Answer Capsule: The Ekman v. Commissioner (184 F.3d 522) case establishes a pivotal precedent in federal tax treatment of research and experimental expenditures. The Sixth Circuit Court of Appeals ruled that the acquisition cost of a depreciable asset (a Porsche engine) used as a research platform cannot be immediately deducted under Section 174, nor can it qualify as a consumable supply for the Section 41 research tax credit. This decision entrenched the “character vs. use” doctrine, demonstrating that an asset’s inherent depreciable character remains intact regardless of its exclusive use in experimentation or physical wear and tear during testing.
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Ekman v. Commissioner
The federal tax treatment of research and experimental expenditures distinguishes the cost of research from the acquisition of durable equipment used to conduct it. Ekman v. Commissioner, 184 F.3d 522 (6th Cir. 1999), illustrates that distinction through a dispute over a Porsche engine. The decision addressed a deduction under the historical version of Section 174, rather than a Section 41 research credit. Its reasoning is relevant by analogy to the separate statutory exclusion of depreciable property from research-credit supplies. This study also considers related-party substantiation, subsequent research-credit litigation, and the domestic deduction rules enacted in 2025.
Historical Context and the Legislative Intent of Section 174
Congress enacted Section 174 in 1954 to reduce uncertainty over whether research and experimental costs had to be capitalized or could be deducted currently. The provision allowed taxpayers to elect current deductions for qualifying expenditures connected with their trade or business, subject to statutory exclusions. This treatment supported business research, including development undertaken before a product generated revenue. The historical deduction rule must be distinguished from both the mandatory capitalization rules applicable to taxable years beginning in 2022 through 2024 and the domestic research rules enacted in 2025.
Congress introduced the research credit in 1981; it is now codified in Section 41. The deduction provisions and the credit perform different functions: one determines the treatment of research costs in computing taxable income, while the other provides a credit calculated from qualifying expenses under the applicable formula. A deductible research expenditure does not automatically qualify for the credit. Section 41 imposes additional activity tests, expense-category limits, and exclusions. For taxable years beginning after December 31, 2024, Section 41(d)(1)(A) refers to expenditures eligible for treatment under Section 174A. The acquisition cost of depreciable research equipment is excluded from the supplies category independently of these activity tests.
The Porsche Engine Controversy: Ekman v. Commissioner (1999)
The litigation concerned the 1991 joint income tax return of Leonard Charles Ekman and Kaye Layne Ekman. Leonard sought to modify a Porsche engine for increased horsepower and racing capability while preserving its usefulness in a street vehicle. He had worked on the concept since approximately 1984. In March 1991, he purchased a damaged four-valve Porsche 928 S4 engine for $7,000 as a platform for development. The opinion describes the standard engine as suited to sustained high-speed driving, but not originally designed for racing.
The research project involved more than just the engine itself; Ekman collaborated with other specialists who were tasked with developing complementary components to enhance the engine’s overall performance and horsepower. The primary objective of the project was not to sell the specific engine purchased but to perfect a series of modifications—including cam, piston, engine block, and cylinder head developments—that could be implemented on other 928 S4 engines for commercial sale.
The Core Dispute and Tax Court Findings
The Commissioner initially disallowed more than $18,000 of Schedule C expenses, including cam, piston, engine block, and cylinder head development expenses and the $7,000 engine purchase. The initial deficiency was $2,929. The disputed expenses were initially characterized as capital expenditures recoverable through depreciation when placed in service. The $7,000 engine cost was part of the disputed expenses, rather than an additional amount above the more-than-$18,000 total.
Before the trial, a partial settlement was reached in which the Commissioner allowed the deductions for the various component development costs. However, the $7,000 expenditure for the engine remained in dispute. The Tax Court, and subsequently the Sixth Circuit Court of Appeals, was forced to grapple with the definition of “property of a character subject to an allowance for depreciation” as found in Section 174(c).
Property Category
Economic Lifespan
Tax Treatment (Historical)
Impact on Section 41 Credit

Consumable Supplies
Typically short-term; may be consumed in research
Qualifying research costs could be deducted under historical Sec. 174
Potential QREs if used in qualified research and other requirements are met
Depreciable Assets
Generally durable property subject to wear, exhaustion, or obsolescence
Acquisition costs generally capitalized and recovered under applicable equipment rules
Acquisition costs excluded from supply QREs
Pilot Models
Variable; experimental representation or model
Qualifying experimental development costs could fall under Sec. 174; later use alone is not determinative
Separate Sec. 41 analysis required; no automatic qualification
The Tax Court held that the engine purchase was the acquisition of property of a character subject to depreciation and therefore was not deductible under Section 174(a). The Sixth Circuit affirmed. The appeal also concerned litigation costs: the court upheld their denial because the Commissioner’s position was substantially justified. The reduction of the deficiency to $307 following concessions did not itself establish that the government’s original position was unreasonable.
The “Character vs. Use” Doctrine in R&D Jurisprudence
Ekman applied the statutory exclusion for acquiring depreciable property used in research. In deciding whether that exclusion applied, the Sixth Circuit focused on the character of the purchased asset rather than the taxpayer’s use of it solely for experimentation. That holding does not resolve every question about internally developed prototypes, experimental production costs, or later pilot-model regulations.
Arguments Regarding Final Goods and Intellectual Property
The taxpayers argued that depreciation presupposed an asset used to produce finished goods for sale. Because the engine served as a development platform, they sought an immediate research deduction. The court rejected that proposed limitation: research use did not prevent an otherwise depreciable engine from falling within the acquisition exclusion. The relevant distinction was between acquiring the durable platform and incurring qualifying research costs while developing modifications.
The “Intentional Destruction” and “Blowing It Up” Defense
The taxpayers also argued that the engine was intended to be destroyed during research. Leonard’s testimony described testing that caused internal damage, followed by disassembly, examination, repair, and further use. Destructive testing can be relevant to the factual classification of property, but an intention to damage an asset does not itself establish that its acquisition cost is a deductible research supply.
The engine remained operational five years after purchase. That evidence supported the finding that the research caused wear and tear, even severe wear, rather than eliminating the asset’s depreciable character. Ekman did not announce a rule that every research supply or pilot model must be physically destroyed. Subsequent Treasury Regulation Section 1.174-2 expressly addresses qualifying pilot-model development costs and provides examples in which later sale or business use does not negate their research character.
Implications for Supply Classification under Section 41
Section 41(b)(2)(C) excludes land, land improvements, and property of a character subject to depreciation from the definition of supplies. Accordingly, a purchased research platform classified as depreciable cannot enter the credit computation as a supply merely because researchers use it. This follows from Section 41’s own language; the Ekman appeal itself did not adjudicate a research-credit claim.
Supply Sub-category
Qualifications
Example
Tax Status in Ekman

Experimental Material
Costs must satisfy the applicable research and expense rules
Experimental metal or chemicals
Not specifically adjudicated as these categories
Tools and Equipment
Depreciable character depends on the property and facts
Reusable wrench or computer
Not separately adjudicated; depreciable acquisition costs fall outside research supplies
Test Platform
Purchased durable platform repeatedly repaired and used
Porsche engine
The $7,000 acquisition cost was depreciable, not deductible under Sec. 174
Businesses in aerospace, automotive development, and heavy machinery should distinguish purchased test equipment from costs incurred to create experimental components or pilot models. A high price, durability, or survival after testing does not alone settle every pilot-model question. Treasury Regulation Section 1.174-2 distinguishes experimental development costs from acquisition and production costs. Section 41 eligibility must then be examined separately, including its exclusion of depreciable property from supplies.
Related-Entity Transactions and Substantiation: Kauffman
The related-entity example concerns Kauffman v. Commissioner, T.C. Memo. 2017-38, rather than a second Ekman decision. A realtor and cinematographer operated disregarded single-member LLCs and a C corporation. The disputed payments included $191,000 described as consulting fees and $75,000 described as commissions and fees. The underlying arrangement involved use of a sophisticated camera owned by the corporation.
The court found inadequate evidence that the claimed payments were ordinary, necessary, and reasonable in amount under Section 162. Accounting entries and bank records demonstrated claimed expenditures but did not adequately explain their business justification or calculation. The common ownership made evidence of reasonable pricing especially relevant. Kauffman was a business-expense case, not an R&D-credit decision.
The Nexus of Reasonableness and R&D Credits
The practical lesson for related-party research arrangements is to document actual services, pricing, business purpose, and the connection between payments and research activities. That is an application of general substantiation principles, not an R&D holding in Kauffman. For a Section 41 claim, taxpayers must also consider contract-research requirements and the aggregation rules of Section 41(f); payments within a controlled group cannot automatically be treated as qualifying third-party contract research. Records prepared during the work are useful, but bookkeeping alone does not establish eligibility.
The Modern Statutory Landscape: Sections 174 and 174A
The Tax Cuts and Jobs Act required capitalization and amortization of specified research or experimental expenditures for taxable years beginning after December 31, 2021. Domestic costs generally followed a five-year period and foreign costs a fifteen-year period, each using a midpoint convention. Public Law 119-21, enacted July 4, 2025, subsequently added Section 174A and restored a current deduction for domestic research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2024. Foreign research remains subject to Section 174’s fifteen-year treatment.
Amortization Timelines and International Implications
The applicable treatment depends on the taxable year, research location, and elections. The table distinguishes the historical capitalization regime from the domestic deduction now available. Its percentages describe a single expenditure cohort under full twelve-month taxable years; they are not research-credit rates.
Expenditure Location
Amortization Period
Effective Annual Deduction

Domestic: taxable years beginning in 2022–2024
5 years under the TCJA, subject to transition elections
Midpoint convention: 10% in year 1, 20% in years 2–5, 10% in year 6, before transition relief
Domestic: taxable years beginning after 2024
Current deduction under Sec. 174A; optional amortization of at least 60 months
Generally deductible when paid or incurred under the applicable method unless an election or limitation applies
Foreign: taxable years beginning after 2021
15 years under Sec. 174
Midpoint convention: approximately 3.33% in year 1, 6.67% in years 2–15, 3.33% in year 16
Separating research expenditures from purchased equipment remains important under both regimes. Section 174A(d)(1) preserves an acquisition exclusion for depreciable property while treating qualifying depreciation allowances as research expenditures for deduction purposes. The acquisition cost and the associated depreciation allowance are therefore distinct. Neither becomes a Section 41 supply expense merely because equipment is used in qualified research. Domestic software-development costs fall within Section 174A for taxable years beginning after 2024; foreign software-development costs remain within Section 174. A computer’s acquisition cost follows the applicable equipment-cost recovery rules.
The Section 41 Four-Part Test and Judicial Scrutiny
Section 41 requires research to meet four cumulative requirements, generally applied at the business-component level. Ekman is relevant to expenditure classification; it did not decide whether the taxpayer met the modern four-part test. Even when activities qualify, only eligible expense categories enter the credit calculation, and statutory exclusions still apply.
Research-expenditure requirement: For taxable years beginning after 2024, expenditures must be eligible for treatment under Section 174A. Earlier claim years must be evaluated under the law applicable to those years.
Technological in Nature: The research must rely on the principles of physical or biological sciences, engineering, or computer science.
Permitted Purpose: The research must be aimed at developing a new or improved business component related to function, performance, reliability, or quality.
Process of Experimentation: Substantially all (at least 80%) of the activities must constitute elements of a process of experimentation.
The Technological Uncertainty Requirement
The research-expenditure inquiry asks whether available information establishes the capability or method of developing or improving the product, or its appropriate design. Routine design work is not automatically qualified research simply because engineers perform it. Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, illustrates the need to prove uncertainty and an evaluative process on the actual projects claimed. Iteration and calculations require factual context; neither automatically proves nor automatically defeats qualification. Records should identify the uncertainty, alternatives, evaluation, and connection to claimed costs.
The “Substantially All” and “Shrinking Back” Rules
Treasury Regulation Section 1.41-4 generally requires at least 80% of the relevant research activities, measured on a cost or other consistently applied reasonable basis, to constitute elements of a process of experimentation for a permitted purpose. The regulation also addresses the remaining activities and other requirements. If a business component does not satisfy the requirements, the shrinking-back rule applies them to the most significant subset of its elements and then successively smaller subsets. It is not permission to designate any convenient percentage of a project as qualified.
For illustration, a vehicle project might require separate analysis of an experimental engine component when the overall vehicle fails the qualified-research requirements. This is a hypothetical application of the shrinking-back regulation, not a finding in Ekman. The Commissioner’s concession of component-development deductions did not establish satisfaction of Section 41 or validate a shrinking-back methodology. Shrinking back also does not convert depreciable equipment into qualifying supplies.
Funded Research and the Allocation of Economic Risk
A major battleground in R&D tax litigation is the “funded research” exclusion. Under Section 41(d)(4)(H), research is excluded from the credit if it is “funded” by another person or entity through a grant or contract. To avoid this exclusion, a taxpayer must prove that they bear the “economic risk” in the event of failure and that they retain “substantial rights” to the research results.
The Impact of System Technologies and Smith Orders
System Technologies, Inc. v. Commissioner, Docket No. 12211-21 (order dated January 3, 2025), and Smith v. Commissioner, Docket Nos. 13382-17, 13385-17, and 13387-17 (order dated December 18, 2024), addressed IRS summary-judgment motions concerning funded research. These were procedural rulings on particular contracts, not final determinations that all claimed research credits qualified.
System Technologies considered Indiana commercial law and customer remedies in assessing whether payment depended on successful performance. Smith involved disputes about contracts and their governing foreign law. Together, the orders illustrate why contract labels and payment schedules alone do not resolve funding. The legal consequences of failure must be examined; a fixed price or progress payment does not categorically establish either funded or unfunded research.
Rights to Exploitation
Treasury Regulation Section 1.41-4A(d) requires examination of the researcher’s substantial rights as well as the funding arrangement. Shared rights can suffice, and exclusive ownership is not invariably required. However, incidental experience or institutional knowledge alone is insufficient. Smith’s denial of summary judgment should not be characterized as a categorical holding that transferring documents always preserves substantial rights. Taxpayers must analyze the rights actually retained under the contracts and governing law.
Substantiation Strategies and the Role of Statistical Sampling
Kapur v. Commissioner, T.C. Memo. 2024-28, concerned a request to restrict discovery to two large projects from a research-credit sampling frame of approximately 2,000 to 3,000 projects. The court denied the requested restriction. A taxpayer’s sampling approach does not by itself prevent the IRS from seeking relevant information about the broader population. The decision concerned discovery and should not be described as a final ruling that all sampling is acceptable or unacceptable.
Discovery Strategy
Risks
Court Precedent

Non-random Subset
Selecting large projects does not automatically limit broader discovery
Kapur, T.C. Memo. 2024-28
Statistical Sampling
Representativeness, underlying data, and procedural acceptance must be supported
Kapur addresses discovery; Union Carbide is not blanket sampling approval
Oral Testimony (Cohan Rule)
Credibility and an evidentiary foundation are necessary; eligibility cannot be presumed
Cohan estimation principles do not replace Sec. 41 proof; Union Carbide requires fact-specific analysis
Union Carbide Corp. v. Commissioner, T.C. Memo. 2009-50, affirmed in 697 F.3d 104 (2d Cir. 2012), involved detailed evidence and the limits on research-credit supply costs in production activities. It should not be presented as a general authorization to recreate missing records or extrapolate credits from unsupported testimony. Credible testimony can help explain activities and records. Estimation under Cohan principles requires an adequate evidentiary foundation and does not dispense with proof that qualified research occurred or that the claimed costs meet Section 41.
The Enacted 2025 Changes and the 2025–2026 Transition
Restoration of the domestic deduction is enacted law, not merely a congressional proposal. Section 174A applies to amounts paid or incurred in taxable years beginning after December 31, 2024. Taxpayers may instead elect capitalization and amortization over a period of at least 60 months under Section 174A(c), subject to its conditions. This domestic election should not be confused with the continuing mandatory fifteen-year treatment of foreign research.
Transition Rules and Small Business Relief
Public Law 119-21 and Revenue Procedure 2025-28 provide transition mechanisms for previously capitalized domestic costs. Eligibility, filing procedures, and deadlines must be evaluated for each taxpayer.
Retroactive election: Eligible small businesses could elect domestic expensing for taxable years beginning after 2021 and before 2025. Eligibility generally required the Section 448(c) gross-receipts test for the first taxable year beginning after 2024 and exclusion of specified tax shelters. Revenue Procedure 2025-28 set July 6, 2026 as the general election deadline, subject to an earlier refund-limitation deadline where applicable. That general deadline has passed as of September 13, 2026; the election should not be described as an indefinitely available option.
Accelerated recovery: Taxpayers with remaining unamortized domestic research costs from taxable years beginning in 2022–2024 may elect to deduct the remaining balance in the first taxable year beginning after December 31, 2024, or ratably over that year and the following taxable year, subject to the applicable procedures. For calendar-year taxpayers, these periods are 2025 or 2025–2026. This relief is enacted and is distinct from the small-business retroactive election.
Businesses should reconcile previously capitalized domestic costs, amounts already deducted, remaining balances, and any transition election. Project and accounting records help prevent duplicate deductions and support required tax-return adjustments. Section 280C coordination with the research credit must also be considered. Revenue Procedure 2025-28 provides the relevant election and method-change procedures.
Final Thoughts
Ekman illustrates the importance of correctly classifying purchased research equipment. The engine’s research use did not override its depreciable character. For a modern claim, taxpayers must distinguish that acquisition issue from experimental development costs, eligible credit expenses, and the four-part qualified-research test. Evidence should connect the claimed activities to the costs included in the computation.
The separate Kauffman decision illustrates why related-party payments require support beyond bank statements. Neither decision establishes that all research expenditures must be consumable, nor that all prototypes must be destroyed. Current treatment depends on the applicable statute, regulations, facts, and claim year, including Section 174A for domestic research expenditures beginning in 2025.
Businesses should evaluate their research costs carefully to ensure compliance with the contemporary Section 174 and Section 41 regulations, maximizing their R&D tax credit potential while maintaining rigorous substantiation.