) A determination (as defined in section 1313) must

establish that the treatment in another year was

incorrect.

(2) Correction of the error in the other year must be

barred by some rule of law, usually the period of

limitations on assessment or refund.

(3) The party successful in the determination must have

asserted a position inconsistent with a position

adopted in the barred year.

(4) The determination must result in one of the seven

circumstances specifically described in section 1312 - for

example, section 1312(2) relates to the double

inclusion of an item of income or the double allowance

of a deduction.

These conditions were all met in Letter Ruling No. 9040002. First, the determination in the current year was that the determination of QRE in the base-period years had been incorrect. Second, the correction of the error was barred since it was assumed that the base-period years are closed. Third, the successful party (i.e., the taxpayer adjusting the QRE in the base period for purposes of computing the R&E credit in the current year) had previously asserted an inconsistent position in the barred years. (The "inconsistent" position, however, was asserted by the taxpayer only after it was imposed on it by the IRS). And fourth, the "adjustment circumstance" in this case was the double allowance of a credit. Possibly (though not necessarily), the taxpayer's inconsistent position had resulted in a double R&E credit - one in the current year and another in one or more of the base-period years.

Since all of the conditions for mitigation were satisfied in the private ruling, the proper response of the IRS should have been to reopen the base-period years. Doing so would have permitted all R&E credit years to be properly reflected, thereby preventing the harsh results engendered by use of the so-called duty of consistency. In other words, the IRS did not need to apply the "duty of consistency" doctrine to reach a fair and equitable result; the mitigation provisions adequately protected the government. In fact, these provisions will always produce the correct result (in the aggregate and on a year-to-year basis), whereas the IRS's "duty of consistency" will produce the correct result, if at all, only by happenstance.(8)

PRECEDENTS IN OTHER AREAS

Considerable guidance exists in other areas of the tax law with respect to the reopening of closed years to reach the correct result in the current year. The overriding principle of the following authorities is that, if a computation in the current tax year is dependent upon closed years, such computation shall be made using the correct figures for the prior years, whether or not the statute of limitations has expired for such years. This principle is effectively codified in section 6214(b) of the Code, which provides that the Tax Court "shall consider such facts with relation to the taxes for other years or calendar quarters as may be necessary correctly to redetermine the amount of [a] deficiency." (Emphasis added.)

Moreover, although many but not all the authorities deal with situations where the principle is invoked to the government's benefit, it clearly is not to be applied one-sidedly. As the Court of Claims stated in Springfield St. Ry. v. United States, 312 F.2d 754 (Ct. Cl. 1963), "we do not understand why recomputation of income for a closed year should only be allowed when it will benefit the Government, and not under similar circumstances when it will benefit the taxpayer." Pointing out that the decision would not "work undue hardship" with respect to either party, the court essentially said what was good for the goose was good for the gander. See also Budd Co. v. United States, 252 F.2d 456 (3d Cir. 19157)(general equitable considerations are as applicable to the government as to the taxpayer). Consistent with the notion that taxpayers and the IRS should operate on a "level playing field," a taxpayer should be permitted to adjust base-period QRE in computing the current year's research tax credit.

A. Tax Reform Act of 1986

The Tax Reform Act of 1986 provides a mixed message with respect to the R&E credit base-period adjustments. Section 231 of the 1986 Act repealed the existing provision treating amounts paid for the right to use personal property (i.e., rental costs) as QRE. The same section also modified the definition of "qualified research" and limited the types of expenditures that constitute QRE. Thus, two issues were addressed: (i) what constitutes qualified research, and (ii) whether specific expenditures (rental costs) devoted to such research qualify for the credit. With respect to the definition of qualified research, the Conference Report on the 1986 Act provides that there should be no adjustment of prior years' expenditures to take into account a changed definition, as follows:

In computing the research credit for taxable years

beginning after December 31, 1985, base period expenditures

for taxable years beginning before January

1, 1986 are to be determined under the credit

definition of qualified research that was applicable in

such base period years and are not to be determined

under the definition of qualified research in the

conference agreement.

H.R. Rep. No. 99-841, 99th Cong., 2d Sess. II-76 n.5 (1986). With respect to the second issue (whether rental expenses attributable to qualified research are eligible for the credit), the House Report provides that a downward adjustment of prior years' expenditures is proper to take into account the more restrictive definition of QRE, as follows:

In computing the research credit for a taxable year

beginning after 1985 (when rental costs will not be

eligible for the credit), a taxpayer may exclude from

the base period amount with respect to such year any

rental costs, etc. ... that were allowable as qualified

expenses under section 30(b)(2)(A)(iii) (as then in

effect) in a base-period year.

H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 179 (1985). The Conference Committee adopted the House bill in respect of qualified expenditures and a base-period adjustment for rental costs is thus clearly authorized. See Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 132, 140 (1987). The legislative history of the 1986 Act, however, provides no guidance on whether base-period QRE is to be adjusted to take into account adjustments (proposed on audit) of credit-year QRE. In light of Congress's explicit instructions with respect to rental expenses (where the change in treatment as QRE was mandated by legislation), we submit such an adjustment is proper.

B. Income Averaging

In Rev. Rul. 74-61, 1974-1 C.B. 239, the IRS ruled that, in determining average base-period income for income-averaging purposes, taxable income for a base-period year barred by the statute of limitations must be adjusted to arrive at the correct taxable income for such year. The ruling states that "the fact that a base-period year is barred by the statute of limitations does not change the definition of taxable income for such year." (Emphasis added.) The ruling does not distinguish between cases where reported taxable income in the base period would be increased from those where it would be reduced to determine the correct taxable income. Its reasoning applies equally to the definition of QRE.

C. Excess Profits Tax

In the excess profits tax area, the Tax Court has held that the correct income for each base-period year must be used in computing the average base-period net income, even though the correct determination differed from that previously reported. E.g., Leonard Refineries, Inc. v. Commissioner, 11 T.C. 1000 (1948), acq. 1949-2 C.B. 2.

D. Net Operating Loss Deduction

In Rev. Rul. 56-285, 1956-1 C.B. 134, the IRS held that, for purposes of determining the portion of a net operating loss (NOL) that may be carried back or forward to a particular year, taxable income must be adjusted even though the year is otherwise closed by the statute of limitations. The rationale underlying the ruling is that the barred year is not being reopened, but rather that a proper determination in the current year requires a correct determination in the barred year. This principle was embraced by the Tax Court in Reilly v. Commissioner, T.C. Memo. 1989-312, 57 T.C.M. (CCH) 807 (1989), which invoked section 6214(b) to allow it to consider the correct facts in closed years to determine the correct amount of NOL and investment credit carrybacks. Accord ABKCO Industries, Inc. v. Commissioner, 56 T.C. 1083, 1089 (1971), aff'd on another issue, 482 F.2d 150 (3d Cir. 1973).

E. Claims for Refunds

In Rev. Rul. 81-87, 1981-1 C.B. 580, the IRS ruled that all adjustments that increase or decrease taxable income - even those barred by the statute of limitations - must be taken into account in determining the amount of an overpayment. Courts have also held that section 6501(a)(which provides a three-year statute of limitations on tax assessments and refund claims) does not prevent the recomputation of taxable income in a closed year in order to determine tax liability in an open year. See Barenholtz v. United States, 784 F.2d 375 (Fed. Cir. 1986) (section 6501(a) of the Code bars assessments, not calculations).

F. Installment Sales

In Letter Ruling No. 8838006 (June 13, 1988), the IRS ruled that a taxpayer was entitled to a refund resulting from an overpayment of taxable income in one year that resulted from an understatement of taxable income in a year barred by the statute of limitations.

G. Bad Debt Reserves

In Rev. Rul. 79-88, 1979-1 C.B. 100, the IRS held that the closing balance in a bad debt reserve must be recomputed to reflect the current amount of the reserve for purposes of computing the reasonable addition to the reserve in the subsequent year, regardless of what the taxpayer actually deducted in the earlier year.

H. Investment Tax Credit

In Rev. Rul. 82-49, 1982-1 C.B. 5, the IRS ruled that the taxpayer's failure to claim an investment tax credit on qualified property placed in service in a closed year did not prevent any "unused credit" from the closed year being carried over to the open year under section 46(b) of the Code.

I. Charitable Contribution Carryforward

In Rev. Rul. 77-225, 1977-2 C.B. 73, the IRS held that the statute of limitations does not foreclose adjustment of a charitable contribution carryforward where an error occurred in a closed year.

J. DISC: Base-Period Export Gross Receipts

For taxable years beginning after December 31, 1975, Treas. Reg. [Sub Section] 1.995-7 provides rules for the computation of taxable income attributable to the base-period export receipts of a domestic international sales corporation (DISC). The amount of such taxable income is included in the income of the DISC's shareholder and the determination of the current-year amount is dependent upon a four-year base period.

Although the regulations are unclear whether consistency is required between the computation year and the base period, in practice the IRS apparently requires consistency. Moreover, Treas. Reg. [sub-section 1.995-7] (c)(4) provides, in part, that - [F]or taxable years of a DISC ending before November 15, 1982, base period export gross receipts do not include receipts attributable to property sold or leased to a WHTC [Western Hemisphere Trading Corporation] or receipts which arose in the absence of a written supplier's agreement unless the receipts were treated as qualified export receipts by the taxpayer.

The clear implication of the foregoing provision is that other qualified export receipts (receipts not attributable to property sold or leased to a WHTC or receipts arising in the absence of a written supplier's agreement) must be included in base-period qualified export receipts regardless of the treatment of such receipts by the taxpayer. In other words, with respect to other qualified export receipts, the base period would be adjusted whether or not the receipts provided a DISC benefit to the taxpayer in the base-period year. Nothing in the regulation requires base-period export receipts to include non-qualified export receipts even if the receipts are treated as qualified export receipts by the taxpayer. (9)

K. Private Foundations

Under section 4942 of the Code, private foundations must make a minimum level of charitable contributions; where a foundation makes qualified distributions in excess of the prescribed minimum level, the excess can be carried over for five years. In G.C.M. 39808 (January 16, 1990), the IRS held that a taxpayer's excess distribution carryover applicable to years not barred by the statute of limitations can be adjusted by recalculating the distributable amount or the amount of qualifying distributions for years that are closed.

L. Estate Tax

In Estate of Frederick R. Smith v. Commissioner, 94 T.C. 872 (1990), the Tax Court held that, after adjusting the value of "adjusted taxable gifts" for estate tax purposes after the statute of limitations has expired on the assessment of any gift tax deficiency on such gifts, the IRS should also adjust the amount of the gift tax subtraction under section 2001(b) to reflect the increase in value. (Thus, the expiration of the gift tax statute of limitations will not preclude an adjustment of a gift's value for estate tax purposes.) Action on Decision CC-1990-032 (Nov. 13, 1990) confirms the correctness of the court's decision and recommends that the IRS formally acquiesce in the decision.

CONCLUSION

Tax Executives Institute appreciates this opportunity to present our views on the consistent treatment of qualified research expenditures in the base period for purposes of calculating the R&E tax credit. If you have any questions, please do not hesitate to call Lester D. Ezrati, chair of TEI's Federal Tax Committee, at (415) 857-2089 or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (202) 638-5601. (1) The discussion of these authorities begins on page 131.

(2) If the base-period years remain open, the taxpayer can effect a recomputation of base-period QRE by filing amended returns for the base-period years and then carrying through the recomputed QRE to subsequent years. If the IRS does not reverse its position, taxpayers could be motivated to keep base-period years open (thereby preserving the option to file amended returns) to avoid being whipsawed. This in turn would delay the ultimate closing of the base-period years, which would be at odds with the IRS's longstanding goal of speeding up the completion of audits.

(3) QRE for 1980 were computed for purposes of determining T's 1981, 1982, and 1983 return credits.

(4) For simplicity's sake, Example 3 assumes that the R&E credit was effective for all of T's 1981 tax year.

(5) A taxpayer in T's position arguably would not claim the utility expenditures as QRE, since the expenditures reduce its credit. A taxpayer cannot, however, pick and choose its QRE merely to inflate its R&E credit. Taxpayers are bound to report all QRE whether they are increasing or decreasing from year-to-year. Hence, if T believed the expenditures constituted QRE, it would be obligated to report them on its returns.

(6) QRE for 1980 were computed for purposes of determining T's 1981, 1982, and 1983 return credits.

(7) For simplicity's sake, Example 4 assumes that the R&E credit was effective for all of T's 1981 tax year.

(8) Indeed, the more common occurrence under the IRS's theory is for an incorrect computation of the R&E credit both in the aggregate and on a year-to-year basis.

(9) The IRS apparently felt compelled to provide an exception to the general rule of consistency in this case because, until November 15, 1982, the regulations explicitly provided that such receipts did not constitute qualified export-gross receipts. See Treas. Reg. [sub.1.993-3](a)(5) (with regard to WHTC receipts), which was deleted by T.D. 7854 (dated Nov. 15, 1982). Presumably, the IRS believed that it would be unfair to require taxpayers to increase their base-period export receipts for receipts on which the IRS's regulations precluded a DISC benefit, except in those cases in which the taxpayer actually claimed a benefit. No such exception is provided for other receipts.
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Author:Ezrati, Lester D.
Publication:Tax Executive
Date:Mar 1, 1991
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Comments on proposed regulations on the definition of research and experimental expenditures.
Maximizing opportunities under the new research and experimentation regulations.
Research and experimentation costs.
Proposed regulations relating to the computation of the research credit and the definition of qualified research.
The mechanics of California's R&D tax credit.
Research tax credit regulations: It's time to jettison the discovery test and start over.
Contract research and the R&D credit.
Form 6765 and the R&D credit.
Affect of research credit final regs. on documentation.
Self-constructed supplies costs are not in-house research expenses.

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