In United States v. McFerrin, 570 F.3d 672 (5th Cir. 2009), the Fifth Circuit vacated the opinion of the lower court which concluded that the taxpayer was not entitled to the research tax credit claimed. McFerrin, a prominent chemical engineer, owns several chemical companies. McFerrin hired a tax consulting firm to prepare a research tax credit study for his companies. McFerrin filed an amended tax return to claim a research tax credit based on the study. The IRS issued a refund and, later, brought suit to recover the refund. The District Court sided with the government. It concluded that McFerrin’s research did not “discover” new information and McFerrin’s evidence supporting its claim, which consisted primarily of employee testimony, was not sufficient. The Fifth Circuit disagreed with both of these conclusions as they are based on incorrect law. The Fifth Circuit remanded the case back to the District Court with instructions for the lower court to consider employee testimony to determine how much, if not all, of the research tax credit claim is allowable.

In FedEx Corp. v. United States, 2009 U.S. Dist. LEXIS 59856 (W.D. Tenn. 2009), a district court in Tennessee rejected the government’s interpretation of its research tax credit regulations for internal use software. In the late 1990’s, FedEx embarked on designing a new client-server billing system that could handle a large number of transactions. FedEx ended up abandoning the project in 2001 due to technical challenges. FedEx claimed credit for the research on its 1997 through 2000 federal income tax returns for this project. The government denied FedEx’s research tax credits because, according to the government, the research did not satisfy the requirements set out in the regulations. The court examined the regulations, noting that the government issued (1) final regulations in 2001 that addressed “internal use software” and contained a strict “discovery test” requirement and (2) final regulations in 2003 that had a more lenient “discovery test,” but did not address “internal use software.” The government had previously conceded that the higher “discovery test” requirement is invalid (after being prompted by Congress to do so); however, the government took the position in this case that the taxpayer must choose to apply either the 2001 regulations (which included “internal use software” rules and the invalid “discovery test”), or the 2003 regulations (which contained a less rigid “discovery test,” but not the “internal use software” rules). The court disagreed with the government. It said that taxpayers can use the “internal use software” rules from the 2001 regulations and the more lenient “discovery test” rules in the 2003 regulations.