The Statutory Architecture and Legislative Intent of the Research Credit

The research credit is an incentive for qualifying research expenditure, rather than a general subsidy for innovative or commercially risky work. Bearing financial risk does not, by itself, entitle a taxpayer to the credit. The activities, expenses, business connection, and applicable exclusions must also satisfy § 41.

The familiar four-part framework addresses research expenditure eligibility and technological uncertainty, technological information, a qualifying business component and purpose, and a process of experimentation. The applicable statutory text must be checked for the tax year involved. A qualifying purpose concerns improved function, performance, reliability, or quality, rather than purely aesthetic or cosmetic changes.

Treasury Regulations §§ 1.41-4(c)(9) and 1.41-4A(d) govern funding. Payments contingent on successful research results are not treated as funding. Separately, a researcher that retains no substantial rights generally has fully funded research for credit purposes. Where substantial rights are retained but payments constitute funding, otherwise qualifying expenses may remain eligible to the extent permitted after the required funding reduction. The rules therefore do not always produce an all-or-nothing result.

Factual Underpinnings of Meyer, Borgman & Johnson, Inc. v. Commissioner

Meyer, Borgman & Johnson, Inc. (MBJ), a Minnesota structural engineering firm, prepared structural designs and construction documents. It claimed approximately $190,000 in research credits for tax years ending September 30, 2010, 2011, and 2013. The IRS disallowed the credits.

The Tax Court examined 14 representative contracts. MBJ relied on fixed-price or lump-sum arrangements and argued that unsuccessful design efforts could require additional work without additional compensation. The dispute concerned whether those arrangements made payment contingent on research success, rather than simply exposing the firm to increased performance costs.

The Contractual Evidence

The contractual record included agreements and proposals. MBJ emphasized the following obligations:

• Professional care: Perform services consistently with professional skill and care.
• Compliance: Meet applicable codes, regulations, and project requirements.
• Termination: Permit termination for substantial nonperformance.
• Approval: Obtain client approval at relevant project stages.

The Tax Court granted summary judgment to the Commissioner on funding. The Eighth Circuit affirmed on May 6, 2024, in Meyer, Borgman & Johnson, Inc. v. Commissioner, 100 F.4th 986. It reviewed the summary judgment and contract interpretation questions de novo.

Judicial Analysis: Distinguishing Success from Proper Performance

The central question was whether the contracts conditioned MBJ’s entitlement to payment on successful research. A duty to deliver competent professional services can differ from an obligation to achieve a specified research result before payment becomes earned.

The Rejection of General Professional Standards

The Eighth Circuit found that general standards of care and code compliance did not establish the necessary contingency. It contrasted the detailed performance obligations in Fairchild with MBJ’s professional services arrangements. Client approval provisions also did not, on this record, establish that research failure would defeat the right to payment.

The decision should not be read as requiring particular tax terminology in every contract. The court addressed both express terms and clear implications. The substance and enforceable effect of the agreements matter; a general promise of competent performance does not automatically establish successful-research risk.

The Inherent Risk of Fixed-Price Contracts

A fixed fee may expose an engineering firm to cost overruns. That exposure is relevant to the commercial bargain, but it does not necessarily mean payment depends on successful research. A firm can incur losses while remaining entitled to payment for properly performed services.

The Eighth Circuit also drew on United States v. Grigsby, 86 F.4th 602 (5th Cir. 2023). An agreement to provide a product or service is not automatically an agreement making payment contingent on research success. Refund, rejection, and acceptance provisions can help establish the allocation of risk, but neither line-item pricing nor an express refund clause is a universal statutory prerequisite.

The Mirror-Image Argument and Gaps in Credit Eligibility

The credit does not necessarily belong to either the customer or the contractor. Each must independently meet the applicable rules. A customer’s inability to claim contract research expenses does not transfer eligibility to the researcher.

Treasury Regulation § 1.41-4A(d)(2) expressly addresses a situation in which the researcher retains no substantial rights while payment is contingent on research success: neither party may treat the affected expenditures as qualified research expenses under that provision. Other failures of the statutory tests can also prevent a credit. Commercially sensible contract terms can therefore leave neither party eligible, but this is not proof that every such outcome results from defective drafting.

Comparative Jurisprudence: Fairchild and Later Rulings

Fairchild Industries, Inc. v. United States, 71 F.3d 868, was decided in 1995 and modified in 1996. It involved development of an aircraft for the U.S. Air Force under a fixed-price incentive contract. Detailed specifications and acceptance provisions governed payment, and progress advances were not unconditionally earned merely because they had been received.

The Federal Circuit focused on which party bore research costs if the work failed, rather than the likelihood of eventual success. Its decision does not require all research contracts to duplicate a defense procurement agreement or contain a particular volume of specifications.

In Populous Holdings, Inc. v. Commissioner, a December 9, 2019 Tax Court order addressed representative architectural contracts and found favorable payment-contingency and retained-rights terms. The order was nonprecedential and fact-specific. It is not a general safe harbor for fixed-price architectural services, and MBJ did not turn every fixed-price arrangement into funded research.

The Substantial Rights Test: Beyond Institutional Knowledge

MBJ’s appellate decision turned on payment contingency; it should not be treated as a separate holding that MBJ transferred all research rights. The retained-rights issue nevertheless remains essential in other contract research claims.

Institutional Knowledge and Substantial Rights

Experience gained while performing a project is not, by itself, a substantial right in its research results. Treasury Regulation § 1.41-4A(d)(2) distinguishes incidental learning from meaningful rights to use or exploit those results.

Lockheed Martin Corp. v. United States, 210 F.3d 1366 (Fed. Cir. 2000), confirms that rights need not be exclusive. Customer ownership of deliverables, copyright provisions, licenses, confidentiality restrictions, and permission requirements must be assessed together. A nonexclusive right can be substantial, and not every restriction automatically defeats it.

Conversely, a complete assignment without meaningful retained use rights can cause the research to be treated as fully funded even when the performer bears financial risk. A clause labeled “work made for hire” deserves scrutiny, but the label alone does not resolve every possible contractual rights arrangement.

IRS Administrative Guidance and Practical Effects

Field Attorney Advice 20223401F, dated November 12, 2021 and publicly released in 2022, discusses research-credit claims and contract funding. It predates the 2024 appellate MBJ decision. The advice applies existing authorities to particular contracts; it is not binding precedent and does not establish a new statute or regulation.

Scope of FAA 20223401F

The advice illustrates IRS attention to payment contingency, substantial rights, and the full set of agreements. It does not establish that all field negotiations have stopped, that every claimant needs Fairchild-length specifications, or that oral evidence and governing law are categorically irrelevant.

Refund-claim screening and substantiation requirements are separate from whether a project is funded. Chief Counsel Memorandum 20214101F and subsequent IRS guidance address information needed for research-credit refund claims. They do not impose a universal vocabulary for time records. Current Form 6765 instructions make Section G optional for tax years beginning before 2026 and generally required for years beginning after 2025, subject to stated exceptions and applicable amended-return instructions.

Later Rulings and the Role of Governing Law

The 2025 orders in System Technologies and Smith illustrate why contract interpretation and procedural posture matter. Governing law can inform enforceable obligations, but a choice-of-law clause does not override federal credit requirements or guarantee a favorable result.

System Technologies and the UCC

In System Technologies, Inc. v. Commissioner, Docket No. 12211-21, the Tax Court’s January 3, 2025 order concerned an Indiana manufacturer of industrial finishing systems. Its purchase agreements incorporated Indiana law. The court found that remedies for nondelivery included recovery of payments, despite a narrower contractual repair-or-replacement warranty.

That analysis supported a research-success contingency and denial of the IRS’s motion for partial summary judgment on funding. It did not finally establish compliance with every research-credit requirement. The court expressly distinguished funding from possible factual questions concerning technological uncertainty. Sales-law reasoning also should not automatically be applied to professional services contracts.

Smith and International Intellectual Property Law

The preliminary Smith proceedings considered whether foreign law and architectural contracts preserved substantial rights. The later opinion, Smith v. Commissioner, T.C. Memo. 2026-50, issued June 16, 2026, makes it misleading to describe the 2025 ruling as an unqualified final taxpayer victory.

The 2026 opinion found no substantial rights for two of six sample projects. For four others, rights were retained but payment was not contingent on research success. Those projects required a funding reduction, with potential credit eligibility dependent on establishing otherwise qualifying expenses exceeding funding under the applicable rules. It did not simply award a full credit for the firm’s client work.

Future Implications and Strategy for AEC R&D Applications

MBJ demonstrates the limits of relying on fixed fees, ordinary approval procedures, or professional care standards. It does not categorically exclude architectural or engineering research. Contract review and technical substantiation should address the actual rights, obligations, and activities for each relevant project.

Contractual Reform Strategies

• Define the commercial result: Where the bargain genuinely depends on successful technical outcomes, describe measurable acceptance requirements and how failure affects payment.
• Clarify remedies: Identify rejection, correction, termination, refund, and payment-retention consequences. A refund clause can be relevant evidence but is not a universal condition of eligibility.
• Address retained rights: Clarify any meaningful rights to reuse research results without paying for permission, and reconcile them with assignments, licenses, and confidentiality obligations.
• Analyze governing law: Determine which legal rules actually apply and whether contractual limitations alter them. Selecting Indiana law or a foreign jurisdiction does not itself establish eligibility.
• Reflect the actual bargain: Prospective drafting should accurately record negotiated responsibilities. Labels or later descriptions cannot replace the obligations applicable when the research was undertaken.

Substantive Documentation and the Process of Experimentation

Funding and technical qualification are separate inquiries. MBJ did not establish that treating a building as a business component always fails. Other cases, including Little Sandy Coal and Phoenix Design Group, emphasize proof of qualifying activities and the correct application of the business-component and experimentation rules.

Identify the relevant product, process, software, technique, formula, or invention used in the taxpayer’s business or held for sale, lease, or license. If necessary, apply the shrink-back rule to appropriate subsets. Merely selecting a smaller subsystem does not make ordinary design work eligible.

Useful records can describe the uncertainty, alternatives evaluated, modeling or simulation, testing, and resulting design changes. BIM use is not automatically experimentation, and the law does not require every qualifying project to follow one formal laboratory protocol. Specific descriptions and supportable expense allocations are more persuasive than generic labels or unsupported percentages.

Legislative Context: Sections 174, 174A, and the OBBBA

Public Law 119-21, commonly called the One Big Beautiful Bill Act, added § 174A and restored an option for immediate deduction of domestic research or experimental expenditures for tax years beginning after December 31, 2024. Foreign research expenditures generally remain subject to 15-year amortization under § 174.

The deduction provisions and § 41 credit are distinct. Establishing unfunded research for credit purposes is not a universal prerequisite for deducting domestic research costs. Taxpayers must separately analyze the applicable expenditure rules and the coordination of deductions and credits under § 280C.

Eligible small businesses could elect retroactive domestic-research treatment for tax years beginning after December 31, 2021 and before January 1, 2025. Eligibility generally depended on the § 448(c) gross-receipts test for the first tax year beginning after 2024, including a $31 million threshold and applicable aggregation and other cond