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Importance of Time Records for R&D Tax Credits: Case of Fudim V. Commissioner Summary

Taxpayers should have strong defensible support to rely on time estimates

  • Court Ruling: 5/26/1994

In 1985, Efrem Fudim formed Light Sculpting Co. and innovated a process that became known as rapid modelling. It utilizes ultraviolet light and light-sensitive liquid polymers to fabricate plastic objects directly from instructions provided by a computer-aided design system. Mr. Fudim employed his wife and daughter as part-time workers in Light Sculpting.

When Mr. Fudim claimed R&D tax credits for 1986, 1987, and 1988, the R&D tax credit was based on his net self-employment income, wages paid to his wife and daughter, and supplies. Since the company did not maintain extensive records related to its research and development activities, it relied on time percentage estimates to determine the amount of time spent in qualified research activities.

The court fully affirmed Light Sculpting engaged in qualified research activities in 1986, 1987, and 1988. The court further noted Mr. Fudim’s training and background attest to his capability to develop the rapid modelling process. Mr. Fudim held a doctorate degree from the Institute of Control Sciences of the U.S.S.R. Academy of Sciences, Moscow, while Mrs. Fudim held a mechanical engineering degree from the Moscow Institute of Chemical Machine Building. There were contemporaneous letters and scientific articles acknowledging and describing Mr. Fudim’s newly developed rapid modelling process included in the court record. Mr. Fudim also provided evidence of two patents he was awarded for his work related to the rapid modelling process.

In its ruling, the court had to decide how much time Mr. Fudim, Mrs. Fudim, and their daughter, Natalia, spent in qualified research activities for the years in question since there were no written records of time spent engaged in development of the rapid modelling process.

The court determined Mr. and Mrs. Fudim spent more than 80 percent of their time engaged in qualified research activities. The substantially all rule stipulates a taxpayer can include 100 percent of the wages for any employee that spends 80 percent or more of their time in qualified research activities. The court was comfortable any non-qualified activities, such as consulting provided by Mr. Fudim to clients, were minimal in nature, and it was clear the 80 percent or more threshold was reached. Their technical backgrounds and training further supported their substantial involvement in research and development.

Notably, the court found there was insufficient information to determine Natalia’s involvement in qualified research activities. The submissions to the court did not reveal Natalia’s age, training, level of expertise, nor sufficient evidence related to the services provided by Natalia. Consequently, the court disallowed the claim for wages related to services provided by Natalia.

This case illustrates that companies without time records can claim R&D tax credits; however, it is critical to provide evidence related to how all associated employees engage in qualified research activities. Highlighting employees’ technical training, background, and education can establish their connection to qualified research activities.