Leon Max v. Comm’r: A Case in Fashion and R&D

Leon Max v. Comm’r. T.C. Memo. 2021-37 (3.29.2021)

Leon Max Inc. (Leon Max) is a clothing designer who specializes in women’s apparel. They submitted an R&D tax credit claim for the 2009 to 2012 tax years. The claims are based on projects that show development of garments. The claims were denied on the premise that the projects did not qualify as eligible R&D under section 41. They more specifically asserted that the process did not qualify for the research credit because the process “was nontechnical, typical of the industry, and [was] concerned more with style, taste, and seasonality.”

Leon Max explained that their development processes began with the design team creating concepts for each collection. Following concept design, they would choose textiles and determine design elements that would suit it best. Uncertainty regarding incorporating design elements were solved through trial and error. Following store approval of these samples, Leon Max then fabricated prototypes to be sent to third-party manufacturers. 

Law and the Court’s Decision

The Tax Court approached this analysis as they normally do -with the four-part test. 

The four-part test under IRC Section 41 is made of the following

    • IRC Section 174 Test
  • Requires research expenditures to be eligible for treatment as expenses – so those costs that are directly linked to the experimental components
      • The court found that Leon Max’s outlined uncertainties (eg. how to drape fabric, proper thread size) are not qualified uncertainties.
      • They further found that the tests applied (eg. test fabric shrinkage by washing it) were not investigative in nature.
    • Technological Information Test
  • Qualifying projects are undertaken in order to discover information that is technological in nature. So the application of hard sciences to further the industry
      • The court found that Leon Max’ testing (eg. fit testing of cloth) does not fall under engineering as they claimed, and therefore they did not utilize any principles of engineering in their process. 
      • The court further found that their method of testing draping fabric did not rely on any material science
    • Process of Experimentation Test
  • All of the research activities must constitute the three elements of a process of experimentation for a qualified purpose.
        • “Substantially all” element
        • “Process of experimentation” element
        • “Qualified purpose” element
      • The court asserted that Leon Max did not meet the qualified purpose element, as a “ “purpose is not qualified if it relates to style, taste, cosmetic, or seasonal design factors.”
      • The court further asserted they did not meet the process of experimentation element, as a process of experimentation inherently requires uncertainty to try and overcome. Without true technical uncertainty, they could not follow a scientific process of experimentation.
      • Finally, the court also asserted Leon Max did not prove that at least 80% of their activities were a part of a process of experimentation, as many of their activities were simply not qualified.
    • Business Component Test
  • The application of this research must result in the development of a new or improved business component of the company/taxpayer
    • The court did not continue it’s evaluation with this test as they had asserted a failure to meet requirements for all other tests already.

Overall, the court ruled in favor of denying these tax credits stating that the activities were “common solutions to common problems.”


While the IRC section 41 does have some historical precedence in relation to the textile and apparel industries, IRC Section 41(d)(3)(B) outlines an exclusion of style, taste, cosmetic or seasonal design factors from the definition of “qualified purpose’. This exclusion absolutely proves to be a hurdle for apparel companies – but it should be evaluated carefully before claiming the tax credit. 

Something to consider – there is a repetitive use of the scientific method as a means to deny a credit claim. The scientific method, however, does not always conform directly into industrial and commercial practices. A systematic process of experimentation does not always follow a scientific process but might still reflect an effective and comprehensive experimentation process. The Tax Court should consider addressing how this terminology may no longer accurately reflect the variety of innovation processes across industries. 

Click here to read the full case.

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