The federal research credit under Section 41 of the Internal Revenue Code requires taxpayers to substantiate qualifying activities and satisfy the funded-research rules. United States v. Grigsby, No. 22-30764 (5th Cir. November 13, 2023), illustrates these requirements for construction and engineering businesses. The litigation involved Leonard and Barbara Grigsby and credits claimed through Cajun Industries LLC. The Fifth Circuit affirmed summary judgment for the government because the taxpayers failed to establish viable business components and the representative projects were funded. The decision applies statutory and regulatory requirements to the particular evidence and contracts; it does not categorically exclude construction research.
The Evolutionary Context of the Research and Development Tax Credit
The R&D tax credit was introduced in the Economic Recovery Tax Act of 1981 to encourage business research. Congress repeatedly extended the credit before making it permanent in the Protecting Americans from Tax Hikes Act of 2015. Permanence did not eliminate the need to establish qualified research expenses and satisfy the statutory exclusions.
For the 2013 tax year at issue, the four-part test required research expenses of a type eligible for treatment under then-applicable Section 174, technological information, an intended application to a new or improved business component, and substantially all research activities constituting elements of a process of experimentation for a permitted purpose. Current Section 41(d)(1)(A), as amended in 2025, instead refers to domestic research or experimental expenditures under Section 174A. The amendment generally applies to amounts paid or incurred in taxable years beginning after December 31, 2024, subject to specified transitional elections. Eligibility does not require an advance in the state of knowledge of an entire industry.
Grigsby illustrates the need to identify a specific new or improved product or process and establish the contractual treatment of alleged research. Its appellate holdings centered on business components, discovery disclosures, and funding. The opinion should not be read as separately deciding that every project failed each technical element of the four-part test.
Factual Narrative and Procedural History of Grigsby v. United States
The dispute originated with Cajun Industries LLC, an S-corporation specialized in civil, mechanical, and marine construction for the oil, gas, and energy sectors. As an S-corporation, Cajun’s tax attributes, including income, deductions, and credits, pass through to its shareholders. Leonard Grigsby, who held a 73% ownership interest, sought to utilize his pro rata share of the company’s R&D tax credits to offset his personal tax liability.
After engaging a consulting firm in 2015, Cajun filed an amended Form 1120S for 2013 claiming a $1,341,420 research credit based on the firm’s study. Leonard Grigsby’s 73% allocation was $979,237. The Grigsbys sought a $576,756 tax refund plus statutory interest. On September 15, 2017, the IRS paid $671,071.38, including $73,663. in interest and an additional $20,652 unrelated to the dispute. The contested portion therefore totaled $650,419.38. Although one sentence in the appellate opinion gives interest as $73,633.38, its footnotes and the stated refund components support $73,663.38. In August 2019, the IRS demanded repayment of the contested refund, and the United States subsequently brought an erroneous-refund action.
The litigation proceeded in the United States District Court for the Middle District of Louisiana. To streamline the proceedings, the parties selected four representative projects to determine the eligibility of the entire $1. million credit. These projects reflected the core business activities of Cajun Industries and served as the basis for the court’s evaluation of the four-part test and the funded research exception.
Detailed Analysis of the Representative Projects
The four projects chosen for review represented a cross-section of heavy industrial construction and infrastructure development. The following table provides a breakdown of the specific contractual and technical aspects of these projects as identified in the court record.
| Project ID | Project Name | Industry Sector | Project Scope and Technical Focus |
|---|---|---|---|
| Project 13-020 | Methanex Project | Methanol Production | Construction supporting relocation of a Methanex methanol plant from Chile to Louisiana, initially including temporary facilities. |
| Project 12-051 | Chevron Project | Oil & Gas Refinery | Construction services for expansion of Chevron’s Pascagoula Refinery, including surveying, excavation, backfill, piping, and inspections. |
| Project 12-001 | Claiborne Project | Flood Control | Development of water management and flood control structures involving marine engineering. |
| Project 12-023 | East Bank Project | Flood Control | East Bank flood-control system modifications for the Sewerage and Water Board of New Orleans. |
The District Court granted summary judgment because the taxpayers did not establish the alleged product business components, their newly asserted process theory was inconsistent with discovery disclosures and insufficiently specific, and the projects were funded. The Fifth Circuit affirmed on November 13, 2023. For Methanex, Chevron, and Claiborne, the funding analysis rested on the absence of retained substantial rights; for East Bank, it rested on the payment provisions. These were distinct grounds rather than a finding that all four contracts failed both funding tests.
The Four-Part Test and the Need for Specific Evidence
Project complexity alone does not establish eligibility under Section 41. Grigsby’s principal technical holding concerned the failure to substantiate identifiable new or improved business components. The remaining technical requirements below explain the statutory framework, rather than additional project-specific findings made by the Fifth Circuit.
The Section 174 Test and the Threshold of Uncertainty
For the 2013 claim, the Section 174 inquiry concerned research or experimental expenditures intended to eliminate uncertainty about developing or improving a product. Uncertainty may concern capability, method, or appropriate design, assessed against information available to the taxpayer. An industry-wide scientific breakthrough is unnecessary. Current claims must account for the Section 174A cross-reference described above.
Engineering challenges can involve qualifying uncertainty, but their existence must be supported by facts tied to the claimed component. The Fifth Circuit did not separately decide that Cajun resolved every challenge through routine engineering. Its decision emphasized the lack of specific evidence establishing the asserted products or processes.
Technological in Nature: Principles over Professionals
Under Treasury Regulation Section 1.41-4(a), the process of experimentation must fundamentally rely on physical or biological sciences, engineering, or computer science. Employing engineers is not itself sufficient, but applying established scientific principles does not itself disqualify research. The regulation does not require information to be new to the industry. This is a general eligibility rule, not a separate technological-in-nature finding against Cajun.
Business Component Identification and the Product vs. Process Variance
Research must be intended to yield information useful in developing a new or improved business component. A component may be a product, process, computer software, technique, formula, or invention held for sale, lease, or license, or used in the taxpayer’s trade or business. The permitted purposes concern function, performance, reliability, or quality; style, taste, cosmetic, and seasonal design factors do not qualify.
During discovery, the taxpayers identified products as the business components. At summary judgment, they asserted construction processes as an additional basis for qualification. The courts applied the separate-component requirement and Federal Rule of Civil Procedure 37(c)(1). The late process evidence could be excluded because it was inconsistent with earlier disclosures and prejudicial to the government. Independently, the taxpayers failed to identify a specific new or improved process with sufficient evidence. The holding does not prohibit a properly disclosed and substantiated process claim.
The Process of Experimentation and the Substantially All Rule
Treasury Regulation Section 1.41-4(a)(6) interprets substantially all as at least 80% of a taxpayer’s research activities for the relevant business component, measured by cost or another consistently applied reasonable basis. Those activities must constitute elements of a process of experimentation for a permitted purpose. The process evaluates alternatives to resolve uncertainty about capability, method, or design. The applicable rules for remaining activities and statutory exclusions must also be satisfied.
The regulations recognize modeling, simulation, and systematic trial and error as possible evaluative methods. Merely performing construction work or citing engineering calculations does not establish the required process, but calculations can be part of qualifying experimentation when the evidence demonstrates their role in evaluating alternatives. Grigsby did not separately hold that calculations communicated to an architect were nonqualifying or determine an experimentation percentage for Cajun.
Deconstructing the Funded Research Exception
Even if Cajun had met the four-part test, the credits were disallowed because the research was deemed “funded” under Section 41(d)(4)(H). This exception states that the term “qualified research” does not include any research to the extent it is funded by any grant, contract, or otherwise by another person or governmental entity. To avoid the funded exception, a taxpayer must prove both that they bore the “economic risk” of the research and that they retained “substantial rights” to the research results.
The Economic Risk Test: Payment Contingent on Success
To satisfy the economic risk test, payment to the researcher must be contingent on the success of the research. If a researcher is entitled to payment regardless of the outcome, the research is considered funded.
The Fifth Circuit’s payment-contingency analysis focused on East Bank. It rejected the argument that delivery of a product, inherent construction risk, or a fixed-price label automatically establishes unfunded research. The contract compensated Cajun for labor and the specified project risks, and the taxpayers did not establish payment contingent on successful research. Methanex’s capped-price agreement included cost-reimbursable items and scope-change provisions, but its substantial-rights terms independently supported the funded-research holding.
The Substantial Rights Test: Retention of Intellectual Capital
The second prong of the funded analysis is whether the taxpayer retains “substantial rights” in the research. If an agreement provides that the researcher retains no substantial rights in the results of the research, the research is deemed funded by the customer.
The Methanex, Chevron, and Claiborne contracts transferred rights that the courts found left Cajun without substantial rights in its alleged research. Methanex received ownership of broadly defined work product. Chevron received rights to engineering data and inventions, discoveries, and improvements, while Cajun’s use was restricted to performing Chevron’s services. Claiborne incorporated federal contract provisions addressing government ownership of material and work covered by progress payments. The result depended on the complete agreements and the undefined research at issue; exclusive ownership is not invariably required for a researcher to retain substantial rights.
Comparative Analysis: Grigsby vs. Little Sandy Coal Co. v. Commissioner
Grigsby and Little Sandy Coal Co. v. Commissioner, No. 21-3145 (7th Cir. March 7, 2023), illustrate different substantiation problems. Grigsby involved construction, business-component evidence, and funding. Little Sandy Coal involved shipbuilding and proof that at least 80% of research activities constituted elements of experimentation. The Seventh Circuit affirmed the denial while disagreeing with parts of the Tax Court’s reasoning.
| Case Detail | Grigsby v. United States | Little Sandy Coal Co. v. Commissioner |
|---|---|---|
| Industry Sector | Heavy Construction / Infrastructure. | Shipbuilding. |
| Primary Legal Hurdle | Funded Research & Business Component definition. | “Substantially All” (80%) Test & Pilot Models. |
| Evidence Standard | Insufficient specific evidence of new or improved products or processes; late process disclosures excluded. | Failed to provide a “principled way” to determine experimentation time. |
| Novelty Argument | Project complexity did not cure missing business-component evidence; no separate novelty-based experimentation holding. | Rejected: Newness of vessels does not equate to experimentation. |
| Procedural Outcome | Repayment of erroneous refund. | Tax deficiency and accuracy-related penalty upheld. |
In Little Sandy Coal, first-in-class vessel designs and percentages based on new physical features did not establish the proportion of research activities that constituted experimentation. The court required a principled evidentiary basis for the allocation. It also rejected categorical reasoning that would exclude direct support or supervision from the experimentation analysis solely because of those labels; the nature of the activities mattered.
A simplified expression of the activity-based substantially-all test, using time when it is a consistently applied reasonable measurement basis, is:
Experimentation ratio = time attributable to research activities constituting elements of experimentation ÷ time attributable to total research activities for the business component ≥ 80%.
The denominator is total research activities for the component, not only activities already assumed to satisfy every qualified-research requirement. Cost or another reasonable, consistently applied basis may be used instead of time. The ratio does not override the other eligibility rules or statutory exclusions. Little Sandy Coal lacked a principled evidentiary allocation; Grigsby did not decide this ratio.
Discovery Disclosures, Variance, and Administrative Rigor
The administrative substantial-variance doctrine generally limits a taxpayer’s refund litigation to grounds adequately presented to the IRS. Grigsby’s rejection of the late process theory, however, rested on discovery obligations under Federal Rules of Civil Procedure 26 and 37, not an appellate holding applying the administrative substantial-variance doctrine. The distinction matters because administrative claim requirements and litigation disclosure duties operate at different stages.
Cajun’s discovery responses identified products, while the process theory emerged at summary judgment. The Fifth Circuit considered the importance of the evidence, prejudice to the government, the possibility of curing prejudice through a continuance, and the explanation for the omission. It upheld exclusion and also found the process allegations insufficiently specific. Taxpayers should identify their components accurately and supplement required disclosures promptly.
Implications for Future R&D Tax Credit Applications
The decision reinforces existing requirements for technical specificity, contract analysis, and adequate substantiation. Its implications depend on the taxpayer’s activities, governing agreements, tax year, and applicable jurisdiction.
Strategic Contract Management and Intellectual Property
Contract review should determine whether payment genuinely depends on successful research and whether the researcher retains substantial rights in the results. A fixed-price label alone does not establish eligibility, and a particular intellectual-property clause cannot guarantee a credit. Evaluate all relevant agreements and the actual research and payment obligations.
Where commercially appropriate, a contract may distinguish ownership of the final deliverable from rights to underlying methods or research results. Retained rights must be meaningful under the full agreement, including confidentiality and use restrictions. A nonexclusive right may be substantial; the customer need not surrender all rights. Rights retention does not cure a separate failure of the payment-contingency or technical tests.
Documentation of the “Nexus” and Technical Uncertainty
Records should connect claimed expenses to the relevant activities and business components. Contemporaneous project records are valuable, but Grigsby did not prescribe one mandatory timekeeping system or a universal rule excluding all retrospective evidence. Treasury Regulation Section 1.41-4(d) requires records in sufficiently usable form and detail to substantiate eligibility.
Useful substantiation includes:
- Identification of Technological Uncertainty: Describe the unresolved capability, method, or design question and the information available to the taxpayer when the work began.
- Systematic Evaluation of Alternatives: Preserve relevant design iterations, modeling, simulations, tests, results, and reasons for selecting alternatives. Failed attempts can be informative, but a failed experiment is not a prerequisite to qualification.
- Time and Cost Allocation at the Component Level: Link wages and other claimed expenses to qualifying activities with a supportable allocation method. Project-wide estimates should not substitute for evidence of the nature and
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What is the R&D Tax Credit? The Research & Experimentation Tax Credit (or R&D Tax Credit), is a general business tax credit under Internal Revenue Code section 41 for companies that incur research and development (R&D) costs in the United States. The credits are a tax incentive for performing qualified research in the United States, resulting in a credit to a tax return. For the first three years of R&D claims, 6% of the total qualified research expenses (QRE) form the gross credit. In the 4th year of claims and beyond, a base amount is calculated, and an adjusted expense line is multiplied times 14%. Click here to learn more.
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