The federal research and development (R&D) tax credit under Internal Revenue Code Section 41 requires evidence of qualifying activities and qualifying expenses. Recent litigation illustrates the risks of generalized project descriptions and unsupported cost allocations. It does not establish a universal ban on retrospective studies, interviews, or reasonable estimates supported by reliable evidence.

This study distinguishes the accounting issues in Potter v. Commissioner from research credit decisions and examines experimentation, sampling, contractual funding, domestic research deductions, and filing requirements. The discussion reflects guidance reviewed as of September 13, 2026.

Historical Precedents and the Standard of Consistency

Potter v. Commissioner, 44 T.C. 159 (1965), involved the tax treatment of receipts from house sales, including first trust deed notes. The court held that correcting inconsistencies in the taxpayer’s application of the cash method did not constitute a change in accounting method for purposes of Sections 446 and 481.

Potter was not a decision about the modern Section 41 research credit. Its references to accounting consistency do not establish a requirement for contemporaneous R&D time sheets or prohibit retrospective research credit studies. Any analogy between accounting consistency and reliable credit substantiation should be understood as a practical observation, rather than a holding of Potter.

Business Components and Refund Claim Requirements

The draft’s attribution of T.C. Memo. 2024-81 to Carolyn Smith Driscoll is incorrect. That citation identifies Keith v. Commissioner, a collection due process case, and should not be used as authority for research credit requirements. The relevant business-component and substantiation requirements instead arise from Section 41, its regulations, and applicable IRS filing guidance.

Taxpayers should connect the claimed activities to identifiable products, processes, software, techniques, formulas, or inventions. Broad descriptions of an engineering department or a company’s overall innovation program may leave the relationship between qualifying work and claimed expenses unproven.

Information Needed to Explain the Research

A useful technical narrative identifies the uncertainty concerning capability, method, or appropriate design; the alternatives evaluated; the evaluation performed; and the resulting technical findings. Evidence may include models, simulations, systematic trial and error, design revisions, and testing records. These are practical ways to support the statutory tests, not a mandatory universal document template.

For research credit refund claims subject to the IRS’s amended-return procedures, the IRS requires identification of the business components, descriptions of research activities for each component, and totals for the applicable expense categories. Effective June 18, 2024, the IRS waived the upfront requirements to identify every individual and state the information each individual sought to discover. That information may still be requested during examination. Initial claim validity and ultimate entitlement to the credit are separate questions; there is no basis here to describe IRS classification as a wholly automated system that bypasses all human review.

Substantive Issues in the AEC Sector: Phoenix Design Group

Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, concerned a firm designing mechanical, electrical, plumbing, and fire protection systems. The court evaluated three trial projects and found that the taxpayer had not established qualified research. The findings on those projects were not automatically binding determinations for every remaining project in the claim.

Technical Uncertainty and Engineering Complexity

The decision illustrates why complexity alone does not establish qualifying uncertainty. A taxpayer should explain what available information failed to establish at the outset and how the claimed investigative work addressed that uncertainty. Routine calculations and professional judgment do not automatically satisfy the test.

However, using established engineering principles, building codes, or existing technologies does not categorically disqualify research. The applicable regulation does not require an advance beyond the knowledge available to the industry. The question is whether the taxpayer’s activities satisfy the requirements for the particular business component.

Demonstrating a Process of Experimentation

A general multistage design process is insufficient without evidence connecting actual activities to the evaluation of alternatives. In Phoenix Design Group, the descriptions and records did not establish the necessary process for the trial projects. A project can involve revisions and client discussions without those activities being qualified experimentation.

Taxpayers should document the alternatives considered, the technical basis for comparing them, and what the evaluation established. The governing regulation recognizes modeling, simulation, and systematic trial and error; it does not require every project to use an identical laboratory protocol.

Statistical Sampling and the Burden of Proof

Kapur v. Commissioner, T.C. Memo. 2024-28, denied a request to restrict discovery and trial to two projects. The procedural decision did not abolish statistical sampling. A proposed sample does not, by itself, relieve a taxpayer of the obligation to substantiate its claimed credit or justify withholding relevant information about the population.

Sampling requires a defensible population, selection method, and method of estimating the relevant amounts. Differences among projects require careful treatment; they do not make all statistical sampling inherently invalid. The IRS’s Form 6765 instructions address sampling under Revenue Procedure 2011-42 and caution that acceptance of a return does not establish acceptance of the sample.

The Funded Research Exclusion and Contractual Risk

Section 41(d)(4)(H) excludes funded research. Under the applicable regulations, the analysis considers whether payments are contingent on successful research and whether the taxpayer retains substantial rights in the research. Contract language, incorporated terms, and governing law can all affect the result.

Fixed-Price Contracts and Contingent Payments

A fixed-price label alone does not establish eligibility. The substantive question concerns the parties’ rights and obligations if the research is unsuccessful. Obligations to deliver a functioning result, refund payments, or remedy a failure may be relevant; ordinary commercial risk must be distinguished from the financial risk addressed by the research credit rules.

In System Technologies, Inc. v. Commissioner, Docket No. 12211-21, the Tax Court’s January 2025 order denied the Commissioner’s motion for partial summary judgment on funded research. The court examined Indiana law incorporated into the purchase orders and concluded that payment was contingent on successful research. This ruling on a particular exclusion did not establish that every other credit requirement had been met.

Substantial Rights and Intellectual Property

Substantial rights need not be exclusive ownership of all intellectual property. The analysis turns on the taxpayer’s retained rights to use the research, taking account of the governing agreement and applicable law. Merely gaining experience from a project is not necessarily sufficient when the agreement transfers all substantial rights. Contract review should therefore address both payment risk and retained research rights.

Legislative Landscape: The One Big Beautiful Bill Act

Immediate Expensing and Amortization

The Tax Cuts and Jobs Act required capitalization of specified research or experimental expenditures for tax years beginning after December 31, 2021, with five-year amortization for domestic research and fifteen-year amortization for foreign research.

Public Law 119-21, commonly known as the One Big Beautiful Bill Act and enacted July 4, 2025, added Section 174A. It generally permits current deductions for domestic research or experimental expenditures paid or incurred in tax years beginning after December 31, 2024. An election to capitalize and amortize domestic expenditures remains available. Foreign research generally remains subject to fifteen-year amortization under Section 174.

Deductibility and research credit eligibility are separate analyses. An expense deductible under Section 174A does not automatically qualify for the Section 41 credit, and the deduction and credit must be coordinated under Section 280C where applicable.

The July 6, 2026 Election Deadline

Revenue Procedure 2025-28 provided procedures for eligible small businesses to elect retroactive treatment for domestic expenditures in tax years beginning after 2021 and before 2025. Eligibility generally required satisfying the Section 448(c) gross receipts test for the first tax year beginning after 2024 and not being a tax shelter. For a 2025 tax year, the inflation-adjusted threshold was average annual gross receipts of $31 million or less, with the applicable aggregation rules.

The July 6, 2026 election deadline has passed. Refund claims also remain subject to Section 6511; the legislation did not override that limitation period. The separate transition option to recover remaining unamortized domestic costs over the first tax year beginning after 2024 or over that year and the next should be evaluated under the applicable procedures and filing deadlines.

Form 6765 Disclosure Requirements

Business Component Information

The December 2025 Form 6765 instructions make Section G optional for tax years beginning before 2026 and required for tax years beginning after 2025, subject to exceptions. Where required, the instructions generally call for detailed information covering at least 80% of qualified research expenses, with no more than 50 business components, and aggregate treatment of the remainder.

Exceptions include qualifying small businesses making the specified payroll tax credit election and certain original-return filers meeting both the $1.5 million qualified research expense ceiling and the $50 million average gross receipts ceiling. Applicable controlled-group rules matter.

The Section G disclosure threshold is distinct from the substantially-all experimentation test. Completing the form does not establish substantive credit eligibility.

Implications for Future R&D Credit Applications

Estimates and the Cohan Principle

It is inaccurate to state that Cohan has been abolished for research credits. A taxpayer must first establish qualifying activities and a reliable basis for quantification. Courts may reject unsupported estimates because the evidence provides no principled allocation, rather than because all estimation is forbidden.

A retrospective study can organize existing technical and financial evidence. Its value depends on that underlying support, the credibility and specificity of testimony, and the connection between claimed costs and qualifying work. Preparing the study after year-end does not by itself make it invalid.

The 80% Test and Supervision

Under Treasury Regulation Section 1.41-4(a)(6), substantially all generally means 80% or more of the relevant research activities, measured using cost or another consistently applied reasonable basis, constitute elements of a process of experimentation. This is an activity-based test; the proportion of a product that is physically new does not establish the required percentage.

In Little Sandy Coal Co. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), the appellate court disagreed with the Tax Court’s categorical exclusion of direct support and supervision from the numerator. Those activities can be relevant when they constitute elements of the experimentation process. Nevertheless, the taxpayer failed to provide a supported allocation. General management time does not qualify merely because research occurs elsewhere in the business.

A useful conceptual expression is: experimentation activities divided by the relevant total research activities for the business component must equal at least 80%, using an appropriate consistent measurement basis. It is not a calculation based on total project spending or supply costs alone.

Practical Recommendations for R&D Compliance

Maintain Project Evidence

Retain technical records as work progresses, including design alternatives, testing results, simulation versions, engineering notes, and relevant meeting records. Connect wage allocations, supplies, and contract research amounts to the activities claimed. Contemporaneous evidence is valuable, but the regulations do not prescribe one exclusive timekeeping system.

Review Contractual Risk

Evaluate customer agreements, purchase orders, incorporated terms, and governing law. Determine what happens if the research fails and what rights the business retains. Review the whole arrangement before drawing conclusions from payment milestones or a fixed-price clause.

Apply the Shrink-Back Rule Where Supported

If the requirements are not met for the overall business component, the regulations provide for applying them to the most significant subset of its elements, continuing as appropriate. A qualifying subsystem may support eligible expenses when the larger component does not. Shrink-back requires evidence of the subset’s activities and costs and does not relax