Section 41 and the PATH Act

The federal research credit began in 1981 and was made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015. Permanence did not remove the statutory eligibility tests or the taxpayer’s obligation to substantiate claimed expenses.

Professional services and software development may qualify when the actual activities satisfy Section 41. There is no general requirement to prove that a project would not have occurred without the credit. Eligibility depends on the governing tax-year law, qualifying activities, expenses, and exclusions.

Factual and Legal Analysis of Glassley v. Commissioner

Glassley v. Commissioner, T.C. Memo. 1996-206, decided April 30, 1996, involved Stephen H. and Judith Glassley and other investors in Jojoba Development Partners, Ltd. The dispute concerned partnership losses arising principally from purported research expenditures, negligence additions, and increased interest. It was not a dental-restoration research-credit case.

The Investment and Claimed Research Expenditures

The claimed deductions arose from a jojoba venture. The opinion does not support attributing a CAD/CAM dental research program, patient-specific restorations, or claims by Gregory and Julie Glassley to this litigation.

The Actual Judicial Holding

The court treated the disputed payments as capital contributions rather than deductible research expenditures. It also sustained negligence additions and increased interest. Its holding did not adjudicate the modern Section 41 four-part test for dental procedures.

Glassley therefore cannot support a dental-specific rule equating clinical adjustments with nonqualifying research. Professional-service claims must instead be tested against Section 41 and the applicable regulations.

The Definition of “Technical Uncertainty”

Treasury Regulation § 1.174-2(a)(1) links research uncertainty to the capability, method, or appropriate design of a product’s development or improvement. Uncertainty is assessed using information available to the taxpayer. Routine quality-control inspection is excluded, but testing to determine whether a design is appropriate may qualify. Sophisticated equipment and customization do not by themselves establish the required research activity.

Comparative Jurisprudence: Distinct Issues and Evidence

The cases address different legal questions. Glassley concerns the characterization of investment expenditures; Little Sandy Coal and Phoenix Design Group concern research-credit eligibility. Their holdings should not be combined into an invented dental precedent.

Little Sandy Coal and the Rejection of the Novelty Argument

In Little Sandy Coal Co., Inc. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), the taxpayer claimed research expenses for eleven first-in-class vessels. Two vessels were selected as representative for trial. Newness did not establish the experimental character of the activities.

The Seventh Circuit affirmed disallowance despite disagreeing with part of the Tax Court’s reasoning. The taxpayer had not supplied a defensible allocation demonstrating the required proportion of experimental research activities.

Phoenix Design Group and Design-Phase Evidence

Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, was decided December 23, 2024. The engineering firm designed mechanical, electrical, plumbing, and fire-protection systems. The trial addressed three projects selected as a nonbinding sample from more than 200 projects.

The court found that the sampled projects did not establish qualified research and sustained accuracy-related penalties. A standard sequence of design phases was insufficient to demonstrate the required technical uncertainty and experimentation. The decision does not categorically exclude engineering firms or make the absence of a particular time-log format independently dispositive.

Research-Credit Refund Claims: The 2021 Memorandum and Later Changes

Chief Counsel Memorandum 20214101F established information requirements for research-credit refund claims. The original requirements included business components, research activities, individuals performing those activities, information each individual sought, and expense totals. This administrative filing requirement is distinct from proving substantive entitlement during examination or litigation.

Effective June 18, 2024, the IRS waived the requirement to provide individual names and the information each individual sought at the time of filing. Claims must still identify the business components and their research activities and provide total qualified wage, supply, and contract-research expenses. The IRS may request the waived details during examination. A deficient filing may face rejection, subject to applicable perfection procedures; the original five-item requirement should not be presented as the unchanged current rule.

Section 174 Amortization and the TCJA Paradigm

Under the Tax Cuts and Jobs Act, research and experimental expenditures paid or incurred in tax years beginning after December 31, 2021 were generally subject to five-year domestic or fifteen-year foreign amortization. The 2025 legislation subsequently changed domestic treatment.

Domestic Expensing Under Section 174A

Public Law 119-21, enacted July 4, 2025, added Section 174A, generally permitting immediate deduction of domestic research and experimental expenditures for tax years beginning after December 31, 2024. Foreign research expenditures remain subject to fifteen-year amortization under Section 174. Transition provisions address remaining domestic 2022–2024 balances and eligible small-business retroactive elections. Eligibility, election deadlines, and accounting-method procedures must be checked for the particular return. A deductible research cost is not automatically a qualified Section 41 expense.

State Conformity and the “Patchwork” Problem

State treatment requires a separate analysis of conformity dates, express modifications, and the particular tax involved. A state’s conformity category alone does not establish whether an expense is deductible or must be amortized.

For example, California’s Franchise Tax Board identifies nonconformity to Section 174A and separate treatment of research expenditures. Nonconformity to the 2025 federal provision does not itself establish that California requires the former federal five-year amortization. Credit eligibility and expense deduction rules must be examined separately for each jurisdiction and year.

The “Substantially All” Fraction: A Deeper Dive into Little Sandy Coal

The substantially-all test is applied to research activities for each business component. Its 80% threshold is measured by cost or another consistently applied reasonable basis. It is not a percentage of physical product parts or an automatic requirement that 80% of all company work be research.

Redefining the Numerator and Denominator

The Seventh Circuit rejected categorical exclusion of pilot-model production activities from the numerator. Such activities can enter both numerator and denominator when they satisfy the relevant research and experimentation requirements. The court nevertheless affirmed the judgment against the taxpayer.

Direct supervision and direct support also require expense-level analysis under Treasury Regulation § 1.41-2. Direct supervision means immediate supervision of qualified research, not general management or supervision of a supervisor. An executive’s title does not establish whether particular services qualify.

The Limits of Estimating Research Expenses

Little Sandy Coal distinguishes proof that qualified research occurred from estimation of the resulting expenses. The Cohan principle does not cure a failure to establish research eligibility.

Contemporaneous activity records are useful, but no universal requirement mandates a particular time-tracking system. The regulatory standard is sufficiently usable and detailed substantiation. Reliable project documents, technical evidence, and supported allocations should establish both what work occurred and how claimed amounts were determined.

The Funded Research Doctrine and Contractual Risk

Section 41(d)(4)(H) excludes funded research. Treasury Regulation § 1.41-4A(d), incorporated by the research-credit regulations, addresses payment contingencies and substantial rights. Contract language, the parties’ rights and obligations, and the applicable law matter more than a label such as fixed-price or research agreement.

The Two-Pronged Test for Funding

For a service provider’s claim, evaluate both the research rights retained and who bears the financial risk:

Retention of Substantial Rights: Determine whether the provider retains substantial rights in research results. Exclusive ownership is not always necessary, but incidental experience from performing services is not automatically sufficient.

Contingent Payment and Economic Risk: Determine whether payment is contingent on successful research. Payments owed regardless of success generally constitute funding to that extent.

A contractual dispute surviving summary judgment does not establish final credit entitlement. Warranty clauses and breach remedies must be read in context; their mere presence does not guarantee that research is unfunded. Contract review should address actual economic risk and rights without assuming that particular wording ensures qualification.

Software Development and Agile Documentation

Agile development is not categorically incompatible with Section 41. The relevant question is whether identified development activities satisfy the statutory requirements. There is no general minimum project or sprint duration in the research-credit rules.

Documenting Sprints

For each claimed software initiative, preserve the technical problem, alternatives evaluated, tests performed, and resulting design decisions. Tickets, source-control history, test results, and architecture notes can help distinguish experimental development from routine maintenance. A sprint label or a record that testing occurred does not itself prove qualified research.

Internal Use Software (IUS) Barriers

Software developed primarily for internal general and administrative functions may be subject to the additional high-threshold-of-innovation test. The test addresses innovation, significant economic risk, and lack of commercial availability for the intended purpose without qualifying modifications. Regulatory exceptions and special rules, including rules for dual-function software, must also be considered. Internal-use classification is not determined solely by whether employees use the software.

Implications for Future R&D Tax Credit Applications

The practical lesson is to connect eligibility and expenses with evidence, while respecting the different holdings and tax years involved. Industry membership, business complexity, and expenditure size are starting points for investigation rather than substitutes for the statutory analysis.

The Shift Toward Real-Time Technical Logging

A year-end study can assist substantiation, but unsupported interview percentages are vulnerable. Gather supporting technical and financial evidence during the project where practical. Useful records include:

Initial Uncertainties: Record the capability, method, or design questions that the project sought to resolve.

Iterative Logs: Identify alternatives considered, evaluations performed, results obtained, and reasons for design changes.

Technical Narratives: Connect actual tasks to the applicable eligibility tests and reconcile the relevant expenses to supporting records.

Why Industry Labels Are Insufficient

The same activity-based inquiry applies across dentistry, architecture, software, and manufacturing. Production supplies should not be swept into a claim merely because a production run also involved research. Identify supplies actually used in qualified research and distinguish them from ordinary production costs. There is no universal statutory rule that every qualifying supply must be an incremental expense or satisfy a separately named primary-purpose test.

Strategic Use of Alternative Dispute Resolution

IRS dispute-resolution programs include Fast Track Settlement and, for eligible matters, pre-filing agreements. Availability depends on the taxpayer, issue, and procedural stage. These programs may assist resolution but do not remove substantiation obligations or guarantee agreement. Unsupported assertions about IRS staffing or a universal litigation trend should not guide the choice.

Recommendations for Compliance and Risk Mitigation

Review the research-credit methodology against the law for the claim year and the filing requirements that apply to the submission. The following actions support a documented, activity-based analysis: