Gary C. George and Robin A. George v. Commissioner

Which Came First: The Research or the Credit?

The Tax Court faced a 'chicken or the egg' dilemma in George v. Commissioner—did the research create the credit, or did the credit study create the research? At stake were millions in research and development (R&D) tax credits tied to the decidedly unglamorous subject of chicken feed. The court reached a split decision. It accepted the novel 'Pilot Model' argument for live chickens, allowing credits for specific projects (Ross 708, LT Priming) while rejecting others as post-hoc data mining. Notably, no penalties were imposed.

Ruling the Roost: Diseases and Consultants

... the egg' dilemma in George v. Commissioner—did the research create the credit, or did the credit study create the research? At stake were millions in research and development (R&D) tax credits tied to the decidedly unglamorous subject of chicken feed. The court reached a split decision. It accepted the novel 'Pilot Model' argument for live chickens, allowing credits for specific projects (Ross 708, LT Priming) while rejecting others as post-hoc data mining. Notably, no penalties were imposed.

For four generations, the George family has ruled the roost in the chicken industry. In more recent times, however, the poultry industry faced a new set of challenges. Mounting pressure from consumers to eliminate antibiotics in chicken production ("No-Antibiotics-Ever" or NAE) forced companies like George's Inc. (GOMI) to adapt rapidly. This shift brought with it a host of new problems. Diseases that were once easily managed with antibiotics, such as coccidiosis (a parasitic infection of the gut) and necrotic enteritis (a bacterial infection also affecting the gut), became major threats to broiler health and profitability. Additionally, GOMI faced "runt and stunt syndrome," a condition causing feed refusal and poor performance.

In response to these challenges, GOMI ramped up its efforts to find alternative solutions. Around 2011, they engaged two consulting veterinarians, Leonard Fussel and David Fields, to help manage these issues. As the industry grappled with these changes, GOMI decided to pursue research and development (R&D) tax credits under Section 41. Section 41 allows a tax credit for increasing research activities. To assist with this endeavor, GOMI hired alliantgroup, a tax consulting firm, to conduct a research credit study. The engagement letter was signed on August 30, 2014. alliantgroup assigned Associate Director Jeremy Troutman as the lead consultant. The goal was to identify and document qualified research activities related to improving broiler production, particularly in the face of antibiotic restrictions and emerging health challenges.

The Pilot Model Argument: Feed as R&D

The core legal dispute centered on whether GOMI's broiler chickens could be considered "pilot models" under Section 174 of the tax code. Section 174 allows taxpayers to deduct expenses for research and development. GOMI argued that its activities in raising broilers, including feed costs, qualified as research expenses because the chickens themselves were "pilot models" used to resolve uncertainties in their production. The IRS countered that these activities constituted routine farming practices, not qualified research.

The Tax Court addressed the definition of "pilot model," referencing Treasury Regulation § 1.174-2(a)(4). This regulation defines a pilot model as "any representation or model of a product that is produced to evaluate and resolve uncertainty concerning the product during the development or improvement of the product.”

The court adopted the "pilot model" theory for broilers under specific conditions. If the broiler is, in fact, the "model" to resolve uncertainty, then the cost to grow it—most significantly the feed—becomes a deductible research supply. This hinges on whether the four-part test under Section 41(d)(1) is met. That test requires that the research (A) be something that can be expensed under Section 174, (B) be undertaken to discover technological information that is intended to be useful in the development of a new or improved business component, and (C) that substantially all of the activities constitute elements of a process of experimentation for a qualified purpose.

The Winners: Genetic Lines and Vaccines

Continuing the analysis of whether the four-part test under Section 41(d)(1) was met, the court next considered specific projects for the research tax credit. Section 41 allows a tax credit for increasing research activities. Crucially, the court distinguished between projects where GOMI demonstrated a "process of experimentation"—hypothesis, testing, and analysis—and those where substantiation was lacking. This distinction determined which projects qualified for the research credit.

The court sided with GOMI on several key projects. For example, research into new genetic lines, specifically a project referred to as 'Ross 708,' was deemed qualified research. Similarly, the 'LT Priming' project in 2014, which involved testing a new method of vaccinating chickens against the Lymphoid Leukosis virus, and the 'HatchPak/Tylan' trials in 2012, which focused on controlling coccidiosis and improving gut health, were also successful.

The court's acceptance of feed costs as qualified research expenditures (QREs) was central to these victories. The IRS had challenged whether feed costs could be included. But the court determined that because these specific flocks were part of a bona fide process of experimentation, significantly, the feed—becomes a deductible research supply. As the court put it regarding HatchPak and Tylan, all costs of developing the broilers under these trials are deductible as pilot model expenses" under Treasury Regulation § 1.174-2(a)(1), (3), (4). Thus, the feed is a necessary expenditure in developing the pilot model broilers and resolving the uncertainty. Therefore, the expenditures would be deductible under section 174.

The Losers: Substantiation and Resolved Uncertainty

Following the allowance of feed as a research supply for projects where flocks were part of a bona fide process of experimentation, the court turned to projects that failed to meet the stringent requirements for the research credit. While all costs of developing broilers under successful trials are deductible as pilot model expenses under Treasury Regulation § 1.174-2(a)(1), (3), (4), several of GOMI's projects fell short. The court disallowed research credits for the Salinomycin, Phytase, Vaxxitek, and HatchPak 2013 trials, citing critical failures in substantiation and the resolution of prior uncertainty.

Regarding the Salinomycin trials, the court found a critical lack of substantiation. The petitioners argued they were uncertain whether higher dosages of Salinomycin, combined with chemical coccidiostats, would increase efficacy in controlling coccidiosis. However, the court noted that GOMI's own feed recipe records showed no change in Salinomycin dosage during the trials, undermining the claim of investigatory activities. Furthermore, while GOMI identified Robenz as a chemical coccidiostat used during the trials, the court found only one instance of its use in a feed recipe, dated April 3, 2012. The court found this was insufficient to link the recipe to the experimental flocks, especially since the flocks were at varying stages of development. The court stated that this situation was "a clear example of the chicken (research credit study) coming before the egg (research)."

The HatchPak and Tylan trials suffered a different fate. While the court deemed the 2012 trials as valid research, the 2013 trials failed the "section 174 test". The court explained that Section 174 allows a deduction for expenses paid or incurred for research and development in the experimental or laboratory sense. The court stated that while uncertainty may extend beyond a single tax year, a taxpayer must demonstrate that information objectively available in the tax year for which the credit is sought did not establish the capability, method, or appropriate design. Citing Siemer Milling Co., T.C. Memo. 2019-37, the court emphasized that a successful test in a previous year resolves uncertainty for a later identical test. Here, the 2012 trials provided definitive data that HatchPak and Tylan effectively controlled coccidiosis in GOMI's standard production process. The court highlighted testimony from Mr. McClure and Dr. Fussel, who both expected the combination to control coccidiosis after the 2012 trials. The court stated that the 2013 failure could not retroactively justify uncertainty that had already been resolved.

The Phytase trials also failed due to a lack of substantiation. GOMI claimed the trials aimed to optimize phytase dosage based on phosphorus content in feed ingredients. However, the court found that feed logs showed consistent Phyzyme TPT 2500 dosages (0.3-0.5 lbs/ton) both before and during the trial period, negating the claim that Dr. Greenwood varied dosages. The court concluded it could not determine that GOMI even undertook the phytase research trials, because there was no variance.

The 6% Solution and Penalty Relief

The Phytase trials also failed due to a lack of substantiation. GOMI claimed the trials aimed to optimize phytase dosage based on phosphorus content in feed ingredients. However, the court found that feed logs showed consistent Phyzyme TPT 2500 dosages (0.3-0.5 lbs/ton) both before and during the trial period, negating the claim that Dr. Greenwood varied dosages. The court concluded it could not determine that GOMI even undertook the phytase research trials, because there was no variance.

The financial aftermath for GOMI was a mixed bag. Because GOMI couldn't substantiate its qualified research expenses (QREs) from 2009-2011, the court invoked Section 41(c)(5)(B). Section 41 governs the credit for increasing research activities. Section 41(c)(5)(B) kicks in when a taxpayer has no QREs in any of the three preceding tax years. Under this rule, GOMI's research credits were limited to 6% of the QREs for each of the tax years at issue (2012, 2013, and 2014).

The court then turned to the IRS's assertion of accuracy-related penalties under Section 6662(a) for the 2014 and 2016 tax years. Section 6662(a) imposes a penalty on any underpayment of federal income tax attributable to negligence or disregard of rules or regulations. However, Section 6664(c)(1) provides an exception: no penalty applies if the taxpayer demonstrates "reasonable cause" for the underpayment and acted in good faith.

The court sided with GOMI, finding reasonable cause existed. The court emphasized that GOMI relied on the advice of alliantgroup, a firm with extensive experience in conducting tax credit and incentive studies, particularly within the agriculture industry. The court distinguished this case from Betz v. Commissioner, T.C. Memo. 2023-84. While Betz suggested that reliance on alliantgroup might not always be reasonable, the court clarified that no "hardline rule" existed. Here, unlike in Betz, GOMI possessed industry knowledge (the constant research and evolution occurring on the ground in chicken production) and alliantgroup's reports captured this. Even though GOMI's representatives lacked tax expertise, they reasonably relied on alliantgroup's thorough analysis. Accordingly, the court declined to impose accuracy-related penalties for 2014 and 2016.