In a recent decision, the IRS chose to concede its case in U.S. Tax Court brought against it by automotive parts supplier TSK of America, Inc. (TSK). The taxpayer included tooling costs for metal stamping and plastic injection molding in the calculation of its 2013 research and development (R&D) tax credit. While the court case wasn’t ruled on and therefore can’t be cited as precedent, it provides valuable insight for manufacturers currently claiming tooling expenses.
Tooling was purchased from a third-party supplier and intended for use in TSK’s production process. The tooling that was purchased wasn’t guaranteed to meet TSK production requirements, and the company argued it undertook a thorough trial-and-error process to ensure the tools performed as designed and could meet its needs for efficiency, accuracy and economic productivity.
Of the $9.2 million of supply expenses, only $1.2 million was allowed by the IRS. Qualified research expenditures were disallowed on the basis that there wasn’t sufficient enough uncertainty surrounding the development of the tooling and the tooling was for production purposes, not R&D. TSK filed a petition with the U.S. Tax Court to dispute the IRS ruling. The IRS notified TSK in August 2018 that it wouldn’t dispute TSK’s credit claim, thus allowing the full tooling expenditure to be claimed as part of the credit.
The inclusion of tooling expense in the R&D credit has long been a contentious issue between the IRS and taxpayers. In TG Missouri Corporation v. Commissioner (2009), the Tax Court upheld the taxpayer’s treatment of tooling expenditures as qualified research expenses because the tooling expenses included weren’t subject to depreciation by the taxpayer. The IRS’s decision to not contest the credit claim at trial indicates it might be re-evaluating its stance on tooling expenditures.
While the case can’t be cited as precedent, it shows the IRS is still actively challenging research credit claims with large supply expenditures. Taxpayers claiming large supply expenses should discuss their methodology and rationale for including these expenses with an R&D tax credit specialist who can help identify, segregate and substantiate qualified supply expenditures. For more information on R&D tax credits, contact Patrick or your trusted BKD advisor.