The Genesis of the Contingent Liability Controversy

In 1998, Black & Decker realized approximately $303 million in capital gains from selling three businesses. It implemented a contingent-liability strategy designed by Deloitte & Touche to generate an offsetting capital loss. The arrangement used Black & Decker Healthcare Management Inc. (BDHMI), a controlled subsidiary.

Black & Decker and its Canadian subsidiary transferred approximately $561 million in borrowed cash to BDHMI in exchange for 10,000 preferred shares and the assumption of future employee and retiree health-benefit liabilities valued at approximately $560 million. The precise future benefit costs were uncertain. The transferors remained primarily liable for the underlying benefits.

The shares were subsequently sold for $1 million to an unrelated trust benefiting a former executive. The taxpayer claimed a $560 million capital loss based on a $561 million stock basis. These amounts describe the claimed tax treatment, rather than a judicial finding that an equivalent economic loss occurred.

The taxpayer relied on Sections 357(c)(3) and 358(d)(2), arguing that assumed liabilities whose payment would generate deductions should not reduce stock basis. The appellate court also noted that Congress had subsequently enacted Section 358(h), addressing liability-related basis reductions, but that provision did not apply retroactively to this transaction.

Judicial Analysis: From Summary Judgment to the Sham Transaction Remand

The District of Maryland denied the government’s summary-judgment motion and granted the taxpayer’s motion. It relied on BDHMI’s business purpose and treated its transactions as objectively reasonable. On February 2, 2006, the Fourth Circuit affirmed the denial of the government’s motion, reversed the judgment for the taxpayer, and remanded for further proceedings.

The appellate decision left material factual questions unresolved. It was not a final appellate determination allowing or disallowing the loss. The existence of a legitimate corporation did not, by itself, settle whether the particular loss-generating transaction was a sham.

The Two-Prong Sham Transaction Test

Under the Fourth Circuit’s then-applicable Rice’s Toyota standard, the sham inquiry examined both the taxpayer’s business motivation and the transaction’s reasonable prospect of profit apart from tax benefits. Both prongs of that historical sham test had to be satisfied to disregard the transaction on that basis.

The subjective inquiry concerned whether the taxpayer had a business purpose beyond obtaining tax benefits. The objective inquiry concerned the reasonable possibility of a pretax profit from the specific transaction. The court required further factual proceedings in this case; it did not announce that subjective intent can never be resolved on summary judgment.

Other economic-substance litigation, including Coltec Industries and Sala, also examined the transactions generating disputed tax benefits. Those authorities arose in different factual and jurisdictional settings and should not be treated as interchangeable research-credit precedents.

Standard of Review and the Codification of the Doctrine

Courts distinguish legal questions from factual findings when reviewing economic-substance decisions. Differences among historical judicial approaches do not establish that appellate review standards alone caused Congress to codify the doctrine.

Section 7701(o), enacted in 2010, provides that when the economic-substance doctrine is relevant, a transaction must meaningfully change the taxpayer’s economic position apart from federal income-tax effects and have a substantial purpose apart from those effects. The codified rule generally applies to transactions entered into after March 30, 2010. It should not be substituted retroactively for the test applied to the 1998 Black & Decker transaction, nor assumed to impose an additional universal eligibility test on every research-credit claim.

Bridging Black & Decker to Section 41: The Reality of Research

The useful comparison is evidentiary: a description or label does not establish that the governing tax requirements are met. However, research-credit eligibility turns on Section 41 and its regulations. A legitimate engineering project can fail those requirements without being a sham or an abusive tax shelter.

The Section 41 Four-Part Test

The research-credit tests generally apply separately to each business component, subject to the shrinking-back rule and statutory exclusions. They are distinct from the subjective and objective inquiries in Black & Decker.

The process-of-experimentation requirement is a recurring litigation issue. Technical difficulty, design revisions, or connection to an innovative project do not alone establish it. Records should explain how alternatives were evaluated through activities such as modeling, simulation, or systematic trial and error. A successful commercial outcome is not required, and merely resolving uncertainty does not establish that every other condition has been met.

Modern Litigation: Little Sandy Coal and Phoenix Design Group

These cases directly address research-credit requirements. Their holdings should be explained through Section 41 and the evidence presented, rather than attributed to a supposed research-credit rule from Black & Decker.

Little Sandy Coal and the 80% Threshold

In Little Sandy Coal Co. v. Commissioner, the Tax Court denied the credit in 2021, and the Seventh Circuit affirmed in 2023. The taxpayer did not adequately substantiate the activities needed to meet the substantially-all requirement. The newness of the vessels and unsupported estimates could not substitute for activity-level evidence.

The regulatory 80% test measures activities, using cost or another consistently applied reasonable basis, rather than the percentage of a finished product that is new. The appellate court disagreed with parts of the Tax Court’s reasoning, including its categorical treatment of direct support and supervision, while affirming the result because the taxpayer had not proved its claim.

Phoenix Design Group and Design Uncertainty

In Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, the Tax Court found that the engineering activities at issue did not qualify. The evidence did not adequately establish qualifying uncertainty and research; applying established calculations or revising designs was insufficient on the record presented.

The decision does not categorically exclude architectural or engineering firms. Such firms must distinguish technical experimentation from ordinary design execution and show how particular activities satisfy the statutory requirements.

The Impact of Documentation and Administrative Mandates

Research-credit substantiation requirements and refund-claim procedures have their own statutory and administrative foundations. They should not be characterized as consequences of Black & Decker without evidence of that connection.

CCM 20214101F and Refund Claim Requirements

The 2021 Chief Counsel memorandum addressed information needed for a valid research-credit refund claim. The IRS subsequently modified its filing requirements. Since June 18, 2024, it has waived submission of individual researchers’ names and the information each person sought to discover with the initial claim, although examiners may request that information later.

The IRS’s amended-return FAQs require identification of the relevant business components, research activities for each component, and total qualified wage, supply, and contract-research expenses for the claim year. These are claim-year expense totals; the FAQ does not require each expense to be itemized by employee at filing. The transition period allowing 45 days to perfect a deficient claim extends through January 10, 2027. Filing requirements do not replace substantive eligibility or recordkeeping obligations.

Revision of Form 6765

The December 2025 Instructions for Form 6765 make Section G optional for tax years beginning before 2026, including 2025. Section G is required for tax years beginning after 2025, subject to stated exceptions. These include specified qualified-small-business payroll-credit filers and original-return filers meeting both the $1.5 million QRE and $50 million average-gross-receipts limits.

Required filers generally supply details for business components covering at least 80% of QREs, capped at 50 components, and aggregate the remainder under the instructions. This filing convention is separate from the 80% process-of-experimentation test. Other applicable parts of Form 6765 and amended-return requirements remain relevant even when Section G is optional.

Section 174 Amortization and Section 174A Domestic Expensing

The Tax Cuts and Jobs Act required capitalization and amortization of research and experimental expenditures for tax years beginning after December 31, 2021: five years for domestic research and fifteen years for foreign research. That describes the original post-2021 regime, rather than the complete current rule.

The One Big Beautiful Bill Act, enacted July 4, 2025, added Section 174A. Domestic R&E expenditures are generally deductible for tax years beginning after December 31, 2024, with an elective capitalization alternative. Foreign R&E expenditures remain subject to fifteen-year amortization under Section 174.

Separate Cost Tracking and Cash Flow Effects

Research-expenditure deductions and research credits use different definitions. Relevant overhead can fall within R&E expenditures without qualifying as a Section 41 expense. Companies should reconcile the two calculations, document where research occurs, and apply the relevant Section 280C coordination rules rather than assume identical treatment.

Revenue Procedure 2025-28 addresses transition elections. Eligible small businesses could elect retroactive domestic expensing for affected 2022–2024 tax years; eligibility generally used the $31 million average-gross-receipts test for 2025, with aggregation and tax-shelter restrictions. The general amended-return election deadline was July 6, 2026, subject to earlier refund deadlines, and has passed as of September 12, 2026. Separate transition relief allows recovery of remaining domestic balances over one or two years, subject to election procedures.

Sector-Specific Implications and Advanced Technologies

Manufacturing and software projects require activity-specific analysis. A technology’s novelty or an industry’s reputation for innovation does not establish credit eligibility.

Advanced Manufacturing and 3D Printing

Additive manufacturing may support qualifying experiments involving materials, geometry, strength, or production methods. Eligible employee services can include performing, directly supervising, or directly supporting qualified research. However, printing an established design, producing routine commercial parts, or purchasing advanced machinery does not inherently qualify.

Company announcements about digital manufacturing cannot establish the tax treatment of particular projects or wages. Likewise, localizing production to reduce tariff exposure is a commercial objective rather than a credit-eligibility test. Any development of a domestic manufacturing process must independently satisfy Section 41.

Software Development and Internal Use

Software developed primarily for internal general and administrative functions, such as human resources or financial management, generally must satisfy the additional [{“@context”:”https://schema.org”,”@type”:”VideoObject”,”name”:”What is the R&D Tax Credit?”,”description”:”The research and experimentation tax credit, most frequently known as the R&D tax credit, is a dollar-for-dollar reduction of your tax liability.”,”thumbnailUrl”:[“https://i.ytimg.com/vi/mzGRiA_MUl4/sddefault.jpg”,”https://www.dropbox.com/s/n1iyfxaeo6rm5tg/Fed%20-%20US%20Flag.jpg?raw=1″],”uploadDate”:”2019-10-14T00:00:00+00:00″,”duration”:”PT3M54S”,”contentUrl”:”https://www.youtube.com/watch?v=mzGRiA_MUl4″,”embedUrl”:”https://www.youtube.com/embed/mzGRiA_MUl4″,”publisher”:{“@type”:”Organization”,”name”:”Swanson Reed”,”url”:”https://swansonreed.com”,”logo”:{“@type”:”ImageObject”,”url”:”https://swansonreed.com/logo.png”}},”transcript”:”the research and experimentation tax credit most frequently known as the r d tax credit is a dollar for dollar reduction of your tax liability it was established in 1981 as an incentive for companies to invent create and innovate within the united states here at swanson read the biggest problem we see as specialized r d tax advisors is self-censorship companies believing they are not eligible for the r d tax credit when in reality the irs has a very broad definition of what it considers r d does your company design engineer or manufacture its own products do you look to improve the functionality performance or reliability of these products do you create new or improved processes in order to make things better faster or cheaper do you develop prototypes or computer generated models or do you develop software technology or other intellectual property if you answered yes to any of the previous questions your company may qualify for the r d tax credit congress has created a four-part test to help you identify activities that would be considered qualified research your work must satisfy these four main requirements it must be technological in nature a process of experimentation there must be technical uncertainty and a permitted purpose let’s go through these one by one one technological in nature this means the process of experimentation used to discover such information fundamentally relies on principles of the physical or biological sciences engineering or computer science two process of experimentation this is defined as a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or method of achieving that result or the design of that result is uncertain the beginning of the research three technical uncertainty as a taxpayer you must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component and four permitted purpose it is a qualified purpose if research relates to a new or improved function increased performance enhanced reliability or enhanced quality it is not a qualified purpose if research relates to aesthetics meaning style taste cosmetics or seasonal design companies that are benefiting from the credit are typically receiving a minimum in the tens of thousands of dollars of federal tax credits each year so don’t pass up this chance to significantly lower your tax liability and improve your cash flow call swanson read representative today for an assessment”},{“@context”:”https://schema.org”,”@type”:”AccountingService”,”name”:”Swanson Reed”,”description”:”One of the largest Specialist R&D Tax Credit advisory firms in the United States, exclusively providing R&D Tax Credit claim preparation and audit compliance solutions for over 30 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