The federal research and development (R&D) tax credit under Internal Revenue Code Section 41 requires evidence of qualifying research and eligible expenses. Recent litigation illustrates the importance of substantiation, while legislation enacted in 2025 changed the separate deduction rules for domestic research expenditures. These developments should be evaluated under the law applicable to each tax year.
Correcting the Case Attribution and Its Significance
The source study identifies its central authority as Wong v. Commissioner, T.C. Memo. 2023-141, but the cited material does not substantiate that identification or an R&D holding under that name. The account of a tax lawyer who failed to file returns for 2010 through 2017 and advanced frivolous constitutional arguments concerns O’Connor v. Commissioner, T.C. Memo. 2025-42. The source’s description of Wong as interchangeable with Scott is also unsupported.
In O’Connor, Judge Arbeit rejected the taxpayer’s arguments and imposed a $2,000 penalty in addition to the tax liabilities and additions to tax. That dispute concerns nonfiling and frivolous tax positions. It does not establish a new Section 41 documentation standard or demonstrate that an unsuccessful research-credit claim is automatically frivolous. The relevant research-credit lessons instead arise from Section 41, its regulations, and decisions such as Little Sandy Coal and Moore.
Statutory Architecture and the Four-Part Test
Research eligibility is tested by business component. Section 41(d)(2) includes products, processes, computer software, techniques, formulas, and inventions held for sale, lease, or license or used in a trade or business. Qualifying expenditure treatment alone does not establish entitlement to the credit.
| Requirement | Statutory Basis | Judicial Interpretation Trend |
|---|---|---|
| Research expenditure test | § 41(d)(1)(A) | For tax years beginning after 2024, the statute refers to expenses eligible under § 174A; earlier years require the applicable historical rules. Research must address uncertainty about capability, method, or appropriate design. |
| Technological in nature | § 41(d)(1)(B)(i) | The research must rely on physical or biological science, engineering, or computer science. |
| Business component and permitted purpose | § 41(d)(1)(B)(ii), (d)(3) | Research must support development of a new or improved business component, with experimentation directed toward function, performance, reliability, or quality. |
| Process of experimentation | § 41(d)(1)(C); Treas. Reg. § 1.41-4(a)(6) | At least 80% of the relevant research activities, measured by cost or another consistently applied reasonable basis, must constitute elements of experimentation. |
A process of experimentation evaluates alternatives to resolve uncertainty present at the beginning of the research. Modeling, simulation, and systematic trial and error may qualify. Routine application of established information does not become experimentation merely because the project is difficult or new to the taxpayer. Statutory exclusions must also be considered.
Mathematical Rigor in the Substantially All Test: Lessons from Little Sandy Coal
In Little Sandy Coal Co. v. Commissioner, decided by the Seventh Circuit in 2023, a shipbuilder claimed expenses relating to eleven first-in-class vessels. Two vessels—a tanker barge and a dry dock—served as representative projects at trial. The appellate court affirmed denial because the taxpayer had not adequately established qualifying research activities.
The 80% test concerns activities, rather than the percentage of a vessel’s physical features that are new. Novelty and arbitrary estimates cannot substitute for an evidentiary basis for measuring experimentation.
The appellate court disagreed with aspects of the Tax Court’s treatment of pilot-model production and direct-support activities. Production work can form part of experimentation when undertaken to resolve relevant uncertainty; calling an entire vessel a prototype does not make all construction work qualifying research. Taxpayers must distinguish experimental activities from routine work using a supportable allocation.
When a whole business component fails the test, the regulatory shrinking-back rule may permit examination of its most significant subset of elements. It requires evidence supporting the smaller component’s eligibility; it does not cure missing proof.
Executive Compensation and the Direct Supervision Challenge
Moore v. Commissioner, T.C. Memo. 2023-20, concerned compensation paid to Nevco’s president and chief operating officer, Gary Robert. The taxpayers included 65% of his compensation in qualified expenses. Although the court accepted that he devoted substantial time to new product development, it found insufficient evidence identifying how much time involved qualified research.
The distinction matters: product development includes commercial and managerial work that may fall outside Section 41. The decision also rejected the claimed direct-supervision and direct-support grounds. The IRS had conceded qualifying wages for the engineering department, including its immediate supervisor; the ruling was not a denial of all company research wages.
Treasury Regulation § 1.41-2(c) limits direct supervision to immediate, first-line management. Supervising another manager does not qualify on that basis alone. Executives may nevertheless perform qualifying research or direct support themselves. Eligibility turns on their actual duties and substantiated allocation, rather than job title.
The employee-wage rule is distinct from the business-component experimentation test. Under Treasury Regulation § 1.41-2(d), an employee meeting the separate 80% qualified-services threshold may have all wages treated as qualified; otherwise, qualifying wages may be allocated under the applicable rules.
Contractual Risk and the Funded Research Doctrine
Section 41(d)(4)(H) excludes research to the extent funded by another person. Treasury Regulation § 1.41-4A(d), incorporated by the current research regulations, requires examination of payment contingencies and substantial rights in the research. A service provider must evaluate both issues.
| Contract Type | Primary Risk Holder | Credit Eligibility Outlook |
|---|---|---|
| Fixed Price | Often the provider for cost overruns; research-failure risk depends on the agreement. | No automatic eligibility. Examine whether payment depends on successful research and whether substantial rights are retained. |
| Time and Materials | Often the customer for reimbursed effort. | Research generally is funded to the extent the provider is paid irrespective of research success; actual terms control. |
| Capped Fee | Depends on payment obligations and the cap. | A cap alone is insufficient. Both success-contingent payment and retained rights require analysis. |
In Meyer, Borgman & Johnson, Inc. v. Commissioner, the Eighth Circuit affirmed in 2024 that the engineering firm’s research was funded. General professional standards, code-compliance duties, and termination provisions did not establish that payment depended on research success. Ordinary commercial risk was insufficient.
Funded status for a provider does not automatically give the customer a credit. The customer must independently satisfy the applicable requirements. Review master service agreements, statements of work, and related contractual provisions together. Substantial rights need not be exclusive, but the provider must retain qualifying rights under the regulations. The source’s unsupported attribution of a separate 2024 holding to “System Technologies” is not relied upon here.
Legislative Changes: From Amortization to Domestic Expensing
The Tax Cuts and Jobs Act required capitalization and amortization of research expenditures for tax years beginning after 2021: five years for domestic research and fifteen years for foreign research. This changed deduction timing, without repealing the Section 41 credit.
Public Law 119-21, enacted July 4, 2025 and commonly called the One Big Beautiful Bill Act, added Section 174A. Domestic research expenditures generally became currently deductible for tax years beginning after 2024, with an election to capitalize and amortize over at least 60 months. Foreign research generally remains subject to fifteen-year amortization.
| Provision | Pre-OBBBA (2022-2024) | Post-OBBBA (2025+) |
|---|---|---|
| Deduction Method | Domestic expenditures generally amortized over five years under § 174. | Domestic expenditures generally deductible under § 174A; elective capitalization is available. |
| Foreign R&D | Fifteen-year amortization. | Fifteen-year amortization generally continues. |
| Small Business Relief | No general immediate domestic deduction under the then-applicable rule. | Eligible small businesses could elect retroactive treatment for 2022-2024, subject to deadlines and procedural requirements. |
| § 280C Election | Credit and deduction coordination depended on the applicable year’s rules. | Coordination remains necessary; Revenue Procedure 2025-28 provides limited late-election and revocation procedures. |
For the small-business retroactive election, the 2025 gross-receipts threshold was $31 million or less, subject to the statutory tests and exclusion of tax shelters. The general deadline was July 6, 2026, or an earlier applicable refund deadline. As of September 13, 2026, that general election deadline has passed; the relief should not be described as an open opportunity for every small business.
Separate transition provisions permit recovery of remaining domestic 2022-2024 balances in the first tax year beginning after 2024 or ratably over two years, subject to the required election procedures. An otherwise timely research-credit refund claim is a separate question from retroactive Section 174A relief. Amended deductions and credits must be coordinated under Section 280C.
Strategic Implications for Future R&D Tax Credit Applications
A defensible study connects the technical work, the relevant legal requirements, and the claimed expenses. The practical recommendations below follow from those requirements; they are not holdings of a verified Wong research-credit decision.
Contemporaneous Documentation
Treasury Regulation § 1.41-4(d) requires records sufficiently usable and detailed to substantiate eligibility. Contemporaneous records are valuable, but the regulation does not mandate one universal project-tracking format or categorically prohibit interviews and reasonable reconstructions supported by evidence.
- Preserve feasibility studies describing the initial technical uncertainty and intended improvement.
- Retain design revisions, test results, simulations, and records of alternatives evaluated.
- Connect payroll and other claimed costs to qualifying activities and distinguish routine or administrative work.
- Document the basis for allocations and reconcile the study to accounting records.
Refund-Claim Review Requirements
The source’s description of an automated “Classifier” system that scans narratives and automatically denies weak claims is not established by the cited evidence. IRS refund-claim guidance instead specifies information needed for a valid claim.
For claims postmarked on or after June 18, 2024, the IRS waived the initial requirement to identify each research individual and the information each sought to discover. Claimants must still identify all relevant business components, describe research activities by component, and provide total qualified wage, supply, and contract-research expenses for the claim year. Additional information may be requested during examination.
The IRS extended the transition period for perfecting deficient claims through January 10, 2027, with a 45-day response opportunity under the applicable procedures. These procedures do not extend the statutory refund limitation period or guarantee allowance. Current Form 6765 instructions and relevant exceptions should be checked for the filing year.
Final Thoughts
The central correction to this study is that the source does not establish the claimed Wong R&D precedent. The substantiation lessons are supported by the research-credit statute, regulations, and actual research-credit litigation. Strong evidence, supportable expense allocations, and careful contract analysis remain essential. The restoration of domestic research expensing changes deduction timing but does not replace the separate requirements for a Section 41 credit.
