The federal research and development (R&D) tax credit under Internal Revenue Code (IRC) Section 41 can apply to architectural and engineering activities when the taxpayer establishes the statutory requirements and substantiates eligible expenses. Complex design work does not qualify automatically, and work that satisfies the technical requirements can still be excluded to the extent it is funded by a customer.
The architecture litigation associated with Docket Nos. 13382-17, 13385-17, and 13387-17 is Smith v. Commissioner and the consolidated Gill and Forest cases, involving partners of Adrian Smith + Gordon Gill Architecture, LLP (AS+GG). Those court records do not identify Stouffer as a petitioner. The relevant authorities are the December 18, 2024 summary-judgment order in Smith and the subsequent opinion, T.C. Memo. 2026-50, filed June 16, 2026. This study analyzes those verified proceedings alongside Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113.
These decisions address different questions: contractual funding and retained rights in Smith, and proof of qualifying research activities in Phoenix Design Group. Neither establishes that architectural or engineering services are categorically ineligible. The analysis must connect the actual research, the business component, the expenses, and the governing agreements.
The Statutory Architecture of the Research and Development Tax Credit
Section 41 requires research to satisfy a four-part test, generally applied separately to each business component. A business component may be a product, process, computer software, technique, formula, or invention held for sale, lease, or license, or used in the taxpayer’s trade or business. Professional expertise can support qualifying research, but its application alone does not establish experimentation.
The Four-Part Test Framework
| Test Component | Statutory Reference | Definitive Requirement |
|---|---|---|
| Research-expenditure and uncertainty test | IRC § 41(d)(1)(A); historical IRC § 174; current IRC § 174A; Treas. Reg. § 1.174-2 | The research must satisfy the applicable research-expenditure requirement. Uncertainty exists when information available to the taxpayer does not establish the capability, method, or appropriate design for developing or improving the business component. |
| Technological in Nature | IRC § 41(d)(1)(B)(i); Treas. Reg. § 1.41-4(a)(4) | The process of experimentation must fundamentally rely on physical or biological sciences, engineering, or computer science. Existing technologies and scientific principles may be used. |
| Business Component Test | IRC § 41(d)(1)(B)(ii), (d)(2), and (d)(3) | The information must be intended to help develop a new or improved business component. The experimentation must relate to function, performance, reliability, or quality, rather than style, taste, or cosmetic factors. |
| Process of Experimentation | IRC § 41(d)(1)(C); Treas. Reg. § 1.41-4(a)(5)–(6) | At least 80% of the relevant research activities, measured by cost or another consistently applied reasonable basis, must constitute elements of a process of experimentation for a qualified purpose, such as evaluating alternatives through modeling, simulation, or systematic trial and error. |
The 80% test concerns activities, not the percentage of a finished product that is new. The remaining research activities must satisfy the applicable expenditure requirement and must not be otherwise excluded. Failure at the business-component level calls for consideration of the shrinking-back rule; it does not necessarily eliminate every potentially qualifying subset.
Taxpayers must maintain records sufficient to establish entitlement to the credit under IRC Section 6001 and Treasury Regulation § 1.41-4(d). Siemer Milling Co. v. Commissioner, T.C. Memo. 2019-37, illustrates the consequences of failing to establish the required experimentation. No particular slogan, project label, or consultant’s study substitutes for evidence of the underlying activities.
Analyzing the Smith Litigation: The Funding Threshold
Section 41(d)(4)(H) excludes research to the extent funded by a grant, contract, or another arrangement with another person or governmental entity. Treasury Regulation § 1.41-4A(d) requires analysis of payment contingencies, the taxpayer’s rights in the results, and the extent of funding. All relevant agreements must be considered, including amendments and settlement agreements.
The December 2024 order denied the IRS’s summary-judgment motion. That ruling allowed disputed issues to proceed; it did not award the claimed credits or hold that milestone payments automatically establish economic risk. The June 2026 opinion subsequently resolved the principal funding issues after trial.
Economic Risk and Milestone Contingencies
The taxpayers argued that project deliverables, approval stages, and contractual obligations made payment contingent on successful research. The IRS maintained that AS+GG was paid for properly performing professional services. In the 2024 order, factual disputes and issues involving foreign law prevented summary adjudication.
In T.C. Memo. 2026-50, however, the court determined that payments under none of the six sample contracts were contingent on the success of the research. Professional standards of care, client approval, and staged payments did not establish the necessary success contingency on the facts presented. The court distinguished proper professional performance from payment tied to specific measures of research success.
A fixed fee, the possibility of cost overruns, or the loss of future profits does not by itself establish the financial risk contemplated by the funding regulation. Contract terms must be evaluated together, including payment, acceptance, termination, reimbursement, and remedies for failure.
Retention of Substantial Rights and the Role of Local Law
The 2024 order did not hold that UAE copyright law preserved AS+GG’s rights. It allowed foreign-law questions to be considered further without deciding their application. The 2026 opinion reached contract-specific findings: AS+GG retained substantial rights for Atrium City Tower, Masdar HQ, Atrium City Masterplan, and Plot R2, but not for Kingdom Tower or Plot 14.
For Plot 14, the court rejected reliance on general UAE copyright protections in the face of contractual provisions transferring rights and restricting reuse. Nonexclusive rights can be substantial, but incidental experience is insufficient, and unrestricted customer discretion to deny permission for reuse can defeat the taxpayer’s claimed rights.
| Contractual Element | IRS Position | Court Finding (Summary Judgment Phase) |
|---|---|---|
| Payment Structure | Payments compensated professional services and were not contingent on successful research. | The December 2024 order found summary judgment inappropriate; it did not conclusively establish a success contingency. |
| Intellectual Property | Contractual restrictions prevented retention of substantial research rights. | Foreign-law and contract questions required further consideration; the court did not decide that default copyright rules preserved rights. |
| Liability | Professional obligations did not establish the required research-failure risk. | Denial of the motion left the funding analysis for further proceedings and did not make professional liability a safe harbor. |
The June 2026 opinion also rejects an absolute all-or-nothing description of funding. Although none of the payments was success-contingent, the court held that partial credits could be available under Treasury Regulation § 1.41-4A(d)(3) for the four contracts with retained substantial rights. The precise amounts, if any, remained undetermined in that opinion. The court also found the partners’ total 2008 compensation reasonable under the applicable independent-investor test. The parties had already conceded satisfaction of the four-part test, so this was not a trial holding that all architectural activities qualify.
The Phoenix Design Group Precedent: A Failure of Substantiation
Phoenix Design Group, Inc. v. Commissioner, T.C. Memo. 2024-113, filed December 23, 2024, examined an engineering firm’s mechanical, electrical, plumbing, and fire-protection work. A retrospective study reviewed projects undertaken between 2012 and 2016 and reduced 419 possible projects to 238. The claimed research credits originated in 2013–2016, while the examined credit-use years were 2015–2019.
The parties selected three projects for trial: Gerald Champion Military Psychiatric Unit, Baptist Memorial Health North Mississippi Oxford, and Vanderbilt University Engineering and Science Building. The opinion held that these projects did not qualify, including at the shrinking-back levels the evidence permitted the court to assess. It expressly stated that the findings were not binding on the remaining projects and did not determine the final deficiency amounts. Describing the opinion as a final denial of every claimed project overstates its scope.
The Difference Between Design Changes and Technical Uncertainty
PDG argued that uncertainty persisted because designs could change until construction was complete. The court rejected the proposition that the possibility of later revisions itself establishes uncertainty about the appropriate design. Particular revisions may raise particular technical uncertainties, but those must be identified and supported rather than attributed automatically to the entire system.
The court also distinguished investigation from calculations made using already available information. The lesson is to establish what information was unavailable, why that mattered to capability, method, or design, and what work was undertaken to resolve it. The regulations do not require an advance beyond the common knowledge of skilled professionals, and the use of established formulas or software is not a categorical disqualification.
The Disconnect Between Design Phases and Experimentation
PDG’s six-stage design process did not, on its own, demonstrate a process of experimentation. The court examined what employees actually did and whether the evidence connected their work to the evaluation of alternatives. A general workflow that resembles experimentation does not prove that the relevant activities meet the statutory test.
Activity descriptions: Generic entries such as design or project coordination did not adequately connect hours to the particular issues described in testimony. Such labels are not automatic admissions of ineligibility, but they may require supporting records explaining the actual activities.
The 80% requirement: PDG did not provide sufficient information to establish that substantially all relevant research activities involved experimentation. Credible allocation methods must connect the numerator and denominator to actual research activities; a broad percentage based solely on project complexity is insufficient.
The Shrinking-Back Rule: Evaluating Identifiable Subcomponents
Under Treasury Regulation § 1.41-4(b)(2), a business component that fails the four-part test is examined at its most significant subset of elements, continuing to smaller subsets as appropriate. In Phoenix Design Group, separate mechanical, electrical, and plumbing systems could provide meaningful subsets. A design phase or a particular employee’s work did not necessarily identify a subset of the business component.
Records must support both the technical analysis and the associated expenses for the relevant subset. A hospital heat-recovery system, for example, may warrant separate consideration if its development involved documented uncertainty and experimentation. There is no automatic rule allowing a credit for an asserted innovative 10% of a project. The identified subcomponent must satisfy the applicable requirements, and its eligible costs must be substantiated.
Procedural Requirements for Refund Claims and Accuracy-Related Penalties
The IRS introduced additional information requirements for research-credit refund claims filed on or after January 10, 2022. Those administrative requirements should not be presented as the original procedural basis of the Smith litigation, which began earlier. For claims postmarked on or after June 18, 2024, the IRS waived the submission of individual researchers’ names and the information each individual sought to discover.
The remaining minimum information includes the business components supporting the claim, the research activities performed for each component, and total qualified wage, supply, and contract-research expenses. A declaration under penalties of perjury is also required. The IRS may request supporting information during examination, and applicable filing instructions and procedural guidance should be checked for the relevant claim.
In Phoenix Design Group, penalty liability followed the parties’ stipulation that penalties would apply in deficiency years if none of the three trial projects qualified. It was not a judicial declaration of a zero-tolerance policy or a holding that weak documentation automatically triggers a 20% penalty in every research-credit case. Penalty liability ordinarily depends on the applicable statutory grounds, procedural requirements, and any available defenses.
| Year/Case | Key Event/Ruling | Impact on R&D Applications |
|---|---|---|
| 2021 and 2023 (Little Sandy Coal) | The Tax Court ruled in 2021; the Seventh Circuit affirmed in 2023, 62 F.4th 287. | The taxpayer must substantiate the substantially-all requirement. The decision does not create a universal ban on supported estimates. |
| 2022 and 2024 (IRS refund-claim requirements) | Additional claim-validity requirements took effect in 2022; two individual-level submission requirements were waived beginning June 18, 2024. | Identify business components, explain their research activities, and provide the required expense totals. |
| 2024 (Phoenix Design Group) | The three trial projects failed to qualify; penalty liability followed a stipulation. | General design phases and unexplained time entries do not establish experimentation. |
| 2024 and 2026 (Smith) | Summary judgment was denied in 2024. The June 2026 opinion found no success-contingent payments but allowed the possibility of partial credits for four contracts with retained rights. | Analyze payment risk, substantial rights, and the extent of funding separately; do not treat milestones as a safe harbor. |
Contract Terms and Technical Evidence Must Work Together
Smith and Phoenix Design Group illustrate distinct statutory requirements rather than a new rule that research must be described in a contract using particular words. Favorable contract language cannot convert routine work into qualified research, and technically qualifying work can still be excluded to the extent funded.
The Effect of Contract Language and Governing Law
In System Technologies, Inc. v. Commissioner, Docket No. 12211-21, an order dated January 3, 2025 denied the IRS’s motion for partial summary judgment on funded research. The court considered Indiana law, which supplied refund remedies if the seller failed to deliver the promised product despite contractual repair-or-replacement limitations. The order resolved the funding argument presented in that motion; it did not establish every other requirement for the credit.
Contract review should therefore examine whether payments genuinely depend on successful results, which remedies apply if development fails, and whether the taxpayer can use research results in its business without paying for that right. Milestones, warranties, and intellectual-property provisions are relevant evidence, but no particular clause is universally mandatory or sufficient. Agreements should accurately reflect the transaction’s commercial substance.
Documentation for Professional Service Firms
Contemporaneous technical records can explain the uncertainty, alternatives evaluated, methods used, and results. Useful evidence may include calculations, simulation files, design iterations, test results, project correspondence, and records linking employee effort to particular activities. A final drawing or a retrospective narrative alone may omit the investigative steps necessary to establish qualification.
Retrospective explanations and reasonable estimates are not categorically prohibited. Their value depends on credibility and a sufficient evidentiary foundation. Taxpayers should reconcile consultant studies with business records and distinguish qualified research, direct supervision, direct support, and nonqualifying activities under the applicable expense rules.
Section 174A and the Research-Expense Landscape
The Tax Cuts and Jobs Act generally required capitalization and amortization of research or experimental expenditures for tax years beginning in 2022–2024: five years for domestic research and fifteen years for foreign research, using a midyear convention. These deduction rules were separate from eligibility for the Section 41 credit.
The One Big Beautiful Bill Act became law on July 4, 2025. It added Section 174A, generally allowing current deductions for domestic research or experimental expenditures in tax years beginning after December 31, 2024, subject to applicable elections and limitations. Foreign research expenditures remain subject to fifteen-year amortization under Section 174. Revenue Procedure 2025-28 addresses implementation, including relevant transition elections and accounting-method procedures.
Immediate deductibility does not automatically make an expense credit-eligible. Section 41 retains its own technical, expense, and exclusion requirements, with deduction-credit coordination under Section 280C. Conversely, an activity outside the research-expenditure definition is not necessarily immediately deductible under another provision; its treatment depends on the nature of the cost and other applicable capitalization rules.
Final Thoughts
The verified cases support a careful, fact-specific approach to R&D tax credits for architectural and engineering firms. The Smith proceedings show why a procedural victory must be distinguished from a later merits ruling. Phoenix Design Group shows why evidence of professional design work must explain the investigative process and connect it to the claimed expenses.
- Contractual analysis: Evaluate success contingencies, retained research rights, and the extent of customer funding across all governing agreements.
- Technical substantiation: Identify the information that was uncertain and document the alternatives and evaluation actually undertaken.
- Expense support: Link eligible costs to activities with credible records and a supportable allocation method.
- Component-level analysis: Apply the shrinking-back rule to identifiable subsets when the larger business comp
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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.
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