The federal research and development (R&D) tax credit under Internal Revenue Code (IRC) Section 41 rewards qualifying research activities, rather than innovation or product development in general. Leon Max v. Commissioner, T.C. Memo. 2021-37, decided March 29, 2021, illustrates the distinction between skilled apparel development and research meeting the statutory requirements. The petitioner was Leon Max individually; Leon Max, Inc. (LMI) was the S corporation whose activities generated the disputed credits.
This study examines the court’s findings, their implications for research-credit substantiation, and related developments in the treatment of research expenditures. The decision applied existing legal tests to LMI’s activities. It did not categorically exclude fashion businesses, establish a general product-complexity requirement, or make laboratory facilities a prerequisite for the credit.
Historical and Statutory Context of the Section 41 Credit
Section 41 generally provides an incremental credit. Under the regular method, the principal research-expense component is 20% of qualified research expenses above a statutory base amount, subject to the applicable calculation rules. An alternative simplified credit is also available. Accordingly, 20% is not a universal credit rate applied to all development spending.
Qualified research must satisfy several requirements at the business-component level. A business component can be a product, process, computer software, technique, formula, or invention held for sale, lease, or license, or used in the taxpayer’s business. Research-expense treatment and credit eligibility are related but distinct: an expenditure can meet the research-expense rules without satisfying every additional requirement of Section 41.
The following table describes the statutory framework applied to the 2011 and 2012 tax years in Max. Later changes to the deduction provisions are addressed below.
| Statutory Requirement | IRC Section | Core Objective |
|---|---|---|
| Section 174 Test | § 41(d)(1)(A), as applicable to the years at issue | Expenditures must be eligible for research or experimental expense treatment under then-applicable Section 174, including the requirement to address uncertainty about development or improvement. |
| Technological Information Test | § 41(d)(1)(B)(i) | The research must seek information through a process fundamentally relying on physical or biological sciences, engineering, or computer science. |
| Process of Experimentation Test | § 41(d)(1)(C); § 41(d)(3) | Substantially all relevant research activities must constitute elements of a process of experimentation for a qualified purpose. |
| Business Component Test | § 41(d)(1)(B)(ii); § 41(d)(2)(B) | The information’s application must be intended to assist development of a new or improved business component. Qualified purposes concern function, performance, reliability, or quality. |
These requirements do not demand an advance in knowledge across an entire industry. Existing scientific or engineering principles can support qualified research. The issue is whether the taxpayer actually used them in qualifying activities and can establish the connection to the claimed expenses.
Factual Underpinnings of Leon Max v. Commissioner
LMI designed and sold women’s clothing through multiple brands, including Max Studio and Leon Max. Its development work involved designers, patternmakers, sample makers, and other personnel who translated concepts into garments for retail sale.
LMI claimed research credits of $426,255 for 2011 and $496,462 for 2012. Those corporate amounts must be distinguished from the credits claimed on Mr. Max’s individual returns: $426,255 for 2011 and $322,700 for 2012. The IRS disallowed the latter amounts, and the Tax Court sustained that disallowance.
Mr. Max argued that the development process involved material science, textile engineering, and experimentation. The activities discussed in the opinion included:
- Concept and design: Designers developed sketches and collections influenced by customer preferences, trends, retailer requests, and seasonal factors.
- Technical sketching and patternmaking: Personnel translated designs into patterns, selected construction details, and adjusted garment dimensions.
- Sample creation and fit testing: Teams evaluated prototype garments on models for appearance, comfort, movement, and adherence to the design.
- Material testing: LMI tested shrinkage, colorfastness, seam strength, fabric strength, and other qualities against company and industry standards.
- Sizing and production preparation: Employees altered patterns, including for plus-size garments, and aligned prints and construction details.
Judge Buch’s 48-page opinion recognized the care and skill involved but concluded that the activities did not constitute qualified research. The distinction concerned the statutory character of the work, rather than its commercial value or the attractiveness of the resulting garments.
The Court’s Application of the Research Tests
The court found failures under the Section 174, technological-information, and process-of-experimentation tests. Because those findings disposed of the claim, it expressly declined to decide the business-component test. It is therefore inaccurate to describe the decision as a separate rejection of every test.
The Section 174 Uncertainty Test
For the years at issue, uncertainty existed when the available information did not establish the capability or method of developing or improving a product, or its appropriate design. Not knowing the final measurements or appearance of a garment did not, by itself, establish that kind of uncertainty.
LMI identified problems involving fabric draping, print alignment, thread selection, shrinkage, sizing, and fit. The court found that employees generally possessed the knowledge needed to resolve these matters through established techniques. Their repeated experience and the practical tasks required during hiring supported that finding.
The court also treated LMI’s standardized textile tests as quality control. Those tests checked conformity with predetermined parameters. Testing intended to resolve uncertainty about an appropriate design can be different, but LMI did not establish that its activities had that investigative purpose. A test’s label or use before commercial production does not determine its eligibility.
The Technological Information Test
Treasury Regulation § 1.41-4(a)(4) requires fundamental reliance on physical or biological sciences, engineering, or computer science. The existence of scientific explanations for fabric behavior was insufficient without evidence that LMI actually relied on those principles in its development process.
| Taxpayer’s Scientific Claim | Court’s Rebuttal | Judicial Reasoning |
|---|---|---|
| Fit Testing = Engineering | LMI’s fit testing did not establish fundamental reliance on engineering. | The court characterized model feedback and ordinary fitting adjustments as garment-development practices. Its dictionary examples of complex products did not add a separate complexity test to the statute. |
| Draping = Material Science | LMI did not establish that its draping and print-alignment work used materials science. | The taxpayer’s expert discussed drape coefficients but did not show that LMI knew of or used them. Identifying a scientific concept after the work did not establish actual reliance. |
| Shrinkage Testing = Chemistry | The washing, steaming, and colorfastness activities did not establish chemical research. | The court viewed the activities as ordinary testing of fabric properties. Its reasoning concerned LMI’s evidence and does not make chemical transformation a universal requirement for research-credit eligibility. |
The court’s baseball analogy distinguished an action governed by physics from an activity that deliberately relies on scientific principles. Its discussion should not be expanded into a rule that every eligible project requires equations, laboratory equipment, or a formally trained scientist. The regulatory standard remains the governing framework.
Systematic Experimentation and the Scientific Method
The opinion described qualifying experimentation in terms of a formalized scientific method: a methodical plan involving trials, analysis, and refinement. It also expressly acknowledged that systematic trial and error can qualify. Consequently, the decision should not be summarized as rejecting trial and error altogether.
Under Treasury Regulation § 1.41-4(a)(5), the taxpayer must identify relevant uncertainty, identify alternatives intended to eliminate it, and evaluate those alternatives through a qualifying process. Modeling, simulation, and systematic trial and error can satisfy this framework when the remaining requirements are met.
LMI’s iterative development steps were not enough on the evidence presented. The court found neither the required uncertainty nor fundamental reliance on science or engineering, and it viewed the steps as an integrated creative-development process. Repeating adjustments until a garment is acceptable does not automatically establish experimentation.
Useful substantiation explains what was uncertain, why available information did not resolve it, which alternatives were considered, how they were evaluated, and what the results showed. A written hypothesis and test log can help establish those facts, but the regulations do not prescribe one mandatory laboratory-style document for every project.
The Exclusion of Style, Taste, and Seasonality
Section 41(d)(3)(B) excludes style, taste, cosmetic, and seasonal design factors from qualified purposes. The court found that customer preferences and appearance drove much of LMI’s work. It also acknowledged that activities such as fitting and patternmaking could serve both functional and aesthetic purposes, but Mr. Max did not provide evidence distinguishing their associated costs.
The substantially-all requirement generally calls for at least 80% of the relevant research activities for each business component to constitute elements of experimentation for a qualified purpose. LMI did not establish that threshold. This is an activity-based inquiry, rather than a count of new garments, a percentage of a product’s physical novelty, or a measure of the entire company’s work.
Comparative Analysis: Leon Max, Siemer Milling, and Little Sandy Coal
Siemer Milling Co. v. Commissioner, T.C. Memo. 2019-37, and Little Sandy Coal Co. v. Commissioner, T.C. Memo. 2021-15, provide useful comparisons. Together with Max, they illustrate the importance of proving actual experimentation and connecting the evidence to the claimed activities. They should not be reduced to a single rule that retrospective studies or particular industries are ineligible.
Documentation and Retrospective Studies
Siemer Milling illustrates why general descriptions of technical development do not establish a qualifying experimental process. In Little Sandy Coal, the taxpayer’s allocations and evidence did not provide a reliable basis for determining the proportion of qualifying activities for the vessels at issue.
In Max, LMI engaged alliantgroup in 2013, and a study was produced in 2014 covering 2009 through 2012. It examined a sample of garments and drew on employee interviews, design materials, correspondence, and financial records. The court nevertheless found that the activities failed substantive eligibility requirements. It also criticized the taxpayer’s technical expert for relying on the study’s description without verifying that LMI actually followed the described process.
These findings do not establish that a study prepared after the work is automatically invalid. A retrospective study must accurately explain eligible activities and rest on reliable evidence. Contemporary records are often persuasive, but records need not take a single prescribed form.
| Case | Industry | Key Documentation Failure | Judicial Lesson |
|---|---|---|---|
| Siemer Milling | Food Processing | Insufficient evidence of a qualifying process of experimentation for the claimed work. | Project descriptions must demonstrate the actual evaluation of alternatives; technical terminology alone is insufficient. |
| Little Sandy Coal | Shipbuilding | Unsupported allocations and insufficient evidence to measure experimentation at the business-component level. | Product novelty and generalized estimates do not establish the substantially-all threshold. |
| Leon Max | Apparel | The evidence did not establish qualifying uncertainty or experimentation, and did not distinguish functional and aesthetic costs. | Skilled development work and an outside study do not replace proof of statutory eligibility. |
The 80% Rule and the Seventh Circuit’s Decision
In Little Sandy Coal Co. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), the Seventh Circuit affirmed the denial of the credit while rejecting the Tax Court’s categorical exclusion of direct-support and direct-supervision activities from the experimentation numerator. Such activities can count when they meet the relevant research and experimentation requirements. The court did not automatically include all support, supervision, or prototype-production work.
The appellate decision was not a reversal awarding the taxpayer a credit. Its interpretation offers a potentially more inclusive analysis, but the taxpayer still failed to substantiate the necessary allocation. That holding arose in Little Sandy Coal; the Max opinion did not separately establish the same support-and-supervision calculation rule.
Implications for Future R&D Tax Credit Claims in the United States
The practical lesson is to examine the substance of development activities before calculating a credit. A business should be able to distinguish technological uncertainty from commercial uncertainty, aesthetic choice, routine implementation, and quality control.
Building a Reliable Research Study
A research study should connect the legal requirements to evidence of work actually performed. Useful practices include:
- Preserving contemporary evidence: Retain relevant design versions, test plans, results, correspondence, and records of unsuccessful approaches.
- Connecting personnel costs to activities: Use time records or another defensible allocation method that supports the claimed work and business components.
- Explaining technical decisions: Show why alternatives were selected, evaluated, revised, or abandoned.
- Separating excluded activities: Identify aesthetic design, ordinary inspection, and other excluded work rather than assigning an entire department to research.
The requirement is adequate substantiation. Neither a particular software system nor a universal requirement for minute-by-minute time sheets follows from these cases. Unsupported percentages and generic narratives remain vulnerable because they do not demonstrate what the taxpayer actually did.
Using the Shrinking-Back Rule
Treasury Regulation § 1.41-4(b)(2) directs taxpayers first to apply the requirements to the discrete business component. If those requirements are not met, the inquiry moves to its most significant subset and continues until a qualifying subset is identified or no further subset exists.
In Max, the court expressly noted that the taxpayer had not argued for shrinking back and declined to apply the rule on his behalf. The decision therefore did not determine whether any smaller part of LMI’s work could qualify under that rule.
A separately identifiable technical feature or manufacturing process may warrant its own analysis, provided the facts support the relevant business component or subset and every applicable requirement. Shrinking back cannot convert routine work into research or justify selecting arbitrary expenses solely to reach 80%.
The Role of Outside Consultants
Outside advisers can help assess eligibility, assemble records, and calculate credits, but a consultant’s characterization does not control the legal result. LMI’s experience demonstrates the need to verify that technical descriptions match actual practice and that expert conclusions are grounded in the taxpayer’s work.
Advisers should test assumptions with the personnel who performed the work and reconcile narrative descriptions with financial evidence. A credible study explains both qualifying and excluded activities and identifies evidentiary limitations.
Implications for Other Industries
The decision does not exclude apparel, software, food development, or architecture as whole categories. Nor does it establish that an eligible project must involve bridges, satellites, or a chemical transformation. Computer science is expressly recognized in the regulations, and qualifying research can use existing scientific and engineering principles.
Businesses in any industry must demonstrate the required uncertainty, technological basis, experimentation, and qualified purpose, while addressing applicable exclusions. Iteration may be part of qualified research, but ordinary revisions or the newness of a product are insufficient on their own.
Research-Expense Deductions and Computational Mechanics
Section 174, the TCJA, and Section 174A
Max concerned 2011 and 2012, before the Tax Cuts and Jobs Act’s mandatory research-expense amortization rules took effect. For taxable years beginning in 2022 through 2024, those rules generally required capitalization and amortization over five years for domestic research and fifteen years for foreign research, using a midpoint convention.
Public Law 119-21, enacted July 4, 2025, added Section 174A. For taxable years beginning after December 31, 2024, domestic research or experimental expenditures generally qualify for a current deduction under that provision, subject to applicable rules and elections. Foreign research expenditures remain subject to fifteen-year amortization under Section 174. Transition provisions address certain earlier domestic expenditures; Revenue Procedure 2025-28 explains relevant procedures.
It is therefore outdated to state that all domestic research expenditures must continue to be amortized over five years. Deduction treatment, credit eligibility, and the coordination rules under [{“@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 – 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