Seventh Circuit upholds Tax Court on R&D comp for COO


The U.S. Court of Appeals for the Seventh Circuit has upheld the Tax Court’s decision in Scott Moore and Gayla Moore v. Commissioner (No. 23-2681) ruling that wages paid to an S Corporation’s chief operating officer (COO) cannot be included in computing the company’s Section 41 research credit claim because the taxpayer failed to adequately substantiate time spent on qualified research and did not engage in direct supervision or support.


The taxpayer appealing the Tax Court decision is the sole shareholder of Nevco, Inc., a manufacturer of scoreboards and related gear for athletic events taxed as an S-Corporation. In its research credit claim for the 2014 and 2015 tax years, the taxpayer included the salary and bonus of the COO as a qualified research expenditure.


The Tax Court’s ruling was primarily based on inadequate documentation, finding that, although Nevco retained payroll records, such records did not log the tasks performed by an employee, and the COO lacked written records regarding his time. Further, the COO was unable to estimate, even approximately, the amount of time he spent performing qualified research. The Tax Court also concluded that the COO did not engage in either direct supervision or direct support of qualified research. The taxpayer challenged the Tax Court’s ruling, arguing that its findings were a legal error.  


The Seventh Circuit rejected the taxpayer’s claim, stating that the Tax Court’s ruling was based on a case-specific finding of fact. In reviewing the factual finding, the Seventh Circuit did not “see any error at all, let alone a clear one.” The Seventh Circuit highlighted the inability of the COO to estimate how much of his research involved experimentation as the key issue, while also acknowledging the lack of written records.

Grant Thornton Insight:

The opinion of the Seventh Circuit demonstrates the consequences of a failure to retain sufficient evidence and contemporaneous documentation to substantiate a research credit claim and the qualified activities performed. Without adequate documentation, the courts have no basis to estimate an individual’s time spent performing qualified research. It is important for taxpayers to substantiate research credit claims with contemporaneous documentation and written records.



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