The IRS Office of Chief Counsel released Administrative Memorandum 20071702F today.  This Memorandum explains when “commercial production” begins for purposes of the federal R&E tax credit.  The IRS examines a multi-phase design and manufacturing process and concludes that two of the phases are either tooling up for or part of the manufacturing process. 

This decision is important becuase it helps taxpayers understand how the IRS may view their design and manufacturing process.  It is very difficult to determine when research stops and the preparation for manufacturing begins.  The R&E tax credit excludes expenses for manufacturing.  As the decision explains, research stops when the product meets “the basic functional and economic requirements for the taxpayer for the component’s sale or use.” 

The IRS designated the research tax credit as a Tier 1 issue pursuant to the IRS’s Industry Issue Focus (”IFF”)  program.  The IRS IFF program is intended to allow the IRS to focus its efforts in examining and developing guidance with respect to issues that occur in multiple industries.  This represents the IRS’s effort to re-focus its efforts now that the IRS has restructured along industry lines.