Research and development (R&D) tax credit cases illustrate the importance of proving the statutory requirements with evidence of the work actually performed. Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, decided December 23, 2024, is particularly relevant to architectural and engineering (A&E) firms. Technical complexity alone does not establish eligibility under Internal Revenue Code (IRC) Section 41. Green v. Commissioner, 83 T.C. 667 (1984), addresses a different but related issue: the trade or business requirement for research expenditure deductions. This study examines these decisions, the uncertainty and experimentation requirements, documentation, contractual funding, and practical implications for research credit claims.

The Foundations of the R&D Tax Credit: Legislative Intent and Historical Precedents

Congress introduced the federal research credit in 1981 to encourage increased research spending. Eligibility does not require a technological breakthrough or an advance beyond industry knowledge. The statutory credit requirements and the rules governing research expenditure deductions must be considered separately, even though the credit incorporates an expenditure test.

The Role of Green v. Commissioner in Section 174 Jurisprudence

A seminal case in this history is Green v. Commissioner (83 T.C. 667), decided in 1984. This case addressed the “trade or business” requirement for deductions under Section 174. The Supreme Court had previously ruled in Snow v. Commissioner that a taxpayer could claim Section 174 deductions even if they had not yet produced or sold a product, effectively allowing “upcoming” businesses to benefit from R&D incentives.

In Green, the Tax Court examined a partnership that acquired interests in technology, commissioned research, and granted exclusive commercialization rights to another company. It concluded that the partnership’s activities amounted to investment rather than a research-related trade or business. The case limited an overly broad reading of Snow: a taxpayer need not already be producing or selling a product, but a qualifying business connection is still required. Green concerns Section 174 deductions; it did not establish the modern Section 41 four-part test or decide the engineering issues later addressed in Phoenix Design Group.

Transitioning to the Modern Standard

For the years at issue in Phoenix Design Group, qualified research had to satisfy the following four requirements under Section 41(d), as well as applicable exclusions. The historical Section 174 reference below describes the law applicable to that litigation. For tax years beginning after December 31, 2024, Section 41(d)(1)(A) instead refers to domestic research or experimental expenditures under Section 174A, following Public Law 119-21. This later change does not alter the historical holding.

In Phoenix Design Group, the parties stipulated that the technological-in-nature and business-component requirements were met. The court therefore focused on the Section 174 expenditure test and the process-of-experimentation requirement.

Case Analysis: Phoenix Design Group, Inc. v. Commissioner (2024)

Phoenix Design Group, a Tennessee-based multidisciplinary engineering consulting firm, designed mechanical, electrical, plumbing, and fire protection (MEPF) systems, including systems for hospitals and laboratories. Its credit study identified 238 potentially qualifying projects from 409 projects for 2013–2016. Credits generated in those years affected the 2015–2019 deficiency years. The parties agreed to try three projects to provide a framework for resolving the others; the sample findings were not automatically binding on the remaining projects.

The Sampled Projects

The court examined three agreed sample projects:

• Gerald Champion Military Psychiatric Unit: A project involving the renovation and construction of a medical center. PDG claimed uncertainty regarding the integration of modern MEPF systems with existing older infrastructure.
• Baptist Memorial Hospital–North Mississippi: A large-scale hospital construction project. PDG cited uncertainty regarding the overall system design for a massive new footprint.
• Vanderbilt University Engineering and Science Building (VUESB): A high-complexity university facility. PDG argued that uncertainties existed regarding the steam distribution and HVAC requirements for specialized laboratory equipment.

The court found that PDG had not established qualified research in any of these three projects. That holding must be distinguished from an adjudication of every project in the broader credit study.

Failure of the Section 174 Test: Routine vs. Experimental Uncertainty

PDG did not adequately establish the specific technical uncertainties and investigative work needed to satisfy the historical Section 174 test. Uncertainty concerns capability, method, or appropriate design in light of information available to the taxpayer at the beginning of the research activities. A generally complex or initially incomplete design is not, by itself, enough.

The court distinguished investigative work from ordinary calculations using information already available to the engineers. It also declined to infer uncertainty throughout an entire MEPF system merely from an unresolved issue in one part. The practical lesson is to identify the particular uncertainty and explain the activities undertaken to resolve it; calculations can contribute to qualifying research when the surrounding facts establish the required investigative and evaluative process.

The Myth of the Automatic Process of Experimentation

PDG relied on its design workflow to support its experimentation argument. Its six stages were basis of design, schematic design, design development, construction documents, bidding, and construction administration. Connecting those stages to professional design practices did not itself prove a qualifying process of experimentation.

The court found the evidence insufficient to show the necessary evaluation of alternatives. In the Vanderbilt project, revisions responding to information from the owner or architect did not, without more, establish experimentation. The decision does not make every sequential design workflow ineligible: the taxpayer must explain the uncertainty, the alternatives considered, and the actual evaluative work within the workflow.

The “Substantially All” Rule and the Shrink-Back Analysis

Treasury Regulation Section 1.41-4(a)(6) requires at least 80% of the taxpayer’s research activities for a business component, measured by cost or another consistently applied reasonable basis, to constitute elements of a process of experimentation for a qualified purpose. This is not an 80% test of how much of the finished product is new. If the component fails the qualification requirements, the shrinking-back rule applies to progressively smaller significant subsets. The starting business component must be identified from the taxpayer’s product or process; it is not necessarily an entire hospital.

Application in Phoenix Design Group

Shrinking back did not establish a qualifying subset of PDG’s work on the record before the court. Breaking a project into mechanical, electrical, plumbing, or other elements does not eliminate the need to prove uncertainty and a qualifying evaluative process for the subset being claimed.

Records that distinguish activities and costs by component or significant subset can support a shrinking-back analysis. The rule is not an automatic allowance for an estimated qualifying percentage, and separate time-entry codes are not its sole permissible form of evidence. The taxpayer still needs sufficient evidence to establish the qualifying activities and associated expenses.

Documentation Standards and the Lessons of Phoenix Design Group

The ruling illustrates the practical value of reliable records connecting claimed expenses to qualifying work. Treasury Regulation Section 1.41-4(d) requires records sufficient to substantiate eligibility and amount; the decision did not create a universally mandatory new timekeeping system or a requirement for a particular contemporaneous narrative template.

The Inadequacy of Generic Timesheets

PDG’s time records and design materials did not adequately explain which employee activities met the research requirements. Broad task descriptions and time attributed to design stages could not substitute for evidence of the underlying work. Project records, testimony, technical analyses, and reasonably supported allocations should be assessed together rather than treating any single record format as conclusive.

The table contrasts the evidentiary weaknesses with useful substantiation practices. Its “Modern Requirement” column describes practical ways to support the existing legal standard, not newly enacted mandatory formats.

The Accuracy-Related Penalty: Financial and Reputational Risks

The accuracy-related penalty outcome followed the parties’ stipulation: if none of the three sample projects involved qualified research, PDG would be liable for the Section 6662(a) penalties; if any did, the IRS would concede them. Because no sample project qualified, the stipulated penalty condition was met. The opinion should not be described as a separate finding that PDG failed to establish reasonable cause or good faith.

The following table shows the disputed deficiencies and Section 6662(a) penalties for the 2015–2019 years. These are years in which credits were used, rather than the 2013–2016 years in which the underlying credits were generated. The amounts shown are the stated disputed amounts; the penalty column should not be recomputed as exactly 20% of every listed deficiency.

Disallowance can require repayment of the tax benefit, with interest and any applicable penalties adding to the cost. A 20% accuracy-related penalty does not ordinarily exceed the associated underpayment by itself. Penalties and any reasonable-cause defense require attention to the governing provisions and the procedural facts of the particular case.

Comparative Analysis: Populous Holdings and Meyer, Borgman & Johnson

The PDG decision must be viewed in the context of other recent A&E sector cases that have shaped the definition of “unfunded research.”

Populous Holdings, Inc. v. Commissioner (Taxpayer Win)

In Populous Holdings, Inc. v. Commissioner, Docket No. 405-17, the relevant Tax Court summary judgment order was issued December 6, 2019, not in 2022. The court held that the contracts it examined did not constitute funded research: the fixed-fee arrangements placed relevant performance risk on the firm, which also retained substantial rights. The ruling addressed the funded-research exclusion; it did not establish that every fixed-price design engagement satisfies all research credit requirements.

Meyer, Borgman & Johnson (MBJ) v. Commissioner (Taxpayer Loss)

In Meyer, Borgman & Johnson, Inc. v. Commissioner, the Eighth Circuit affirmed the Tax Court on May 6, 2024. It concluded that the contracts did not make payment contingent on successful research. General obligations to produce designs, comply with codes, and exercise professional skill did not establish the required contingency. Fixed-price terms alone are insufficient, and contract-specific outcomes do not necessarily establish a split between courts.

Synthesis of Judicial Trends

These decisions address distinct conditions. Populous and Meyer, Borgman & Johnson concern funded research, while Phoenix Design Group principally concerns uncertainty and experimentation. A firm must meet all applicable conditions. Neither an actual failed experiment nor a demonstrated monetary loss is a universal prerequisite; successful research may qualify, and economic risk must be evaluated under the funding rules rather than inferred from a project loss.

Technical Implications for Engineering and Construction

A&E firms should distinguish qualifying research from ordinary design, coordination, and construction work. Phoenix Design Group applied existing eligibility standards to the evidence presented; it did not announce an industry-wide disqualification or a new exclusion effective in 2024.

Disqualified Activities in MEPF and Construction

The following distinctions help avoid overinclusive claims. Little Sandy Coal Co. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), also emphasizes substantiation of the substantially-all experimentation requirement, but it should not be treated as a categorical prohibition on every supporting activity:

• Standard Calculations: Applying established formulas to known inputs does not by itself establish qualified research. Calculations used within a substantiated process of evaluating alternatives may nevertheless be relevant.
• Code Compliance: Meeting building codes or professional standards alone does not prove experimentation. Research undertaken to achieve a technical improvement while satisfying regulatory constraints is not automatically excluded.
• Aesthetic or Functional Design: Work directed only at style, taste, or cosmetic factors lacks a qualified purpose. Improvements in function, performance, reliability, or quality can satisfy the purpose requirement if the other tests are also met.
• Direct Supervision: General project management is not enough. However, Section 41(b)(2)(B) expressly includes direct supervision and direct support of qualifying research within qualified services; personal performance of experiments is not required for every eligible wage expense.

The “Discover” vs. “Investigative” Test

The litigation raised questions about what distinguishes investigative work from routine engineering. The controlling analysis is the applicable statutory and regulatory uncertainty standard, not a requirement to invent a new scientific concept. Treasury Regulation Section 1.41-4(a)(3)(ii) expressly provides that discovering technological information need not expand the common knowledge of skilled professionals in the field.

Taxpayers should explain why information already available did not establish capability, method, or appropriate design and how their work evaluated alternatives. They need not prove an industry-first advance or an unsuccessful outcome. The distinction is between supported research activity and an unsupported characterization of ordinary work as research.

The Impact on Future R&D Tax Credit Applications

Green and Phoenix Design Group offer complementary lessons about business connection and proof of research activity. They concern different statutory issues and periods and should not be presented as creating a single new legal test.

Strategic Retooling of R&D Studies

A defensible research credit study should connect technical evidence, employee activities, eligible expenses, and contractual rights. Useful practices include:

• Evaluation of Alternatives: Record the uncertainty, the alternatives considered, and the modeling, simulation, systematic trial and error, or other evaluative work used to resolve it. Preserve unsuccessful approaches when they occur, without implying that failure or a formally labeled hypothesis is always mandatory.
• Labor Allocation: Explain how employee time relates to qualifying research, direct supervision, or direct support. Distinguish nonqualifying work using a reasonable evidentiary basis. Engineering discipline and job title alone do not decide eligibility, and CAD work is not categorically excluded.
• Proactive Contract Review: Examine the actual payment contingencies and retained substantial rights under all relevant agreements. Exclusive ownership of intellectual property is not invariably required. Contract language should accurately reflect the arrangement and should not be treated as a substitute for the other qualification tests.

Refund-Claim Validity Review and Form 6765

The IRS reviews research credit refund claims for sufficient supporting information before substantive consideration. Its published procedures should not be characterized as a new court-created “Classifier” test, and Meyer, Borgman & Johnson was a funded-research case