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Shami v. Commissioner - 741 F.3d 560 (5th Cir. 2014)


The United States Tax Court has discretion to make an estimate under the Cohan rule. The United States Court of Appeals for the Fifth Circuit made clear that, even though the Tax Court might have considerable latitude in making estimates of amounts probably spent, the Cohan rule certainly does not require that such latitude be employed. The Fifth Circuit explicitly held that the Tax Court may not be compelled to estimate even though such an estimate, if made, might have been affirmed. This is so because the basic requirement is that there be sufficient evidence to satisfy the trier that at least the amount allowed in the estimate was in fact spent or incurred for the stated purpose, and until the trier has that assurance from the record, relief to the taxpayer would be unguided largesse. 


Farouk Systems, Inc. (FSI) sought tax credits for the tax years 2003, 2004, and 2005, for increasing research and development (R&D) under § 41 of the Internal Revenue Code, which grants a taxpayer a 20% tax credit for the amount of "qualified research expenses" (QREs) it incurs that exceed a base amount. QREs include, among other things, wages and supply costs expended on qualified research. However, the tax court concluded that the petitioners had not carried their burden of proving how much of its employees, Shami's and McCall, wages could be allocated to qualified services, if any. It explicitly found the testimony offered by Petitioners was not credible. On appeal, the petitioners claim that the Tax Court abused its discretion by refusing to permit them to introduce over 4,500 pages of records of laboratory tests into evidence. They also asserted that they used samples rather than all underlying documents only because counsel for the Commissioner conceded that the case was not a "documentary substantiation case."


Did the Tax Court abuse its discretion?




The Court held that it was not an abuse of discretion for the Tax Court to refuse to permit the taxpayers to introduce voluminous laboratory tests into evidence as the records did not address the performance of qualified services. The Tax Court also made no error with respect to the burden placed on the taxpayers as there was no evidence that they were required to provide a particular form of documentation. The Court likewise rejected the argument that a supervisor's wages could be allocated to qualified services under § 41 as the concessions made by the IRS Commissioner did not compel the conclusion that the supervisor directly supervised the actual performance of qualified services. 

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