United States

The IRS concedes R&D tax credit tooling case

Taxpayer was able to utilize tooling costs for R&D credit

TAX ALERT  | 

Recently, the IRS chose to concede a case in the United States Tax Court brought by an automotive parts supplier.  The taxpayer sought to treat tooling costs as qualified supplies and material expenses for purposes of the research tax credit.

TSK of America Inc., an automotive supplier, included tooling costs for metal stamping and plastic injection molding in its 2013 research and development tax credit.  TSK purchased the tools from a third party with the intention of using the tools in its production process. Typically, TSK’s customers required it to sell any unique tools produced for the customers, but TSK retained possession of the tool to produce the part.  TSK argued that it undertook an extensive trial and error process to refine the various tools to ensure that the tools performed as designed and met its needs for efficiency, accuracy and economic productivity.  While a third party produced the tool for TSK, the third party did not guarantee that the tool satisfied TSK’s requirements and specifications.

In calculating its 2013 research credit, TSK treated $9.3 million research expenses as supplies and material expenses.  The IRS wanted to allow only approximately $1.2 million of those expenses, which reduced TSK’s research credit by $503,416. 

Whether or not a taxpayer may treat tooling costs as a supply and material expenditure for purposes of the research credit has long been a contentious issue.  Because the case did not go to trial and result in a decision, there is no precedential value to the case.  Nevertheless, the IRS’s decision to concede the case suggests that a taxpayer similarly situation to TSK has a stronger argument for including the expenses.  A taxpayer can now point to the IRS’s decision to concede the TSK case as a hazard of litigation. 

Typically, an IRS agent will not consider the hazards of litigation during the examination phase of a matter, however Appeals does consider the hazards of litigation.

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