Applying “Vegas Rules” to Business

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I’m betting that most of you have heard the wildly-successful advertising campaign, “What Happens in Vegas, Stays in Vegas.” That same idea applies to tax deductions as well!

I read recently about a taxpayer who learned that simply having a business wasn’t an automatic guarantee of receiving a tax deduction – especially when the deduction related to someone else’s business.

Our tax system allows for tax deductions and tax credits for companies that carry out qualified research and development activities. These incentives apply not only to research performed in a laboratory, but also to a broad spectrum of developmental activities, including manufacturing process improvements, production trials and software integration issues. Taking advantage of these tax deductions and credits can put more money back into a business’s pockets, helping to fuel further creativity.

But the key here is that the company taking the tax credits and deductions has to be the same company that is going to use the technology in its own trade or business. And, in this case study, our taxpayer learned that lesson the hard way.

The taxpayer here was a computer software expert who specialized in marketing software products. He created an agreement with his own company to develop some new computer technology that he would own, but license to his company. It was the taxpayer’s intention to have his company market the technology to other companies, for use in their own business operations.

All was well until the IRS took a closer look at our taxpayer’s return, and disallowed all of the R&D deductions and tax credits. They said that the taxpayer had no intention of using that technology in his own business. His stated intention was to market it to other companies, to use in their own businesses. The taxpayer objected, and claimed that just because he was planning to market the technology to others didn’t mean there wasn’t a reasonable prospect that he would use it in his own business.

Unfortunately, our taxpayer’s argument didn’t sway the Tax Court. When they looked at all of the evidence presented at trial, they didn’t find any evidence that pointed to the taxpayer’s plans to use the technology in his own business at the time he was incurring the costs and taking the research and development credits. Without that evidence, or any clear intention of the taxpayer to use the technology himself, the Tax Court had no choice but to stick to the letter of the law, which said that research and development deductions may only be taken by a business that can show it is going to use whatever it develops.

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