Leonard L. Grigsby et al. v. The United States: A Case in Construction and Contracts
Leonard L. Grigsby et al. v. The United States (No. 19-00596-BAJ-SDJ)
The United States filed a civil suit against Leonard Grigsby, seeking the return of an erroneously issued tax refund. The Government further moved that the company did not conduct any qualified research activities, and so the credit is ineligible from the start.
The Erroneous Refund
Cajun Industries, LLC & Subsidiaries (Cajun) claimed an R&D tax credit for the tax year 2013, wherein the entity elected to be treated as an S Corporation. During this year, Leonard Grigsby was a member of Cajun.
Leonard and Barbara Grigsby filed multiple tax returns, including amended returns following Cajun’s amended return. This return filing history is outlined here:
- Leonard and Barbara Grigsby filed a timely filed return for 2013, claiming an overpayment carryforward to tax year 2014 of $239,310;
- Leonard and Barbara Grigsby filed a second joint federal income tax return for 2013, claiming an overpayment carryforward of $259,962 to the 2014 tax year
- Cajun filed an amended federal tax return around October 3, 2016 which claimed $1,341,420 of research credits
- After this, Leonard and Barbara Grigsby filed another amended 2013 federal income tax return, claiming a tax refund in the amount of $576,756.
- This amount was attributable to the portion of the Cajun R&D tax credit allocable to Leonard Grigsby as a shareholder.
On September 18, 2017, the IRS processed the individual’s second 2013 return as an amended return, allowing the additional overpayment of $20,652 claimed on that return. The IRS then processed the third return, erroneously allowing the $576,756 refund claimed on that return. On September 15, 2017, the IRS erroneously issued to Leonard and Barbara Grigsby a refund in the amount of $671,071.38, which reflected the amount of the refund claimed by the Grigsbys on their Third 2013 Return, plus statutory overpayment interest of $73,663.38.
Cajun is a civil construction company which contracts with hundreds of private and public clients to provide a range of construction services in numerous markets. With consultation from AlliantGroup, the company identified 105 research projects in their 2012 tax year, which ended September 30, 2013. They amended their tax return, claiming a tax credit in the amount of $1,341,420.
In review of the credit, Cajun and the Government agreed that a sampling of four of Cajun’s projects for the tax year ending September 2013 would be sufficient to determine the outcome of the dispute. The company provided brief descriptions of each representative project.
Each project was subcontracted work and, upon review of contracts and service agreements, the Government identified the following key contract terms and details:
- Each contract was a fixed-fee with a capped payment; however, each contract also contained provisions wherein Cajun may receive additional compensation in stated circumstances such as if the scope of work is changed or expanded.
- Each contract stated that work was subject to approval by the hiring entity, with different outcomes for how this would impact payment (if at all).
- Three of the contracts outlined IP and Work Product rights, asserting that any IP or Work Product developed is the property of the hiring entity.
Outcomes and Learnings
The devil is in the details, especially when it comes to contracts and service agreements. At first glance, each of these subcontracted projects were fixed-base and the financial risk would be placed on Cajun. However, reading the detailed contract terms highlighted that there were provisions and clauses that would ensure Cajun was compensated in almost every instance that would create financial risk. The contract allowed the taxpayer to receive compensation for “all loss, damages or risks … connected with … the work.” This included unanticipated amounts for inspection and testing.
This level of protection financially favored Cajun, protecting them well in business but ultimately removing the right to the tax credit. What was good for business is not necessarily suitable for tax.
The Government also found, and reinforced, that “Works Made for Hire” are funded. Cajun did not retain rights to the research, work product, or IP in 3 of the 4 representative projects. Since the final product benefitted the hiring entity, it would be considered funded research, again removing Cajun’s eligibility for the credit.
The Government found that Cajun’s credit was ineligible and was denied. Similarly, the court ruled in favor of the US in the civil suit against Grigsby, requiring the erroneous refund to be recollected.
The lesson here is understanding eligibility and financial risk is essential to determining who has rights to the credit. A simple overview of a contract is not always sufficient and diligence is crucial.
The full case can be found here.
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