Tax Court declines to limit discovery in R&D credits case


The Tax Court has denied a taxpayer’s request in Kapur et al. v. Commissioner (T.C. Memo. 2024–28) to limit discovery to the two largest projects from a statistical sampling frame used to support a research credit claim.

The case centers around Kapur & Associates (KAI), a civil and engineering-focused S corporation that claimed a total of $238,958 in research and development (R&D) credits for the 2014, 2016, 2017 and 2018 tax years. The IRS challenged some of the claims, issuing a deficiency of $186,648, as well as a Section 6662(a) penalty of $7,187.


To determine the available R&D tax credits, KAI engaged a professional services firm that computed the QREs using “variable sampling” from a population listing, or “sampling frame,” consisting of 2,000–3,000 projects. Nonqualifying projects were removed from consideration and then eligibility for the R&D credit was determined on a sample that was extrapolated to the remaining projects.


The IRS initially requested information regarding the business components of the entire sampling frame and requested to interview 16 employees. However, KAI wanted to narrow the list to two to four employees that related to two to four specific projects, of which two were the largest projects, arguing that discovery related to 2,000–3,000 projects is not proportional to the amount in controversy.


The Tax Court noted that while it has the authority to limit discovery, it agreed that the IRS would not be able to choose a representative sample for discovery if it did not have preliminary information on all projects.


The court cited other case law where different methods of statistical sampling were used in R&D credit studies and noted that this was a unique instance where the IRS rejected sampling completely. The court held that evaluating compliance with Section 41 involves consideration of the underlying business components and that the taxpayer has the burden of proof when claiming an R&D credit. To the taxpayer’s argument regarding the request being disproportionate to the expense, the court added that the taxpayer could simply claim less credit to the extent that the credit can be substantiated and if it wishes to claim incremental credit, then it should be ready to substantiate the incremental qualified research expenditures. The court also added that the taxpayer could cooperate with the IRS and identify information regarding business components in the sampling frame to try to get the IRS to agree to a representative sample. 


Grant Thornton insight:

The case reinforces the importance of reaching an agreed-upon statistical sample with the IRS to avoid substantiating all business components to meet the burden of proof. It’s important to note that the case does not address the initial use of random sampling to extrapolate QREs, which remains a valid mechanism for determining a credit. Instead, this case involves the taxpayer’s attempt to limit the examination of the original random sample to a nonrandom subset of that sample, which is not based on statistical theory. When selecting non-random cases for extrapolation, it is important for them to represent the population to make statistically reasonable conclusions from the selections. The taxpayer selected the two largest projects in the population, which would typically not be representative of the broader sample.



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