Edward J. Tangel and Beatrice C. Tangel, et al. v. Commissioner of Internal Revenue

January 11, 2021 | Judge Lauber | United States Tax Court | Docket Nos. 27268-13, 27309-13, 27371-13, 27373-13, 27374-13, 27375-13

 

Short Summary

In this case, the Tangel family, who were shareholders in Enercon Engineering, Inc., challenged the IRS over denied research and development (R&D) tax credits. Enercon had claimed R&D credits for work done on a custom project for Vericor Power Systems, arguing that the research qualified for the credit. The IRS disagreed, saying the project didn’t qualify because Enercon’s contract with Vericor meant all the research was fully paid for by Vericor, and Enercon had no substantial rights to use or benefit from the research results afterward. The Tax Court agreed with the IRS, ruling that because the contract gave all rights and ownership of the research to Vericor, Enercon’s expenses for this project didn’t qualify for the R&D tax credit. 

Key Issues

• Did Enercon’s research for Vericor qualify for the federal R&D tax credit? 

  The court needed to decide whether the work Enercon did for Vericor met the requirements for the federal research and development tax credit. This meant looking at whether the activities involved genuine research efforts that the tax law is designed to reward, rather than just routine work or work that didn’t involve technical innovation. 

• Was Enercon’s research considered “funded” by Vericor? 

  A central question was whether the research expenses were truly paid for by Enercon or whether Vericor covered all the costs. If a customer like Vericor completely pays for the research through a contract, then by law, the research is “funded” and does not qualify for the R&D credit. The court had to carefully examine the contract between Enercon and Vericor to see who really bore the financial risk. 

• Did Enercon retain any substantial rights to the research results? 

  The court also needed to decide if Enercon was left with any meaningful rights to use or benefit from the results of its research after the project ended. If all rights, such as ownership of technical data, designs, or intellectual property, were given to Vericor, then Enercon would not have the “substantial rights” required by law to claim the R&D tax credit. The exact wording and restrictions in the contract played a key role in this decision. 

Primary Holding

The court ruled in favor of the IRS and decided that Enercon’s research project for Vericor did not qualify for the federal R&D tax credit. The main reason was that Enercon’s contract with Vericor made the research fully “funded”; meaning Vericor paid all the costs and took full ownership of the results. The contract stated that Enercon could not use the research, technical data, or any related information for any other purpose or client without Vericor’s written permission. Because Enercon did not keep any substantial rights to use or benefit from the research, the court found that the expenses for this project did not meet the requirements for the R&D tax credit.  

In simple terms, the court said that if a company is hired to do research and the customer pays for everything and owns all the results, the company doing the work cannot claim the R&D credit. This outcome was based on both the contract language and the tax rules that prevent tax credits for fully funded research projects. 

Specific Rulings 

1. Ruling on Whether the Research Was “Funded” by Vericor 

   • What the court decided: The court found that all of Enercon’s research for Project No. 37688 was fully funded by Vericor. 
   • Reasoning: The court looked at the contract and saw that Vericor paid for all the research and had exclusive rights to use the results. Enercon was not allowed to use the research, designs, or data for anyone else unless Vericor gave written permission. Because of these strict terms, Enercon had no substantial rights to the work it created, and so the research was considered fully funded by Vericor. 
     

2. Ruling on Enercon’s Rights to the Research Results 

   • What the court decided: The court held that Enercon did not retain any substantial rights to the research it performed for Vericor. 
   • Reasoning: The contract language was clear that any information, designs, or inventions Enercon developed belonged to Vericor. Enercon could only use them when working for Vericor, and all technical information had to be returned to Vericor if requested. Even the possibility of using the research in the future depended entirely on getting Vericor’s permission. The court said that having to ask for permission, with no guarantee, meant Enercon did not truly have any rights in the research.
     
     

3. Ruling on Substantiation of Research Expenses 

   • What the court decided: Because the court found the research was fully funded and Enercon retained no substantial rights, it did not rule on whether Enercon had provided enough documentation to back up its claimed research expenses for this project. 
   • Reasoning: Since Enercon was already ineligible for the credit due to the funding and rights issues, the court didn’t need to address the question of substantiation. 

Helpful Takeaways for Taxpayers

• Review Contract Terms Before Claiming R&D Credits 

  It’s important to pay close attention to the terms in your contracts when you plan to claim the R&D tax credit. The court in this case emphasized that the exact wording about ownership and rights can determine whether your company is eligible for the credit. If the contract says that all research results and intellectual property belong to the customer, your business might lose out on the credit. Reviewing and negotiating contract language before work starts can help you avoid surprises later. 

• Understand the Impact of “Funded Research” Rules 

  Many businesses don’t realize that if a customer fully funds the research and keeps all the benefits, the IRS usually won’t allow the contractor to claim the R&D credit. The “funded research” rule is there to prevent both parties from claiming the same credit and to ensure the credit goes to the party truly at risk. This means you need to consider how your projects are structured and who is really bearing the costs and risks before assuming you’ll be eligible for the credit. 

• Retain Substantial Rights to Qualify for Credits 

  To claim the R&D tax credit, your company must keep substantial rights in the research it performs. This means you need the ability to use, benefit from, or further develop the research without having to ask for permission. If your contract says you must get the customer’s approval for any future use of the work, you likely don’t have “substantial rights,” and you won’t qualify for the credit. Aim for contract terms that let you keep some independent rights to the research or its results. 

• Work Closely with Legal and Tax Advisors 

  The rules around R&D credits can be complex, especially when contracts and intellectual property are involved. Before you sign any agreement for a research project, consult with legal and tax professionals who understand these issues. Their guidance can help you structure deals, so your company keeps the rights it needs to claim tax credits and avoids costly mistakes. 

• Keep Detailed Documentation 

  Even though documentation wasn’t the deciding factor in this case, having thorough and organized records is always a smart move. Good documentation supports your claims if the IRS reviews your credits and can help resolve any questions quickly. This includes saving contracts, project records, research notes, and any communication about rights or ownership. Clear records not only help with compliance but also make it easier to defend your position if ever challenged.