Main Issue:
Supplies expense
“Substantially all” rule
Facts:
Credits claimed for development of special order ships
Claimed all expenses associated with the construction and development of the first article/prototype ships which were then sold
IRS argued that non-experimental aspects of the ship development were not included as a qualified expense
Conclusion:
If at least 80% of the project is part of the process of experimentation, all costs associated with the project are eligible for the credit
Prototypes sold to third parties were also considered eligible expenses
The court allowed 2 of the 6 ships to be considered qualified for the credit
Take-Away Point:
Supplies can be substantial and if they are, need to make sure you have the analysis to prove that 80% of the project was part of a process of experimentation
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