The federal research credit, codified in Section 41 of the Internal Revenue Code, was introduced in 1981 to encourage research activities. Its application to tangible products raises recurring questions about which costs qualify as research expenses. TG Missouri Corp. v. Commissioner, 133 T.C. 278 (2009), clarified that the depreciable-property exclusion for supplies is assessed in the hands of the taxpayer claiming the credit. This study examines that holding alongside subsequent case law, the pilot-model regulations, and later changes to the deduction of research expenditures.

The Statutory and Regulatory Framework of Section 41

Section 41 provides a credit for qualifying research expenditures, subject to expense-category rules, statutory exclusions, and a four-part research test applied to each business component. Research outside the United States, Puerto Rico, and U.S. possessions is excluded. For taxable years beginning after December 31, 2024, the expenditure threshold in Section 41(d)(1)(A) refers to Section 174A; the historical version relevant to TG Missouri referred to Section 174.

Treasury Decision 9104, finalized in 2004, rejected a requirement that research expand knowledge beyond what skilled professionals already know. The inquiry instead concerns uncertainty about the taxpayer’s capability, method, or appropriate design. Eliminating uncertainty alone is insufficient: the technological, business-component, experimentation, and other Section 41 requirements must also be satisfied.

The Role of Supply Costs in Qualified Research Expenditures

Qualified research expenses include eligible in-house expenses and qualifying contract research payments. In-house categories include wages for qualified services, supplies used in qualified research, and certain payments for computer use. Section 41(b)(2)(C) excludes land, land improvements, and property of a character subject to depreciation from supplies. In TG Missouri, the IRS argued that the molds had an inherently depreciable character. Eligibility turns on the legal and economic facts, rather than a taxpayer’s choice of accounting label.

Factual Background of TG Missouri Corp. v. Commissioner

TG Missouri manufactured injection-molded automotive products, including steering wheels, air bags, and body side molding. Its production molds had to meet customer specifications.

The Mold Development Lifecycle

During the years at issue, development, design, construction, and testing generally took 24 to 36 months from quotation request to customer acceptance. Third-party toolmakers built molds to TG Missouri’s specifications. After acquiring production molds, TG Missouri performed further engineering and modifications needed to produce acceptable parts.

TG Missouri depreciated molds it retained and owned, and did not claim the disputed supply treatment for those molds. Other molds were sold to customers, with title transferring after completion and payment. TG Missouri retained physical possession for parts production, while the customer bore the risk of loss for the sold mold.

The Dispute Over 1997-1999 Tax Returns

The litigation concerned adjustments to the 1998 and 1999 returns, including credits and carryovers arising from 1997–1999 expenditures. TG Missouri included payments to third-party toolmakers for customer-sold molds in its research-credit supply costs. Its 1997 claimed research credit totaled $2,316,601; this was a credit amount, not mold expenditure. The IRS argued that the molds’ useful lives and susceptibility to wear made them depreciable property excluded from supplies.

Judicial Analysis and the Tax Court’s Ruling

The Tax Court was tasked with interpreting the phrase “property of a character subject to the allowance for depreciation.” The central question was whether this character should be determined in a vacuum (the “generic character” approach) or whether it depended on the taxpayer’s specific economic relationship with the property.

The Significance of Section 174(c)

The court considered Sections 41 and 174 as they applied to the years in dispute. Historical Section 174(c) excluded acquisition or improvement costs for depreciable research property, while the regulations separately addressed research expenditures resulting in such property. The central issue was whether the customer-sold molds were depreciable in TG Missouri’s hands. This historical analysis must be distinguished from current Section 174A deduction rules and Section 280C coordination of the deduction and credit.

The “In the Hands of the Taxpayer” Interpretation

A pivotal element of the court’s reasoning involved a comparison with other sections of the Internal Revenue Code. Specifically, the court looked to Section 1239(a), which governs the sale of depreciable property between related parties. Section 1239(a) clarifies that its provisions apply if the property is, “in the hands of the transferee,” of a character subject to the allowance for depreciation.

The court concluded that depreciation character must be assessed for the relevant taxpayer. TG Missouri lacked a depreciable economic interest in the molds sold to customers, despite retaining possession to manufacture their parts. Those molds therefore were not excluded from supplies on depreciation grounds, and the disputed third-party mold costs were allowable on the record before the court. This does not make every customer-owned tool or related expenditure creditable.

Continued Use and the Limits of the Holding

TG Missouri allowed the disputed mold costs even though the molds remained usable in commercial production after sale. The opinion’s express holding concerns depreciability in the taxpayer’s hands; it should not be characterized as abolishing a universal requirement that supplies be totally consumed. Taxpayers must still establish use in qualified research and satisfy all other applicable requirements.

Comparative Analysis with Related R&D Case Law

Related decisions illustrate different questions: whether supplies directly serve research, whether a business component satisfies the experimentation test, and whether costs belong to an eligible expense category. Their holdings should not be collapsed into a single rule favoring or excluding all prototypes.

Union Carbide and Ordinary Production Costs

In Union Carbide Corp. v. Commissioner, T.C. Memo. 2009-50, the taxpayer sought credits for raw materials used in manufacturing process experiments. Unlike TG Missouri, which was developing a product (the molds) for sale, Union Carbide was testing improvements to its internal production processes while simultaneously creating commercial products.

The Tax Court disallowed the disputed raw-material costs that would have been incurred in ordinary production regardless of the process research. The Second Circuit affirmed in Union Carbide Corp. v. Commissioner, 697 F.3d 104 (2012). The decision distinguishes direct research supplies from ordinary production inputs and indirect expenses; describing it as a universal primary-purpose test is too broad. Sale of an output, by itself, does not decide whether every associated research expense qualifies.

Trinity Industries and the Shrink-Back Rule

Trinity Industries, Inc. v. United States, 691 F. Supp. 2d 688 (N.D. Tex. 2010), addressed research-credit claims involving ship development and allowed credits for qualifying projects based on the evidence. Its analysis should not be described as an automatic rule that 80% of a prototype’s construction cost qualifies the whole vessel. The substantially-all test concerns research activities and requires at least 80% to constitute elements of a qualifying process of experimentation, measured by cost or another consistently applied reasonable basis. The shrink-back rule separately applies the tests to the most significant subset of a business component when the whole component fails, then to smaller subsets as necessary. Little Sandy Coal Co. v. Commissioner, 62 F.4th 287 (7th Cir. 2023), later emphasized that novelty and arbitrary estimates do not establish the activity-based test. Pilot-model construction may be part of experimentation when supported by evidence; the prototype label alone is insufficient.

The 2014 Final Regulations and the Definition of Pilot Models

Treasury Decision 9680, issued in 2014, clarified the Section 174 treatment of research expenditures involving tangible property, including pilot models. These deduction regulations did not eliminate the independent requirements for the Section 41 credit.

Defining the Pilot Model under Section 174

Under Treas. Reg. § 1.174-2(a)(4), a “pilot model” is any representation or model of a product that is produced to evaluate and resolve uncertainty concerning the product during its development. This definition explicitly includes fully functional representations or models.

The regulations state that ultimate success, failure, sale, or use does not determine whether an expenditure is research or experimentation under Section 174. This is consistent with recognizing that a useful or saleable result can arise from research. It is not a blanket codification of all claimed implications of TG Missouri, and it does not automatically qualify those costs for the Section 41 credit.

Addressing Uncertainty in Pilot Model Development

Uncertainty exists when available information does not establish the capability, method, or appropriate design for developing or improving a product. Costs must relate to resolving that uncertainty in the experimental or laboratory sense. Starting production does not automatically establish or defeat qualification, but ordinary production costs after the relevant uncertainty is resolved are excluded from research treatment. The credit adds its own activity and expense tests.

Legislative Transition: TCJA and the Restoration of Expensing via OBBBA

The Tax Cuts and Jobs Act of 2017 required capitalization and amortization of specified research expenditures for taxable years beginning after December 31, 2021: generally five years for domestic research and fifteen years for foreign research, using the midpoint convention. Public Law 119-21, enacted July 4, 2025 and commonly called the One Big Beautiful Bill Act, added Section 174A for domestic research while retaining Section 174 treatment for foreign research.

Section 174A: The Return of Immediate Expensing

Section 174A permits deduction of qualifying domestic research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2024, with no scheduled sunset. This changes deduction timing; it does not expand the definition of supplies eligible for the Section 41 credit. Acquisition and improvement costs for depreciable assets remain subject to separate limitations. Section 280C generally requires a corresponding deduction or capital-account adjustment unless a valid reduced-credit election applies.

For domestic research, taxpayers now have three primary accounting options starting in 2025:

• Immediate Deduction: Full expensing in the year costs are incurred under Section 174A(a).
• 60-Month or Longer Amortization: Section 174A(c) permits an election to capitalize qualifying expenditures and amortize them over at least 60 months, beginning when benefits are first realized, subject to statutory and procedural conditions.
• 10-Year Amortization: Section 59(e) permits an election for qualifying amounts to be deducted ratably over ten taxable years. The election has specific scope, timing, and revocation rules; it is not an unrestricted annual reversal of an accounting method.

Relief for Small Businesses and Retroactive Elections

Eligible small businesses could elect retroactive domestic treatment for taxable years beginning after December 31, 2021 and before January 1, 2025. Eligibility generally uses the Section 448(c) test for the first taxable year beginning after December 31, 2024: average annual gross receipts of $31 million or less for 2025, applying aggregation and other applicable rules and excluding tax shelters. Revenue Procedure 2025-28 set July 6, 2026 as the general election deadline, with refund limitation periods also relevant. That general deadline has passed as of September 13, 2026; relief should not be presented as an unrestricted current option. Separately, taxpayers of any size may elect recovery of remaining unamortized 2022–2024 domestic balances in the first taxable year beginning after December 31, 2024, or ratably over that year and the next, under the applicable procedures. These are 2025 and 2026 for calendar-year taxpayers.

Implications for Future R&D Tax Credit Applications

TG Missouri, the pilot-model regulations, and Section 174A address related but distinct issues: depreciation character, research-expenditure classification, and deduction timing. A defensible credit claim addresses each relevant rule separately.

Supply Costs for Specialized Tooling and Molds

TG Missouri supports considering qualifying tangible tooling costs as supplies where the tooling is not depreciable in the claimant’s hands and is used in qualified research. Customer ownership or transfer of title alone does not establish eligibility. Employee design wages, purchased tangible property, and contracted research services must be classified under their respective Section 41 categories rather than treating all tooling-related costs as supplies.

Contracts and supporting records should establish ownership, payment conditions, acceptance requirements, financial risk, and rights to research results. These facts help determine depreciability and whether the funded-research exclusion applies. The conclusion must reflect the substance of the arrangement as well as its wording.

Prototyping and the “Pilot Model” Strategy

A fully functional first-of-its-kind unit may be a pilot model when built to resolve qualifying uncertainty. Its full cost is not automatically a qualified research expense. Taxpayers must distinguish eligible wages, supplies, and contract research from depreciable assets, nonexperimental production, and other excluded costs.

For example, multiple models built to evaluate heat, cold, or vibration performance may support research treatment when each is needed to resolve documented uncertainty. Later selling a model does not by itself disqualify its research expenditures. Each claimed cost must nevertheless satisfy the applicable deduction rules and, separately, Section 41.

Strategic Considerations for Process Research

Process-development claims should distinguish research on the process from routine manufacture of the product. Union Carbide makes the allocation of ordinary production inputs particularly important. A saleable output does not categorically bar qualifying process research, but it does not convert normal manufacturing costs into research supplies.

To distinguish their activities from routine production, taxpayers should:

• Isolate experimental runs from standard production schedules.
• Document specific process changes and the uncertainties being addressed (e.g., yield improvement, cycle time reduction).
• Quantify any “incremental” costs, such as additional raw materials required solely for the test phase.

Documentation and Audit Readiness Checklist

The December 2025 Instructions for Form 6765 make Section G optional for taxable years beginning before 2026 and required for years beginning after 2025, subject to specified exceptions. Where required, detailed business-component information generally covers at least 80% of QREs, limited to 50 business components, with