The Legal Architecture of Ginsburg v. United States (Case No. 17-75T)

Samuel E. and Joan A. Ginsburg participated through Hawthorne Village, LLC, in New York’s Brownfield Cleanup Program. Hawthorne acquired contaminated property in Brooklyn in 2005 and completed its conversion from a former shoe factory into a residential rental building in 2011. The program provided credits related to qualifying site preparation and tangible property costs.

Under New York Tax Law Sections 21 and 606(dd)(2), qualifying credit amounts exceeding state tax liability could be credited or refunded. In 2013, the Ginsburgs received $1,903,951 attributable to the brownfield credit. They did not include the payment in federal income. The IRS included $1,864,618 of that amount in taxable income, and the taxpayers later sought a federal tax refund of $602,530 plus interest.

The Accession to Wealth Doctrine

The courts applied the broad definition of gross income in IRC Section 61. Under Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), realized economic gains over which a taxpayer has control generally fall within gross income unless an exclusion applies. Ginsburg applied this existing doctrine; it did not establish a new economic-substance or R&D test.

The disputed excess credit was a gain the taxpayers could use without spending restrictions. It did not repay state taxes they had previously paid. The fact that the payment rewarded investment in remediation did not itself remove it from federal gross income.

Theoretical Exclusions and Judicial Rejection

The taxpayers advanced several exclusion theories. The following table summarizes the reasoning relevant to those arguments. Applying that reasoning to another incentive requires examining the particular program and any applicable federal exclusion.

The state’s treatment of an excess credit as an overpayment did not determine the federal result. By analogy, a refundable state R&D incentive that supplies new funds may be taxable. Ginsburg did not hold that every refund or every state R&D credit receives identical treatment.

Implications for Future R&D Tax Credit Applications

For businesses receiving refundable state innovation incentives, Ginsburg supports examining whether a payment returns previously paid tax or provides an additional economic benefit. Refundability, eligibility limits, and federal treatment differ by program and tax year. The decision does not establish that practitioners universally used an incorrect historical treatment or that every state credit requires a change in tax reporting.

Taxability of State R&D Credit Refunds

A cash payment exceeding state tax liability may constitute federal gross income if no exclusion applies. As a simplified illustration, a corporation receiving a fully taxable $1,000,000 excess state R&D credit payment would retain $790,000 after a 21% federal income tax, assuming no offsetting deductions, losses, other taxes, or credit interactions. This illustration is not a universal valuation of refundable credits.

The timing of income recognition depends on the taxpayer’s accounting method and the governing program. Cash-method taxpayers generally recognize taxable receipts when actually or constructively received. Accrual-method taxpayers generally apply the all-events test, including whether the right to income is fixed and the amount reasonably determinable, subject to applicable Section 451 rules. State certification or an application alone does not establish the recognition year in every case.

Substance Over Form and State Certifications

Ginsburg illustrates that state characterization does not control federal income taxation. Separately, approval under a state incentive program does not automatically establish qualified research expenses under federal Section 41. The brownfield litigation did not adjudicate whether the cleanup met the federal research-credit tests.

Federal research-credit eligibility must be evaluated under Section 41 and its regulations. State programs may adopt federal definitions or impose their own requirements. Applicants should establish compliance with each applicable regime.

The Standard for Qualified Research: The Four-Part Test

Section 41(d) and Treasury Regulation Section 1.41-4 govern qualified research independently of Ginsburg. The four-part test addresses research expenditure eligibility, technological information, a qualifying business purpose, and experimentation. For current domestic research, Section 41(d)(1)(A) refers to Section 174A; historical claims must be evaluated under the law applicable to their years.

Permitted Purpose

The research must be undertaken for a “permitted purpose,” which means it must relate to a new or improved business component. This component could be a product, process, software, technique, formula, or invention that the taxpayer intends to hold for sale, lease, or license, or use in its own trade or business. The objective must be to improve the performance, function, reliability, or quality of that component.

Technological in Nature

The process used to discover information must fundamentally rely on physical or biological science, engineering, or computer science. Social-science, economic, and humanities research is excluded. Ginsburg made no finding that the brownfield activities failed this technological requirement.

Elimination of Uncertainty

Technical uncertainty exists when information available to the taxpayer does not establish the capability or method for developing or improving a business component, or its appropriate design. Knowing a development method does not necessarily eliminate uncertainty about design. Business or market uncertainty alone does not satisfy this requirement.

Process of Experimentation

Under Treasury Regulation Section 1.41-4, at least 80% of the relevant research activities, measured by cost or another consistently applied reasonable basis, must constitute elements of a process of experimentation for a qualified purpose. The analysis applies at the business-component level, with the shrinking-back rule available where appropriate. Activities may include:

• Developing and testing hypotheses.
• Evaluating alternative designs or methods.
• Refining the solution through iterative trial and error.

Internal Use Software and the High Threshold of Innovation

Treasury regulations finalized in 2016 distinguish software developed primarily for internal general and administrative functions from software outside that category. Internal business use alone does not make all software internal-use software (IUS).

Defining Internal Use Software (IUS)

IUS is defined as software developed for use in general and administrative (G&A) functions that facilitate the conduct of the taxpayer’s business. These functions are limited to:

• Financial Management: Payroll, bookkeeping, and general ledger functions.
• Human Resources Management: Personnel records, benefits administration, and recruiting.
• Support Services: Facility management, data processing, and internal communications.

Software developed to be commercially sold, leased, licensed, or otherwise marketed to third parties generally is not IUS. Software enabling third parties to initiate functions or review data on the taxpayer’s system can also fall outside IUS, subject to the dual-function rules. An online ordering portal or banking application must be analyzed by its functions and development intent.

The High Threshold of Innovation (HTI) Test

IUS generally must satisfy the high threshold of innovation test as well as the ordinary research-credit requirements. Regulatory exceptions include certain software used in qualified research, in a qualifying production process, or as part of an integrated hardware-software product. Where the additional test applies, all three requirements must be met:

• Significant Economic Risk: Substantial development resources must be committed, with substantial uncertainty, because of technical risk, that they will be recovered within a reasonable period. The regulation focuses on uncertainty about capability or methodology, rather than design uncertainty alone.
• Innovative: Successful development must produce a substantial and economically significant cost reduction, speed improvement, or other measurable improvement.
• Not Commercially Available: The taxpayer cannot purchase or license a product that would satisfy the intended purpose without modifications that themselves meet the first two HTI prongs.

Dual-Function Software and Safe Harbors

Dual-function software serves both internal general and administrative functions and third-party interaction. It is presumed to be IUS, but an identifiable third-party-only subset can be evaluated separately. For remaining dual-function software or a subset, the 25% safe harbor requires reasonably anticipated third-party interaction of at least 10% of use, measured objectively. Only otherwise qualified research expenses receive the 25% treatment; the safe harbor does not waive the ordinary research-credit requirements.

Executive Wages and the Direct Supervision Requirement

Executive wages may qualify under Treasury Regulation Section 1.41-2 to the extent attributable to performing, directly supervising, or directly supporting qualified research. A CEO or COO title alone establishes neither eligibility nor ineligibility.

Direct Supervision vs. General Management

Direct supervision means immediate, first-line supervision of qualified research. An executive’s technical reviews may qualify if they actually constitute such supervision. Supervising a manager who supervises research personnel is not itself direct supervision, even if the executive is technically trained.

General administrative oversight, departmental budgeting, and ordinary personnel management do not qualify merely because they concern a research department. Eustace v. Commissioner, T.C. Memo. 2001-66, affirmed, 312 F.3d 905 (7th Cir. 2002), illustrates the need to substantiate claimed research expenses; it should not be read as a categorical ban on executive wages.

Allocation and Substantiation

Taxpayers must substantiate wage allocations with reliable evidence connecting services to qualified research. Contemporaneous records are valuable, but the regulations do not impose a universal requirement to use a particular time-tracking system. Unsupported percentage estimates are vulnerable to challenge. Useful practices include:

• Contemporaneous Time Tracking: Using project management software to log specific technical review hours.
• Meeting Minutes: Documenting the technical nature of meetings where executives provided direct supervision.
• Interviews and Narratives: Conducting internal quarterly reviews to document the technical uncertainty resolved by executive input.

Funded Research and the Economic Risk Standard

The funded-research exclusion is a separate Section 41 issue, not a holding of Ginsburg. Under Section 41(d)(4)(H) and Treasury Regulation Section 1.41-4A(d), research is excluded to the extent another person funds it. All relevant agreements must be considered; federal taxation of a state credit does not by itself resolve the funding analysis.

The Two-Prong Test for Funded Research

For research performed under an agreement with another person, two central questions are:

• Economic Risk: Are amounts payable contingent on successful research, or is the taxpayer entitled to payment regardless of that success? Ordinary commercial risk or a fixed-price label alone does not resolve the question.
• Substantial Rights: Does the taxpayer retain substantial rights to use the research results? Exclusive rights are not required, but retaining only incidental benefits such as general experience is insufficient.

In Meyer, Borgman & Johnson, Inc. v. Commissioner, 100 F.4th 986 (8th Cir. 2024), the Eighth Circuit upheld denial of research credits because the contracts did not make payment contingent on successful research. General economic risk and obligations to perform professional engineering services were insufficient. The exclusion applies to the funded portion under the governing agreements and regulations.

Documentation Standards and the Modern Audit Environment

Research-credit substantiation follows Section 6001 and Treasury Regulation Section 1.41-4(d), independently of Ginsburg. Records must be sufficiently usable and detailed to establish eligibility and expense amounts. The law does not universally require a separately prepared contemporaneous study for every project.

Contemporaneous vs. Retrospective Studies

Records created during development are often stronger evidence than unsupported recollections. A retrospective study is not automatically disallowed: it may organize credible technical records, financial information, and testimony. Its value depends on whether that evidence establishes the activities performed and connects claimed costs to qualified research.

The Role of R&D Technical Advisers

IRS examiners may consult research-credit specialists and use audit technique guides. The Research Credit Claims Audit Techniques Guide dates to 2008 and contains coordination guidance; it is not evidence of a newly introduced universal pre-disallowance protocol. Such guides describe examination approaches and are not binding substantive law. Applicants should be prepared to explain both the technical work and the expense calculations.

Future Outlook: Legislative Changes and Strategy

The TCJA required five-year amortization of domestic specified research expenditures and fifteen-year amortization of foreign expenditures for tax years beginning after December 31, 2021. Public Law 119-21 changed the domestic rule in 2025: Section 174A generally permits immediate deduction of domestic research or experimental expenditures for tax years beginning after December 31, 2024. Foreign research remains subject to fifteen-year amortization under Section 174.

Coordination of Sections 174, 174A, and 41

A taxable state incentive and the deductions for related research costs may affect different tax years. The 2025 restoration of domestic expensing changes the cash-flow analysis from the earlier TCJA-only framework. Section 174A deduction eligibility does not automatically establish Section 41 credit eligibility, and Section 280C coordinates the federal research credit with related deductions.

Revenue Procedure 2025-28 provides procedures for the 2025 statutory changes, including elections and accounting-method changes. Transition rules address remaining domestic costs capitalized for 2022–2024, and eligible small businesses have a separate retroactive-election option subject to the applicable deadlines. Revenue Procedure 2025-8 addressed the earlier framework and should not be treated as the sole authority for current domestic research deductions.