in-20260930-IR-045260327NRA: LETTER OF FINDINGS: 04-20251657; 01-20251552; 01-20251654

DEPARTMENT OF STATE REVENUE LETTER OF FINDINGS: 04-20251657; 01-20251552; 01-20251654 Corporate Income Tax and Individual Income Tax For the Years 2021 and 2022 HOLDING Taxpayers failed to establish that they qualified for claimed credits. Waiver of penalty is warranted. ISSUES

III. Individual Income Tax – Penalty.

Authority: IC 6-8.1-10-2.1; 45 IAC 15-11-2. Shareholders protest the imposition of penalty. STATEMENT OF FACTS Taxpayers ("Taxpayers") include an Indiana company ("Company") as well as three individual shareholders and their spouses ("Shareholders"). Company is an S-Corporation. For tax years 2021 and 2022, Company filed Indiana Corporate Adjusted Gross Income Tax Returns ("Form IT-20S"), which included Indiana Research Expense Tax Credit schedules ("Schedule IT 20REC"). Shareholders filed Indiana Full-Year Resident Individual Income Tax Returns ("Form IT-40"). After review, the Department determined that Company was not entitled to the claimed research expense credits ("REC"). Because Company is an S-Corporation, credits claimed at the corporate level "flowed through" to Shareholders' returns. The Department also adjusted Shareholders' returns to remove claimed REC and issued Notices of Proposed Assessment for additional individual income tax and penalty. Taxpayers protested the removal of the REC at the Company level and subsequent adjustments to Shareholders' returns. An administrative hearing was held in which Taxpayers and their representative explained the basis for the protest. This Letter of Findings results. Additional facts will be provided as necessary.

I. Corporate Income Tax – Qualified Research Expense Projects, Research Expense Credits, and Documentation.

DISCUSSION Company filed Forms IT-20S with Schedule IT-20REC for 2021 and 2022. The Department conducted an audit of Company and determined that under 26 U.S.C.A. § 41(d), Company did not meet any portion of the four-part test set forth in the statute and reduced all REC amounts to zero. Taxpayers protested the denial of REC, explained that Company was conducting research, and provided additional information in support. As a threshold issue, it is the taxpayer's responsibility to establish that the existing tax assessment is incorrect. As stated in IC 6-8.1-5-1(c), "The notice of proposed assessment is prima facie evidence that the [D]epartment's claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made." Indiana Dept. of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012); Lafayette Square Amoco, Inc. v. Indiana Dept. of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007). Consequently, a taxpayer is required to provide documentation explaining and supporting his or her challenge that the Department's position is wrong. Further, "[W]hen [courts] examine a statute that an agency is 'charged with enforcing . . . [courts] defer to the agency's reasonable interpretation of [the] statute even over an equally reasonable interpretation by another party.'" Dept. of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014). Thus, all interpretations of Indiana tax law contained within this decision shall be entitled to deference. Indiana imposes a tax "on the adjusted gross income of every resident person, and on that part of the adjusted gross income derived from sources within Indiana of every nonresident person." IC 6-3-2-1(a). For Indiana income tax purposes, the presumption is that taxpayers properly and correctly file their federal income tax returns as required pursuant to the Internal Revenue Code. Thus, to efficiently and effectively compute what is considered the taxpayer's Indiana income tax, the Indiana statute refers to the Internal Revenue Code. IC 6-3-1-3.5(a) provides the starting point in determining the taxpayer's taxable income and calculating what would be his/her Indiana income tax after applying any particular additions and subtractions. The statute provides in part that Indiana adjusted gross income starts with "'adjusted gross income' (as defined in Section 62 of the Internal Revenue Code) . . . " Id. A tax credit is an amount a taxpayer claims on a tax return to reduce the amount of income tax owed. REC is a tax credit for companies that spend money on certain types of research expenses in a particular taxable year. These are called "qualified research expenses" ("QRE's"). IC 6-3.1-4-2(a). Indiana uses the federal definitions for purposes of RECs. IC 6-3.1-4-4; I.R.C. § 41. QRE is the amount of money paid or incurred by a taxpayer during the taxable year for in-house research expenses and contract research expenses. I.R.C. § 41(b). The Internal Revenue Code defines "qualified research" as follows: This definition sets out a four-part test to determine whether an activity is qualified research. First, the research must qualify for a business deduction under I.R.C. § 174. I.R.C. § 41(d)(1)(A). Second, the research must be for the purpose of "discovering information [] which is technological in nature[.]" I.R.C. § 41(d)(1)(B)(i). Third, the taxpayer must intend to use the research to develop a new business component or improve an existing one. I.R.C. § 41(d)(1)(B)(ii). Last, the taxpayer must use a "process of experimentation" during "substantially all" the research. I.R.C. § 41(d)(1)(C). An activity must satisfy all four parts to qualify for the credit. Under the federal code, a taxpayer claiming REC under Section 41 must retain records in "sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit." Treas. Reg. § 1.41-4(d). A person required to file a return with respect to income, "shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information." Treas. Reg. § 1.6001-1(a). Additionally, Indiana requires general record keeping under IC 6-8.1-5-4(a): When claiming REC, contemporaneous time records for research activities are essential. Unsupported estimates of time spent on research activities are not sufficient. Little Sandy Coal Company, Inc. v. Commissioner of Internal Revenue, 62 F.4th 287, 312 (7th Cir. 2023). Here, Company filed Form IT-20S along with Schedule IT-20REC. Documentation provided in the course of the protest process related to six projects completed by Company, and REC was claimed. To support its REC claim, Company used estimates and not contemporaneous records. This information was based on interviews Company conducted with its employees after the projects were completed. Because these records were not contemporaneous, as discussed in Little Sandy Coal, the records do not meet the requirements under Treas. Reg. § 1.41-4(d) and IC 6-8.1-5-4(a). As a result, Company was not eligible to claim the related REC on its return. Company failed to provide documentation proving that the Department's proposed assessment was wrong under IC 6-8.1-5-1(c). Company's protest is denied. FINDING Company's protest is denied.

II. Individual Income Tax – Assessment.

Shareholders filed Form IT-40 and reported their income for 2021 and 2022. Credits related to REC were reported on Schedule 6 and corresponded with amounts reported by Company. The Department audited Company and determined that Company had no allowable REC. Accordingly, the Department adjusted Shareholders' tax returns and disallowed the REC. The adjustments resulted in assessments for additional Indiana income tax. Shareholders protested, and Shareholders' representative explained that Company was conducting research. Taxpayers provided additional information in support. A taxpayer that incurs Indiana QRE in a tax year is entitled to REC for the taxable year. IC 6-3.1-4-2(a). Section 41 of the Internal Revenue Code and related regulations apply to the interpretation and administration by the Department for the REC. IC 6-3.1-4-4. This includes allocation and pass through of credit to applicable taxpayers. Id. If a pass-through entity does not have a state income tax liability against which the REC may be applied, a shareholder of the pass-through entity is entitled to a REC on his/her taxes. IC 6-3.1-4-7(a). As previously discussed, Company is an S-Corporation which claimed REC on its corporate return. REC credits flowed through to Shareholders' returns. The Department determined Company had no allowable REC and that adjustment also flowed through to Shareholders. The removal of the REC credit resulted in an increase in Shareholders' individual income and related tax. Because Company lacked contemporaneous documentation supporting the claimed REC as required by Treas. Reg. § 1.41-4(d) and IC 6-8.1-5-4(a) there is no REC credit to flow through to Shareholders. Shareholders failed to provide documentation proving that the Department's proposed assessments were wrong under IC 6-8.1-5-1(c). Shareholders' protests are denied. FINDING Shareholders' protests are denied.

III. Individual Income Tax – Penalty.

As previously discussed, Shareholders filed Form IT-40 and reported their income for 2021 and 2022. The Department adjusted Shareholders' tax returns and disallowed the REC, resulting in assessments for additional Indiana income tax. Taxpayers failed to pay the additional income tax. Because of this, they were issued a penalty by the Department. A person is subject to a ten percent penalty if the person "fails to pay the full amount of tax shown on the person's return on or before the due date for the return or payment." IC 6-8.1-10-2.1(a)(2) and (b). IC 6-8.1-10-2.1(d) states that "[i]f a person subject to the penalty imposed under this section can show that the failure to . . . pay the full amount of tax shown on the person's return, . . . or pay the deficiency determined by the department was due to reasonable cause and not due to willful neglect, the department shall waive the penalty." 45 IAC 15-11-2(b) further explains: The Department shall abate the penalty when a taxpayer "affirmatively establishes that the failure to . . . pay the full amount of tax due . . . or pay a deficiency was due to reasonable cause and not due to negligence." 45 IAC 15-11-2(c); see also IC 6-8.1-10-2.1(d). Finally, in order to establish reasonable cause, the taxpayer is required to demonstrate that it "exercised ordinary business care and prudence in carrying out or failing to carry out a duty giving rise to the penalty imposed" 45 IAC 15-11-2(c). The Department is mindful that "[r]easonable cause is a fact sensitive question and thus will be dealt with according to the particular facts and circumstances of each case." Id. In determining whether the taxpayer has reasonable cause, the Department is required to consider the following factors: Here, Shareholders have a history of compliance. Given the circumstances, the Department will waive the penalties pursuant to IC 6-8.1-10-2.1(d). Shareholders' protests are sustained as to the penalties. The Department notes that, now that Taxpayers have been through the audit and protest process and have received this Letter of Findings, waiver of penalty may not be warranted in the future. FINDING Shareholders' protests are sustained. CONCLUSION Taxpayers' protests are sustained in part and denied in part. Company's protest related to assessment of additional corporate income tax is denied because Company failed to provide documentation proving that the Department's proposed assessment was wrong under IC 6-8.1-5-1(c). Shareholders' protests related to the assessment of additional individual income tax are denied. Shareholders protests related to a waiver of a penalty are sustained, and the Department will waive the assessed penalties. July 22, 2026 Replaces Finding Document: New