The federal research and development tax credit under Internal Revenue Code Section 41 supports qualifying technological research. Eligibility depends on the taxpayer’s activities, expenses, and contractual arrangements, rather than an industry label or the complexity of a finished design.

The case attribution in the underlying McGeorge study requires correction. T.C. Memo. 2023-149 is Minemyer v. Commissioner, a civil fraud penalty decision issued on December 13, 2023. It does not establish an R&D credit ruling involving the University of the Pacific or its McGeorge School of Law. The construction-design business-component discussion instead corresponds to Harper v. Commissioner, T.C. Memo. 2023-57. This study examines that decision alongside Phoenix Design Group, Little Sandy Coal, Smith, and System Technologies.

The Statutory Architecture of the Research Credit

Section 41 requires research to satisfy its four-part framework and avoid the statutory exclusions. Qualification must be tested separately for each business component. Establishing qualified research is distinct from calculating qualified research expenses and the resulting credit.

The Research-Expense Foundation and Technical Uncertainty

For the historical years considered in the cases discussed here, Section 41’s expense requirement referred to Section 174. Following the 2025 legislation, Section 41(d)(1)(A) refers to domestic research or experimental expenditures under Section 174A for the applicable years. Historical decisions must be read under the law governing their tax years.

Research in the experimental or laboratory sense addresses uncertainty about developing or improving a product. The relevant uncertainty concerns capability, method, or appropriate design, based on information available to the taxpayer. Uncertainty over commercial demand, profitability, or simply finishing a project does not by itself establish qualifying technological research.

For tax years beginning in 2022 through 2024, the Tax Cuts and Jobs Act generally required five-year amortization of domestic research expenditures and fifteen-year amortization of foreign expenditures. Section 174A restored a current deduction option for domestic research expenditures for tax years beginning after December 31, 2024, subject to the applicable rules and elections. The historical five-year requirement should therefore not be presented as the general current rule for new domestic expenditures.

The Technological Information Test

The research must rely fundamentally on physical or biological science, engineering, or computer science. Research in the social sciences, arts, or humanities is excluded, and experimentation directed only at style, taste, cosmetic appearance, or seasonal design does not serve a qualified purpose. Architectural work requires an activity-specific distinction between aesthetic choices and technical investigation into functional performance.

The Business Component Requirement

Section 41(d)(2)(B) identifies products, processes, computer software, techniques, formulas, and inventions that will be sold, leased, licensed, or used in the taxpayer’s trade or business. A component need not be patented. The examples below illustrate potential components; none qualifies automatically.

Analyzing Harper v. Commissioner

In Harper v. Commissioner, T.C. Memo. 2023-57, the taxpayers claimed research credits arising from Harper Construction Company’s design-build activities. The Commissioner sought partial summary judgment on the ground that the construction designs did not meet the statutory business-component requirement.

The Procedural Ruling for Design-Based Research

The Tax Court denied the motion. It found no basis on the summary-judgment record to conclude, as a matter of law, that the projects failed the business-component test. The analysis was not limited to whether designs were products; processes, techniques, and inventions were also relevant statutory categories.

This was a ruling on the Commissioner’s motion, not a final determination that every project or expense qualified for a credit. Taxpayers must still establish the other requirements and address applicable exclusions. The decision should not be attributed to the University of the Pacific or McGeorge School of Law.

The Shrinking-Back Rule in Construction and Engineering

Treasury Regulation Section 1.41-4(b)(2) provides for testing successively smaller elements when the overall business component fails the qualification requirements. The analysis begins with the most significant subset and continues until a qualifying subset is found or the most basic element fails. This rule requires evidence of qualifying activities within the subset; it does not establish eligibility merely because a component can be divided into smaller parts.

In Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, the court found that none of the three trial projects qualified, either as a whole or at the shrinking-back level. This decision illustrates why component identification and proof of experimentation must be addressed together.

The Process of Experimentation

Under Treasury Regulation Section 1.41-4(a)(5) and (6), a process of experimentation evaluates alternatives to resolve uncertainty about capability, method, or design. At least 80% of the relevant research activities must constitute elements of experimentation for a qualified purpose, measured by cost or another consistently applied reasonable basis.

Systematic Evaluation and Routine Design

Qualifying evaluation may involve modeling, simulation, or systematic trial and error. There is no universal requirement for a formal laboratory protocol, but merely making revisions or performing engineering calculations does not demonstrate that an evaluative process occurred.

Phoenix Design Group involved mechanical, electrical, plumbing, and fire-protection engineering. The court found insufficient proof of qualifying research in the three projects tried. A general description of the firm’s design stages did not adequately explain the technical uncertainties, alternatives evaluated, and activities performed to resolve them. The decision does not establish that engineering design is categorically ineligible.

The Numerator and Denominator of Substantially All

Little Sandy Coal Co. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), affirmed disallowance of research credits because the taxpayer failed to substantiate the required proportion of experimental activities. The Seventh Circuit rejected the categorical exclusion of direct support and direct supervision from the numerator. Such activities can count when they constitute elements of experimentation; job titles or generalized estimates do not establish that relationship.

The table distinguishes activity treatment for the experimentation analysis. It should not be confused with the separate wage-expense rules governing employees who perform, directly supervise, or directly support qualified research.

Documentation and Substantiation

Taxpayers must maintain records sufficient to substantiate credit eligibility and amounts. Contemporaneous technical records are valuable, but the regulations do not prescribe a single mandatory narrative format or make the absence of a particular style of time log automatically fatal. Credible evidence must connect the claimed activities and costs to the legal requirements.

Lessons from Phoenix Design Group

The court’s December 2024 opinion addressed a nonbinding sample of three projects drawn from more than 200 projects. It found none of the trial projects qualified and imposed accuracy-related penalties as stipulated by the parties. The opinion expressly did not determine the final deficiency amounts. Describing it as an immediate final denial of every claimed project overstates its scope.

Practical Documentation Measures

• Identify uncertainty: Record the capability, method, or design issue being investigated and the information available at the outset.
• Track alternatives: Preserve designs, models, test results, and explanations of why alternatives were rejected or refined.
• Connect expenses: Reconcile claimed wages, supplies, and contract research expenses to the relevant activities and business components.
• Support allocations: Use records and a reasonable method to distinguish experimental work from routine design, administration, and other excluded activities.

The Funded Research Exclusion

Section 41(d)(4)(H) excludes research to the extent it is funded by another person or governmental entity. Treasury Regulation Section 1.41-4A(d) requires analysis of payments and rights in research results. Customer payment does not automatically eliminate all eligibility, and a fixed-price contract does not automatically establish that research is unfunded.

Substantial Rights and Financial Risk

Payments contingent on successful research generally are not treated as funding under these rules. The researcher’s retention of substantial rights must also be considered. Where payments are not contingent on success but substantial rights remain, research expenses exceeding the funding may still be eligible under the allocation rules. If the researcher retains no substantial rights, the research is treated as fully funded. These distinctions make a simple all-or-nothing two-prong checklist misleading.

Smith and System Technologies

The January 2025 summary-judgment proceedings in Smith and System Technologies highlighted the importance of contract interpretation and governing law. Denial of the Commissioner’s motion did not establish blanket entitlement to the credits.

In its January 3, 2025 order in System Technologies, Inc. v. Commissioner, Docket No. 12211-21, the Tax Court concluded that Indiana law provided a refund remedy if the company failed to deliver the promised product. Contractual repair-or-replacement provisions did not eliminate that remedy in the circumstances considered. The court denied the Commissioner’s partial-summary-judgment motion on funded research. Other qualification requirements remained distinct.

The later decision in Smith v. Commissioner, T.C. Memo. 2026-50, issued June 16, 2026, prevents treating the earlier procedural ruling as the end of that case’s analysis. The court found payments under the six sample projects were not contingent on research success, but the firm retained substantial rights in four projects. Credits for those four projects could be available to the extent research expenses exceeded funding, subject to allocation and computation. The court also found the partners’ aggregate 2008 compensation reasonable. Copyright provisions, settlement agreements, payment terms, and the specific rights retained required individual analysis.

Software Research and Internal Use

Software development is subject to Section 41’s qualification requirements and exclusions. Using computers or writing code does not itself establish qualified research.

The Discovery Standard

The current regulation expressly states that discovering technological information does not require expanding the common knowledge of skilled professionals in the field. Taxpayers may use existing technologies and scientific principles. Older decisions such as Norwest and United Stationers must not be used to impose a general current-law requirement for industry-wide novelty. The taxpayer must nevertheless demonstrate relevant uncertainty and qualifying experimentation; novelty to the taxpayer alone is insufficient.

The High Threshold of Innovation

Software developed primarily for internal general and administrative functions generally must satisfy an additional high-threshold-of-innovation test, unless an exception applies. Not all software used within a business is internal-use software for this purpose; third-party interaction and dual-function software have specific rules.

• Innovation: The intended improvement must produce a substantial and economically significant cost reduction, speed improvement, or other measurable improvement.
• Significant economic risk: Substantial development resources must face significant uncertainty about recovery within a reasonable period because of technical risk.
• Commercial unavailability: The software cannot be purchased, leased, or licensed and used for its intended purpose without modifications satisfying the innovation and economic-risk requirements.

Domestic Research Deductions After the 2025 Legislation

Public Law 119-21, commonly called the One Big Beautiful Bill Act, was enacted on July 4, 2025. Its domestic research deduction changes are enacted law, rather than a prospective proposal. Deduction eligibility remains separate from research-credit eligibility.

Expensing and Transition Relief

Section 174A generally permits immediate deduction of domestic research expenditures incurred in tax years beginning after December 31, 2024. An election to capitalize and amortize over at least 60 months is also available. Foreign research expenditures generally remain subject to fifteen-year amortization under Section 174.

The legislation provided eligible small businesses a time-limited election for retroactive domestic treatment for 2022–2024 and provided options to accelerate remaining domestic amortization balances over one or two years. Revenue Procedure 2025-28 set procedures and deadlines, including a general July 6, 2026 deadline for the small-business retroactive election, subject to earlier refund limitations. That deadline has passed as of September 2026; the relief should not be described as an unrestricted option still available to every small business. Section 280C coordination must also be addressed.

Foreign Research and Other Credit Restrictions

Section 41 excludes research conducted outside the United States, Puerto Rico, and U.S. possessions. The 2025 legislation’s prohibited-foreign-entity and material-assistance restrictions for certain energy incentives should not be presented as a general new Section 41 test requiring research resources to originate in a friendly country. The applicable research-location exclusion must be assessed under Section 41 itself.

Implications for Research Credit Claims

Identify Business Components Precisely

A project may correspond to a statutory business component, but a project label alone does not demonstrate that it does. Identify the actual product, process, software, technique, formula, or invention and apply the requirements separately. Where shrinking back is necessary, retain evidence supporting qualification and expenses at the relevant subset.

Explain the Research Activities

Describe the technical uncertainty, alternatives, evaluation, and results in terms that a reviewer can understand. Avoid unsupported percentages and generic claims that all engineering work is experimental.

The IRS’s research-credit refund-claim guidance began with a memorandum published in October 2021, with requirements taking effect after a grace period ending January 10, 2022. Since June 18, 2024, the IRS has waived the initial submission of individual researcher names and the information each person sought to discover. Its guidance still requires identification of the business components, research activities for each component, and total qualified wage, supply, and contract research expenses. The waived information m