Research Credit Case Update

October 2024

Leonard and Barbara Grigsby claimed the Research Tax Credit for their company, Cajun Industries, focusing on oil refinery and flood control projects. To qualify, research must be technological and useful for new or improved business components, but not funded by grants or contracts.

The IRS challenged their claim, and the U.S. District Court for the Middle District of Louisiana ruled against them. The court found their projects didn’t meet the necessary criteria and noted they failed to update their claims from products to processes in time. Some projects were also funded, making them ineligible.

The 5th U.S. Circuit Court of Appeals upheld this decision, agreeing that the projects didn’t qualify and were funded. The court confirmed the IRS’s assessment was correct, and the Grigsbys couldn’t prove otherwise.  In the case of Grigsby v. United States, it is likely that SCOTUS did not see the case as presenting a significant federal question or a conflict that needed resolution at the national level.  The decision of the 5th U.S. Circuit Court of Appeals was likely deemed sufficient to resolve the issues at hand.

  1. Background and Legal Framework:
    • The R&D tax credit, under Section 41 of the Internal Revenue Code, provides a tax credit for qualified research expenses, including wages and expenditures incurred in pursuit of qualified research.
    • Qualified research must be technological in nature and intended to develop new or improved business components.
    • Research funded by grants, contracts, or other external sources is not eligible for the credit.
  2. Court Findings:
    • The court found that Cajun Industries’ projects did not meet the criteria for qualified research because they were not sufficiently technological and were funded by external contracts.
    • The Grigsbys argued that their contracts were not funded in a way that disqualified them from the credit, but the court disagreed, stating that the contracts were contingent on the success of the research.
  3. Implications for Taxpayers:
    • This case highlights the importance of ensuring that research activities meet all criteria for the R&D tax credit, including the requirement that the research is not funded by external sources.
    • Taxpayers must carefully document their research activities and ensure that they can substantiate their claims for the credit.

If you need further details or have specific questions, please reach out to CFO Services.

IRS Circular 230 Required Notice‐‐IRS regulations require that we inform you that to the extent this communication contains any statement regarding federal taxes, that statement was not written or intended to be used, and it cannot be used, by any person (i) for the purpose of avoiding federal tax penalties that may be imposed on that person, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. 

End of Summer 2024 

The summer of 2024 might have seemed slow for the credits and incentives news cycle, but there was a bit still happening.  Below is a summary of the items taking place in regard to the IRA credits. 

Navigating the 45Q Tax Credit for Carbon Oxide Sequestration

Claiming the 45Q tax credit for carbon oxide sequestration involves multiple steps. To begin, taxpayers must ensure that carbon capture equipment is installed at a qualified facility. Next, they need to prepare a detailed lifecycle analysis (LCA) report, which outlines the greenhouse gas emissions linked to their carbon capture and sequestration activities.

This comprehensive report, along with supporting documents, must be submitted to both the IRS and the Department of Energy for approval. Upon receiving approval, taxpayers are then eligible to claim the 45Q tax credit.

By following these following steps, taxpayers can effectively leverage the 45Q tax credit to support their carbon sequestration efforts and contribute to a more sustainable future.

  1. Installation of Carbon Capture Equipment:
    • Ensure that the carbon capture equipment is installed at a qualified facility. This facility must meet specific criteria set by the IRS to be eligible for the tax credit.
  2. Lifecycle Analysis (LCA) Report:
    • Prepare a comprehensive LCA report. This report should detail the greenhouse gas emissions associated with your carbon capture and sequestration activities. It includes:
      • The amount of carbon oxide captured.
      • The methods used for capturing and sequestering the carbon oxide.
      • The environmental impact of the sequestration process.
  3. Submission for Approval:
    • Submit the LCA report along with all supporting documents to both the IRS and the Department of Energy. This step is crucial for verifying the accuracy and legitimacy of your carbon sequestration efforts.
  4. Claiming the Credit:
    • Once you receive approval from both the IRS and the Department of Energy, you can claim the 45Q tax credit on your tax return. This credit can significantly reduce your tax liability, making it a valuable incentive for carbon sequestration projects.

By following these steps, taxpayers can effectively leverage the 45Q tax credit to support their carbon sequestration efforts and contribute to a more sustainable future.

New IRS Regulations on Prevailing Wage and Apprenticeship Requirements

The IRS has issued final regulations under the Inflation Reduction Act of 2022 (IRA) concerning prevailing wage and apprenticeship (PWA) requirements. These regulations are essential for taxpayers aiming to qualify for increased credit or deduction amounts under the IRA:

  1. Prevailing Wage Rates:
    • Employers must pay workers prevailing wage rates for the construction, alteration, or repair of facilities. These rates are determined by the Department of Labor and are intended to ensure fair compensation for workers.
  2. Apprenticeship Ratios:
    • Employers must adhere to specific apprenticeship ratios. This means that a certain percentage of total labor hours must be performed by qualified apprentices. The goal is to promote training opportunities and develop a skilled workforce within the clean energy industry.
  3. Compliance and Penalties:
    • Failure to meet these requirements can result in penalties and reduced tax benefits. Employers must maintain accurate records and documentation to demonstrate compliance with the prevailing wage and apprenticeship requirements.

By complying with these regulations, employers can benefit from increased tax incentives and contribute to a more equitable and skilled workforce in the clean energy sector.

One clarification is that these final regulations do not apply to 48 or 48E ITC credits, but hopefully the IRS will make that adjustment some time this fall. 

IRS Outlines Steps for Clean Fuel Production Credit Registration

The IRS has detailed the registration process for the Clean Fuel Production Credit, outlining several key steps for producers to follow:

  1. Application Submission:
    • Producers must submit an application to the IRS. This application should include detailed information about the taxpayer, the production facility, and the type of clean fuel being produced. The application process ensures that only eligible producers can claim the credit.
  2. IRS Review:
    • The IRS will review the application to ensure all required information is provided and that the producer meets the eligibility criteria. This review process helps maintain the integrity of the credit program.
  3. Registration Letter:
    • Upon approval, the IRS will issue a signed registration letter to the producer. This letter serves as official confirmation that the producer is registered and eligible to claim the Clean Fuel Production Credit.
  4. Ongoing Compliance:
    • To maintain eligibility, producers must comply with all ongoing reporting and record-keeping requirements. This includes submitting periodic reports to the IRS and maintaining accurate records of clean fuel production activities.

These steps are designed to streamline the process and ensure that only qualified producers benefit from the Clean Fuel Production Credit.

Public Hearing on Clean Electricity Credits Highlights Key Clarifications

A public hearing was held on August 12th and 13th to discuss the proposed regulations for Section 45Y Clean Electricity Production Credits and Section 48E Clean Electricity Investment Credits. The meeting featured 44 speakers, including Nick Panko from CFO Services, who provided valuable insights and suggestions to help taxpayers better understand the qualifications.

Key suggestions and clarifications discussed during the hearing included:

  1. Qualified Facility Definition:
    • Clear Examples: Provide examples that clearly define what constitutes a qualified facility. This helps taxpayers understand the specific criteria that must be met.
    • Code Consistency: Review and ensure there is no ambiguity between different code sections. Consistency across sections helps prevent confusion and ensures that taxpayers can accurately determine their eligibility.
  2. Reference Requirements:
    • If the “Constructed by the taxpayer” and “Original use” requirements are necessary for Production Tax Credits (PTCs), they should be referenced from Section 48E into Section 45Y or directly included in Section 45Y. The current inconsistency could allow taxpayers to count non-qualified investments to meet the 80/20 rule. Specifically, under Section 45Y, a taxpayer could include “non-original use” equipment as FICP under the 80/20 rule.
  3. 80/20 Rule:
    • Integral Property Inclusion: Clarify whether integral property should be included in the 80/20 rule under Section 45Y.
    • Rewording for Clarity: Reword Section 1.48E-4(c)(5) to ensure it does not imply that adding new to used components should be excluded. While examples help, the paragraph remains unclear.
    • Original Use Clarification: Clarify if “Original Use” is included in the 80/20 rule. It seems implied but is not clearly defined. If the 80/20 rule is meant to be consistent across code sections, it should be clarified whether “original use” property is included within the qualified facility. Specifically, a new component in Section 1.45Y-4 does not require satisfying the “original use” condition. Therefore, a taxpayer under Section 1.45Y-4 could include property that is “new to the taxpayer.” This property might be a used piece of equipment that is new to the taxpayer, thus becoming a new component of property. This distinction should be clarified across Sections 1.45Y-4 and 1.48E-4, as well as the coordinating code sections. It’s important to make this clear because a new component versus a new “original use” component could be defined as two different costs.

These discussions and suggestions aim to provide clearer guidelines and ensure consistency across the regulations, ultimately helping taxpayers navigate the complexities of qualifying for clean electricity credits.

If you need further details or have specific questions about any section, feel free to ask!

IRS Circular 230 Required Notice‐‐IRS regulations require that we inform you that to the extent this communication contains any statement regarding federal taxes, that statement was not written or intended to be used, and it cannot be used, by any person (i) for the purpose of avoiding federal tax penalties that may be imposed on that person, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.