Sun Microsystems Inc v Commissioner (1995)


Sun Microsystems Inc. (“Sun Microsystems”) v. Commissioner, T.C. Memo 1995-69

Sun Microsystems was a computer company that sold computers, computer components, software, and IT services. It was founded in 1982 in California.

At Sun Microsystems, an incentive stock option (ISO) plan was given to employees who engaged in R&D work from April 1983 to July 1986. They were allowed to be exercise this (i.e. buy and sell stock) from August 1985 to June 1987.  Then, in 1987, the plan ended and any ISO shares that employees held were sold back to the company. These sales were referred to as ‘disqualifying dispositions’. Employees, in 1987, therefore may have had income from these sales (i.e. the sales price minus the market value when they were bought). This income was called ‘spread income’ and was reported on the employees’ W-2 forms.


When Sun Microsystems filed its 1987 return, it claimed the R&D Tax Credit, and included wages as Qualified Research Expenses (QREs). Within these wage expenses was $1,025,918 from spread income from the disqualifying dispositions. The IRS disallowed the claim. The company and the IRS disagreed about whether ‘wages’ (for R&D purposes) include income from disqualifying dispositions of stock purchased through the company’s ISO plan.

When claiming the R&D Tax Credit, “in-house research expenses” count as QREs. They’re defined as “any wages paid or incurred to an employee for qualified services performed by such employee”, and often just referred to as ‘wages’. It’s also specified that ‘wages’ refers to all remuneration for services performed by an employee for their employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash. By this logic, Sun Microsystems argued that spread income is classed as wages.


The court referenced Apple Computer, Inc v Commissioner, in which spread income was found to constitute wages. It also acknowledged that there was no language in legislative history that excluded spread income from the definition of wages. As such, the court agreed with Sun Microsystems, and held that spread income constituted wages, and QREs.


QREs include wages, supplies and computer rentals, but, within these groupings, it’s important to understand what can and can’t be claimed. Many companies utilize different pay structures, and must take these into account when claiming wages for their R&D Tax Credit refund. Or, get professional assistance when making the claim.

Want to know more about claiming R&D tax credits? Connect with our R&D tax experts today.


Swanson Reed is one of the U.S.’s largest Specialist R&D tax advisory firms, offering tax credibility assessments, claim preparation, and advisory services. We manage all facets of the R&D tax credit program, from claim preparation & audit compliance to claim disputes. 

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