Opinion
11581-20
08-10-2023
STEVEN FELLER & LOUISE FELLER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Christian N. Weiler, Judge
On July 14, 2023, petitioners and respondent filed separate Status Reports informing the Court of the current status of this case. On July 16, 2023, petitioners filed a First Supplemental Status Report. The parties represent that they have been unable to reach an agreement regarding the selection of a sample of projects for discovery and trial purposes or a method of choosing a sample. The Court expects the parties to diligently continue with their mutual discovery, based on Court's guidance below, and update the Court on their progress through a future status report.
Background
In their Status Report, petitioners represent that they proposed different avenues of sample selection during a July 7, 2023, telephone conference, but all were rejected by respondent. Petitioners state that they are willing to work with the current owner of Feller PE to turn over design drawings for all projects to identify the business components to allow respondent to choose a reasonable and representative sample. In their Response to Motion to Compel Responses to Interrogatories, petitioners indicate that the documents comprising the business components-schematics, drawings, project records, etc.-are in the control of the current owner of Feller PE. In September 2016, petitioners finalized the purchase agreement of Feller PE and petitioner, Steven Feller, was terminated as an employee of Feller PE and removed as an officer in February 2021. Subsequently, petitioners relinquished all ownership interests in Feller PE, and now represent that they are no longer in possession or control of the documents respondent requests. However, petitioners note that the current owner of Feller PE expressed a "willingness to make his team and the records available to assist both parties with this case, and to meet their burden and save judicial resources and costs."
In their Supplemental Status Report, petitioners argue that the Notice of Deficiency should not enjoy a presumption of correctness due to respondent's seemingly counterintuitive argument that the sample used in the IRS's examination is "objectively unrepresentative." Additionally, petitioners offered the Court their proposed sample, which included the following 5 projects: Aloft Hotel @2360 Collins Ave; Chateau @Surfside; Me by Media-1100 Biscayne; Crown Hotel @Miami Beach; and Miami Heart.
In his Status Report, respondent does not provide a proposed sample of projects. Respondent argues that agreeing now to a sample of projects, prior to considering the business components of each of the total projects, disproportionately "relieves the taxpayer of its burden of proving entitlement to the [claimed credit]." Betz v. Commissioner, T.C. Memo. 2023-84, at *77 n.30 (citing Bayer Corp. & Subs. v. United States, 850 F.Supp.2d 522, 538, 545-46 (W.D. Pa. 2012) ("Bayer")), see also Max v. Commissioner, T.C. Memo. 2021-37. Respondent is correct that it is petitioners' burden at trial to prove entitled to the claimed credit; however, parties to this Court (and other courts) have regularly agreed to a mutually acceptable and representative sample, rather than litigating each project and presenting evidence on all qualified research.
Discussion
Pursuant to section 41, qualified research expenditures (QREs) must be related to "qualified research," involving activities that meet the following four-part threshold tests: (1) the section 174 test, (2) the technological information test, (3) the business component test, and (4) the process of experimentation test. I.R.C. § 41(d); Max, T.C. Memo. 2021-37, at *9 n.10 (citing Siemer Milling Co. v. Commissioner, T.C. Memo. 2019-37, at *19). In his Status Report, respondent focuses on the business component test, maintaining that he cannot engage in working towards proposing a representative sample prior to examining the business components of each project.
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times.
The issues presented here are somewhat similar to those in Bayer, where the government sought to conduct discovery on all business components for each project, before engaging in a sampling proposal. See Bayer, 850 F.Supp.2d at 539 (rejecting plaintiffs' proposed sample plan that did not fully identify all business components). The Federal District Court's decision in Bayer provides helpful insight here. The District Court notes that identifying the business components for each project is a necessary precursor to claiming QRE tax credits; accordingly, a proposed sample "that would not identify all of the business components underlying the claimed QRE credits is not acceptable in the absence of agreement by the Government." Id. at 545- 46.
This Court has previously resolved the issue of a taxpayer's eligibility for QREs tax credits using a mutually agreed to sample. In Little Sandy Coal Company, Inc., this Court recognized the "complexity of factual issues involved in determining a taxpayer's eligibility for the research credit." Little Sandy Coal Company, Inc. v. Commissioner, T.C. Memo. 2021-15, at *20. However, we also noted that "it is not unusual for the taxpayer and the Commissioner to agree . . . to single out a sample of research projects to be addressed by the [C]ourt." Id.
Although, the Court appreciates petitioners' position that they are working with limited resources, identification of the business components underlying the claimed QRE credits are the foundation of entitlement to those credits. Taxpayers who claim QREs are required to identify what product or process is developed or what process or product is improved as a result of the research underlying the claimed credit. Siemer Milling Company, T.C. Memo. 2019-37, at *35. Like the court in Bayer reasoned, petitioners have not demonstrated the existence of compelling circumstances sufficient to extend such "extraordinary relief" to petitioners by lessening their burden of proof. Bayer, 850 F.Supp.2d at 538.
We also acknowledge that the 30 projects considered in the IRS's examination may not constitute a representative sample of the 1,210 projects. Considering the forgoing, the Court encourages petitioners to first identify the business components for all projects and then continue working toward selection of a mutually agreed to representative sample for litigation. In Betz, the parties were unable to reach an agreement on a sample for discovery and trial purposes, thus placing at issue all projects for which petitioners claimed the research credit. Betz, T.C. Memo. 2023-84, at *77. However, in this case the total number of projects (some 1,200) is much larger than in Betz (less than 50); therefore, the Court advises respondent that his continued cooperation and willingness to better streamline this case for trial is expected since it will preserve both judicial resources and resources of the parties.
In respondent's Status Report, he notes that the projects considered in the IRS's examination are not representative of all the projects at issue because "they account for only 3.64% of the total wage QREs claimed for tax year 2014 and only 1.53% of total wage QREs for tax year 2015."
Considering the foregoing, it is
ORDERED that on or before October 20, 2023, the parties shall file a joint status report (or separate reports, if preferred) informing the Court of their progress in this case.