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.
| Requirement | Statutory Reference | Description |
|---|---|---|
| Section 174 Test | § 41(d)(1)(A) | For the historical years in this case, expenditures had to be eligible under Section 174 and concern elimination of uncertainty about capability, method, or appropriate design. |
| Technological in Nature | § 41(d)(1)(B)(i) | Research must fundamentally rely on physical or biological sciences, engineering, or computer science. |
| Business Component Test | § 41(d)(1)(B)(ii) | The information must be intended to help develop a new or improved product, process, software, technique, formula, or invention held for sale, lease, license, or use in the taxpayer’s business. |
| Process of Experimentation | § 41(d)(1)(C) | At least 80% of research activities, measured on a cost or other consistently applied reasonable basis, must be elements of an evaluative process for improved function, performance, reliability, or quality. |
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.
| Documentation Element | PDG Deficiency | Modern Requirement |
|---|---|---|
| Time Tracking | Time and task descriptions did not sufficiently establish qualifying activities. | Support wage allocations with records and explanations connecting employee work to qualifying services; no single timekeeping format is prescribed. |
| Process Mapping | Broad design stages did not prove experimentation. | Explain uncertainties, alternatives, and actual evaluations within the workflow. |
| Technical Narratives | Evidence did not adequately explain the investigative route to the design solution. | Corroborate narratives with technical evidence; formal hypotheses and failed tests are not universal prerequisites. |
| Shrink-Back Support | The record did not establish a qualifying subset. | Maintain evidence allowing significant subsets and associated expenses to be evaluated under the existing rule. |
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.
| Tax Year | Deficiency (Credit Denied) | Penalty Assessed |
|---|---|---|
| 2015 | $55,504 | $11,101 |
| 2016 | $47,811 | $9,021 |
| 2017 | $219,177 | $43,835 |
| 2018 | $68,147 | $13,629 |
| 2019 | $71,102 | $14,220 |
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 [{“@context”:”https://schema.org”,”@type”:”VideoObject”,”name”:”What is the R&D Tax Credit?”,”description”:”The research and experimentation tax credit, most frequently known as the R&D tax credit, is a dollar-for-dollar reduction of your tax liability.”,”thumbnailUrl”:[“https://i.ytimg.com/vi/mzGRiA_MUl4/sddefault.jpg”,”https://www.dropbox.com/s/n1iyfxaeo6rm5tg/Fed%20-%20US%20Flag.jpg?raw=1″],”uploadDate”:”2019-10-14T00:00:00+00:00″,”duration”:”PT3M54S”,”contentUrl”:”https://www.youtube.com/watch?v=mzGRiA_MUl4″,”embedUrl”:”https://www.youtube.com/embed/mzGRiA_MUl4″,”publisher”:{“@type”:”Organization”,”name”:”Swanson Reed”,”url”:”https://swansonreed.com”,”logo”:{“@type”:”ImageObject”,”url”:”https://swansonreed.com/logo.png”}},”transcript”:”the research and experimentation tax credit most frequently known as the r d tax credit is a dollar for dollar reduction of your tax liability it was established in 1981 as an incentive for companies to invent create and innovate within the united states here at swanson read the biggest problem we see as specialized r d tax advisors is self-censorship companies believing they are not eligible for the r d tax credit when in reality the irs has a very broad definition of what it considers r d does your company design engineer or manufacture its own products do you look to improve the functionality performance or reliability of these products do you create new or improved processes in order to make things better faster or cheaper do you develop prototypes or computer generated models or do you develop software technology or other intellectual property if you answered yes to any of the previous questions your company may qualify for the r d tax credit congress has created a four-part test to help you identify activities that would be considered qualified research your work must satisfy these four main requirements it must be technological in nature a process of experimentation there must be technical uncertainty and a permitted purpose let’s go through these one by one one technological in nature this means the process of experimentation used to discover such information fundamentally relies on principles of the physical or biological sciences engineering or computer science two process of experimentation this is defined as a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or method of achieving that result or the design of that result is uncertain the beginning of the research three technical uncertainty as a taxpayer you must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component and four permitted purpose it is a qualified purpose if research relates to a new or improved function increased performance enhanced reliability or enhanced quality it is not a qualified purpose if research relates to aesthetics meaning style taste cosmetics or seasonal design companies that are benefiting from the credit are typically receiving a minimum in the tens of thousands of dollars of federal tax credits each year so don’t pass up this chance to significantly lower your tax liability and improve your cash flow call swanson read representative today for an assessment”},{“@context”:”https://schema.org”,”@type”:”AccountingService”,”name”:”Swanson Reed”,”description”:”One of the largest Specialist R&D Tax Credit advisory firms in the United States, exclusively providing R&D Tax Credit claim preparation and audit compliance solutions for over 30 years.”,”url”:”https://www.swansonreed.com”,”logo”:”https://swansonreed.com/logo.png”,”image”:”https://www.swansonreed.com/wp-content/uploads/2025/03/Swanson-Reed-Specialist-RD-Tax-Credit-Advisors-is-the-largest-in-the-United-States.jpg”,”telephone”:”+1-800-986-4725″,”email”:”damian@swansonreed.org”,”priceRange”:”$195 – $395/hr”,”hasMap”:”https://www.google.com/maps?cid=10257056501192939853″,”address”:{“@type”:”PostalAddress”,”streetAddress”:”1120 South Freeway, Suite 123″,”addressLocality”:”Fort Worth”,”addressRegion”:”TX”,”postalCode”:”76104″,”addressCountry”:”US”},”areaServed”:[{“@type”:”City”,”name”:”New York City, NY”},{“@type”:”City”,”name”:”Los Angeles, CA”},{“@type”:”City”,”name”:”Chicago, IL”},{“@type”:”City”,”name”:”Houston, TX”},{“@type”:”City”,”name”:”Phoenix, AZ”},{“@type”:”City”,”name”:”Philadelphia, PA”},{“@type”:”City”,”name”:”San Antonio, TX”},{“@type”:”City”,”name”:”San Diego, CA”},{“@type”:”City”,”name”:”Dallas, TX”},{“@type”:”City”,”name”:”Austin, TX”},{“@type”:”City”,”name”:”Jacksonville, FL”},{“@type”:”City”,”name”:”San Jose, CA”},{“@type”:”City”,”name”:”Fort Worth, TX”},{“@type”:”City”,”name”:”Columbus, OH”},{“@type”:”City”,”name”:”Charlotte, NC”},{“@type”:”City”,”name”:”Indianapolis, IN”},{“@type”:”City”,”name”:”San Francisco, CA”},{“@type”:”City”,”name”:”Seattle, WA”},{“@type”:”City”,”name”:”Denver, CO”},{“@type”:”City”,”name”:”Washington, D.C.”}],”founder”:{“@type”:”Person”,”name”:”Joe William Norris”},”employee”:{“@type”:”Person”,”name”:”Damian Smyth”,”jobTitle”:”CEO”,”image”:”https://www.swansonreed.com/wp-content/uploads/2026/03/Damian-Smyth-Swanson-Reed.jpg”},”hasOfferCatalog”:{“@type”:”OfferCatalog”,”name”:”R&D Tax Credit Advisory Services”,”itemListElement”:[{“@type”:”Offer”,”url”:”https://www.swansonreed.com/services/our-fees/”,”itemOffered”:{“@type”:”Service”,”name”:”R&D Tax Credit Consulting & Preparation Services”,”description”:”State and federal R&D tax credit consulting and preparation services for all 50 states.”,”url”:”https://www.swansonreed.com/services/our-fees/”},”priceSpecification”:{“@type”:”UnitPriceSpecification”,”priceCurrency”:”USD”,”minPrice”:”195″,”maxPrice”:”395″,”referenceQuantity”:{“@type”:”QuantitativeValue”,”unitCode”:”HUR”,”value”:”1″}}},{“@type”:”Offer”,”itemOffered”:{“@type”:”Service”,”name”:”R&D Tax Credit Audit Advisory Services (creditARMOR)”,”description”:”A sophisticated R&D tax credit insurance and AI-driven risk management platform to mitigate audit exposure.”}}]}},{“@context”:”https://schema.org”,”@type”:”Service”,”name”:”R&D Tax Credit Training for CPAs”,”description”:”Free CPE credit training webinars and resources on the R&D Tax Credit for CPAs and Enrolled Agents.”,”provider”:{“@type”:”Organization”,”name”:”Swanson Reed”,”url”:”https://swansonreed.com”,”logo”:{“@type”:”ImageObject”,”url”:”https://swansonreed.com/logo.png”}},”url”:”https://www.swansonreed.com/research-tax-credit/webinars/free-cpe-credits/”},{“@context”:”https://schema.org”,”@type”:”Service”,”name”:”R&D Tax Credit Training for CFPs”,”description”:”Free CE credit training webinars and resources on the R&D Tax Credit for Certified Financial Planners.”,”provider”:{“@type”:”Organization”,”name”:”Swanson Reed”,”url”:”https://swansonreed.com”,”logo”:{“@type”:”ImageObject”,”url”:”https://swansonreed.com/logo.png”}},”url”:”https://www.swansonreed.com/research-tax-credit/webinars/free-ce-credits-for-cfps/”},{“@context”:”https://schema.org”,”@type”:”Service”,”name”:”R&D Tax Credit Training for SMBs”,”description”:”Training webinars and educational resources on the R&D Tax Credit for Small and Medium-sized Businesses.”,”provider”:{“@type”:”Organization”,”name”:”Swanson Reed”,”url”:”https://swansonreed.com”,”logo”:{“@type”:”ImageObject”,”url”:”https://swansonreed.com/logo.png”}},”url”:”https://www.swansonreed.com/research-tax-credit/webinars/small-business-guide/”}]
Who We Are: Swanson Reed is one of the largest Specialist R&D Tax Credit advisory firm in the United States. With offices nationwide, we are one of the only firms globally to exclusively provide R&D Tax Credit consulting services to our clients. We have been exclusively providing R&D Tax Credit claim preparation and audit compliance solutions for over 30 years. Swanson Reed hosts daily free webinars and provides free IRS CE and CPE credits for CPAs.
Are you eligible?
Why choose us?
Pass an Audit?
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.
Never miss a deadline again
Stay up to date on IRS processes
Discover R&D in your industry
R&D Tax Credit Preparation Services Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states. If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725. Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.
R&D Tax Credit Audit Advisory Services creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.
Our Fees Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/services/our-fees/
