The Economic and Industrial Evolution of Troy, Michigan

To fully comprehend the application of research and development (R&D) tax incentives within Troy, Michigan, it is essential to analyze the historical and economic forces that transformed the region from an agrarian township into a premier technological and commercial powerhouse. The industrial composition of Troy—dominated by automotive engineering, robotics, financial services, and healthcare—is the direct result of mid-twentieth-century urban decentralization, strategic municipal planning, and targeted infrastructure development.

From Rural Township to the “Golden Corridor”

For over a century after its initial settlement in 1819, the area that would become Troy remained a patchwork of dairy farms, dirt roads, and small agricultural enclaves. However, the post-World War II era triggered a massive demographic and industrial shift across Southeast Michigan. In the 1950s, the deindustrialization of the Detroit urban core began as major manufacturing plants closed, and corporations sought larger, more affordable parcels of land outside the central city to build horizontal manufacturing facilities and sprawling corporate campuses. To prevent aggressive annexation attempts by neighboring municipalities such as Royal Oak and Birmingham, Troy officially incorporated as a city in 1955, giving local leaders the autonomy to control their economic destiny.

The ultimate catalyst for Troy’s meteoric rise was the construction of Interstate 75 (I-75). By linking Macomb and Oakland counties directly to Detroit and the broader national highway system, I-75 turned Troy into a highly accessible commercial hub. Recognizing this geographical advantage, municipal planners and developers envisioned an “edge city”—a concentrated hub of business, shopping, and entertainment located outside a traditional downtown.

In 1968, the City Center Plan drafted by Crane, Gorwic, and Shrem Associates identified the intersection of Big Beaver Road and I-75 as the optimal location for high-density corporate development. This led to the aggressive zoning of the Big Beaver Corridor for office, business, and commercial use. This stretch of roadway, eventually dubbed the “Golden Corridor,” quickly attracted Fortune 500 headquarters, massive office complexes, and luxury retail destinations such as the Somerset Collection, which began as an outdoor mall in 1969. The relocation of the Kmart Corporation’s international headquarters from Detroit to Big Beaver Road in 1972 served as a monumental anchor, signaling to the broader corporate world that Troy was the new epicenter of suburban commerce. By 1980, Troy possessed the second-largest tax base in the state of Michigan, surpassed only by Detroit.

Sector-Specific Industrial Migration

The architecture of Troy’s current R&D landscape was built upon the migration and incubation of specific industries within the Golden Corridor and its surrounding light-industrial zones:

The migration of the automotive industry was the most prominent early driver of technical innovation in the region. As the global automotive industry expanded, Tier 1 and Tier 2 suppliers required expansive facilities for research, design, and manufacturing that were unavailable in the increasingly congested Detroit grid. Troy’s light industrial districts, specifically south of Big Beaver Road, became home to aerospace and automotive drivetrain manufacturers by the late 1960s. Companies sought the logistical advantages of the I-75 corridor while simultaneously tapping into the highly educated white-collar workforce settling in Oakland County. Today, Troy houses 41 of the state’s 330 dedicated automotive R&D facilities, solidifying its role as a critical node in the global mobility supply chain.

As traditional manufacturing evolved, Troy actively positioned itself at the vanguard of the Fourth Industrial Revolution. In 1999, the technology business association Automation Alley was founded in Troy to drive regional growth and assist companies in navigating the transition toward cyber-physical systems. Recognizing the rapid shift toward digital manufacturing, the state designated Automation Alley as Michigan’s official Industry 4.0 knowledge center. This designation fostered massive localized R&D in artificial intelligence, 3D printing, autonomous guided vehicles, and robotics integration. The presence of the World Economic Forum’s United States Centre for Advanced Manufacturing, hosted at Automation Alley, further elevated Troy’s status as a global leader in production technology.

Simultaneously, the migration of white-collar professionals to the suburbs in the 1960s and 1970s brought a corresponding shift in financial institutions and corporate services. Corporations like Kelly Services, which evolved from a Detroit-based office service in 1946 into a global workforce solutions provider, established massive headquarters in Troy. Financial titans such as Standard Federal Bank and Flagstar Bank constructed prominent administrative footprints along Big Beaver Road, taking advantage of the centralized location and robust infrastructure. This influx created a dense ecosystem of financial technology (FinTech) development, mortgage underwriting innovation, and professional services software engineering.

Finally, rapid population growth in Oakland County necessitated advanced medical infrastructure. The establishment and continuous expansion of facilities like Beaumont Hospital in Troy (now integrated into the Corewell Health system) created an ecosystem capable of supporting clinical research and medical device engineering within the city borders. This clinical footprint attracted biomedical engineers, specialized physicians, and medical device startups to the immediate area to conduct clinical trials and translational research, further diversifying the city’s innovation portfolio.

Troy, Michigan Industry Case Studies

The following case studies synthesize the historical context of Troy, Michigan, the 2026 federal One Big Beautiful Bill Act (OBBBA) requirements, the new Michigan Public Acts 186 and 187 regulations, and recent Tax Court jurisprudence. They demonstrate how distinct, localized industries can secure substantial tax benefits through meticulous compliance.

Automotive Engineering: Tier 1 EV Drivetrain Supplier

The legacy of automotive engineering in Troy stems from the 1960s outward migration of suppliers seeking expansive testing facilities along the I-75 corridor. Today, this infrastructure supports cutting-edge mobility research.

A Troy-based Tier 1 automotive supplier with 800 employees and $300 million in gross receipts initiates a multi-year project to design a highly advanced, lightweight composite housing for an electric vehicle (EV) drivetrain. The engineering team faces significant technical uncertainty regarding the composite’s ability to dissipate thermal loads generated by high-voltage EV motors while maintaining structural integrity during rigorous crash simulations.

To meet the federal four-part test under Internal Revenue Code (IRC) Section 41, the supplier documents the permitted purpose of improving EV performance. The research relies heavily on the hard sciences of materials engineering and thermodynamics. To overcome the uncertainties regarding thermal dynamics, the firm utilizes a systematic process of experimentation through iterative finite element analysis (FEA) and physical prototype crash testing. To avoid the penalization seen in the Phoenix Design Group Tax Court case, the firm’s chief engineers contemporaneously document the exact baseline metrics and the hypothesized thermal failure points before any physical testing begins.

Because the firm operates with over $31 million in average annual gross receipts, it does not qualify as a small business under the retroactive provisions of the OBBBA. Instead, the firm files its 2026 return electing to fully and immediately expense its current-year domestic R&E under the newly restored Section 174A. Concurrently, it accelerates the recovery of its unamortized capitalized costs from 2022 through 2024 via the automatic accounting method change established in IRS Revenue Procedure 2025-28, choosing to split the remaining deduction ratably over 2025 and 2026 to optimize its cash flow.

At the state level, as a C-Corporation paying the Corporate Income Tax (CIT), the supplier qualifies as a Large Business under Michigan Public Act 186. Assuming the firm incurred $15 million in Michigan Qualified Research Expenses (MQREs) in Troy during 2025, and its base amount (the average of 2022-2024) was $10 million, the state credit calculation yields a 3% credit on the $10 million base ($300,000) and a 10% credit on the $5 million excess ($500,000). The total state credit amounts to $800,000. To secure this, the firm strictly adheres to the April 1, 2026, deadline to file its tentative claim using actual expenses through the Michigan Treasury Online portal.

Robotics and Industry 4.0: Autonomous Mobile Robot (AMR) Integration

As traditional manufacturing contracted, Troy pivoted to Industry 4.0, largely driven by the establishment of Automation Alley, which cultivated a dense ecosystem of robotics and cyber-physical systems development.

A robotics integration startup located in a light-industrial park off Stephenson Highway, employing 120 people with $18 million in gross receipts, is developing a proprietary computer-vision algorithm. This algorithm allows Autonomous Mobile Robots (AMRs) to dynamically navigate highly congested, unstructured factory floors without relying on pre-mapped magnetic floor tape or LiDAR bounds.

Software development is explicitly treated as an eligible research and experimental expenditure under Section 174. The integration firm qualifies as an eligible small business under the OBBBA’s $31 million gross receipts threshold. Taking advantage of the retroactive transition rules, the firm elects to amend its 2022, 2023, and 2024 tax returns by the strict July 4, 2026 deadline, recouping previously capitalized R&D costs for an immediate cash refund.

However, because the firm’s total QREs exceed $1.5 million, they are not exempt from the stringent new Form 6765 Section G reporting requirements that became mandatory in 2026. The firm must meticulously detail the algorithmic component under column 49(c), specify the exact AI learning models tested to overcome spatial uncertainty, and provide an exact wage allocation for the software engineers directly engaged in the coding and testing phases.

Filing as a flow-through entity, the firm qualifies for the Small Business tier under Michigan Public Act 187. Assuming $3 million in MQREs and a base amount of $1 million, the calculation yields 3% on the base ($30,000) and 15% on the $2 million excess ($300,000). Because the combined calculation yields $330,000, the firm hits the statutory small business cap and is limited to a maximum credit of $250,000. Following the issuance of the state proration notice, the firm claims the finalized credit against its withholding tax return (Form 5081), effectively reducing its periodic withholding payments.

Healthcare & Medical Technology: Biometric Wearable Collaboration

The rapid expansion of the Beaumont Hospital campus in Troy created a nucleus for clinical research, drawing biomedical engineering talent to the region.

A Troy-based medical device manufacturer is developing a non-invasive, continuous blood-glucose monitoring wearable for pediatric patients. The firm lacks the specialized clinical facilities to validate the sensor’s optical data against actual pediatric blood samples in a controlled environment. Consequently, the firm enters into a formal, written agreement with researchers at Oakland University to conduct human trials and refine the sensor’s calibration algorithms.

The manufacturer meets the federal four-part test through the rigorous application of biological sciences and optical engineering. The contract research expenses paid to the university qualify as QREs, although under IRC Section 41, only 65% of standard contract research expenses (or up to 75% for specific research consortiums) are generally eligible for the credit calculation. To align with the Seventh Circuit’s ruling in Little Sandy Coal v. Commissioner, the manufacturer ensures that the wages of their internal clinical trial directors—who provide direct supervision and support to the university project but do not physically build the hardware—are captured and accurately placed in the numerator of the “substantially all” 80% fraction.

At the state level, the firm unlocks a highly lucrative incentive. Because the firm formalized a written agreement with a Michigan public university for research conducted within the state, they qualify for the University Collaboration Bonus under Public Act 186. In addition to their standard corporate CIT credit, they can claim an extra 5% on the MQREs generated specifically by the university partnership. If the firm spent $3 million on the collaboration, they generate an additional $150,000 bonus credit. This bonus sits entirely outside the standard taxpayer caps, subject only to its own $200,000 annual limit, providing a powerful mechanism to subsidize advanced clinical testing.

Financial Services and FinTech: Internal Use Software (IUS)

During the 1970s and 1980s, Troy aggressively courted major white-collar institutions, offering customized corporate campuses that the dense downtown Detroit landscape could not support. Financial and staffing titans constructed massive administrative footprints, turning Troy into a regional banking epicenter.

A national mortgage lender headquartered in Troy initiates the development of a proprietary, blockchain-based risk assessment platform to automate the underwriting of subprime commercial real estate loans. The software is built solely for the bank’s internal loan officers and will not be sold, leased, or licensed to third parties.

Software developed for internal administrative or operational functions is classified under federal law as Internal Use Software (IUS). The IRS subjects IUS to a significantly higher threshold of scrutiny. In addition to the standard four-part test, the FinTech firm must satisfy a three-part “High Threshold of Innovation” test: the software must be highly innovative, resulting in a substantial reduction in cost or improvement in speed; the development must involve significant economic risk; and the software must not be commercially available. Because the blockchain integration involves novel cryptographic hashing specific to the bank’s commercial underwriting criteria, it passes the test. On Form 6765 Section G, the firm must distinctly categorize this project under Column 49(e) as “A. IUS”. To comply with the OBBBA, the firm must capitalize any foreign contractor costs over 15 years while electing immediate Section 174A expensing for its Troy-based developers.

Assuming the bank operates as a unitary business group (UBG), the Michigan Department of Treasury mandates that the UBG itself is considered the singular taxpayer. The bank must calculate its base amount and current-year MQREs by aggregating the qualified wages and cloud-computing costs across all legal entities within the UBG that performed the software development within Michigan. Given the massive scale of the enterprise, the UBG will easily cap out at the $2,000,000 maximum state credit limit allocated to large businesses.

Architecture and Structural Engineering: Golden Corridor High-Rise

The skyline of Troy is a testament to decades of aggressive commercial zoning. The constant demand for Class-A office space and mixed-use lifestyle destinations along Big Beaver Road cultivated a dense local ecosystem of architectural and structural engineering firms.

A Troy-based structural and mechanical engineering firm is contracted by a commercial real estate developer to design the HVAC and load-bearing framework for a new 15-story, mixed-use tower on Big Beaver Road. The building design features a highly irregular cantilevered glass facade and aims for unprecedented LEED Platinum energy efficiency, creating massive technical uncertainty regarding airflow routing and structural load distribution under heavy Michigan snow loads.

The firm conducts extensive computational fluid dynamics (CFD) and structural modeling to resolve these uncertainties. However, the primary federal hurdle for the firm is the Meyer, Borgman & Johnson precedent regarding “funded research” under IRC Section 41(d)(4)(H). If the firm operates under a standard fixed-fee contract where they are paid merely for delivering blueprints that meet building codes, the IRS will disallow the credit, viewing the research as funded by the client. To survive an audit, the engineering firm’s legal counsel structures the contract with strict contingency clauses: payment is explicitly tied to the successful validation of the HVAC energy efficiency metrics, and the firm retains the intellectual property rights to the novel airflow routing designs. Furthermore, to avoid the penalties seen in the Phoenix Design Group case, the firm meticulously documents the specific engineering alternatives evaluated during the schematic design phase, proving they engaged in a process of experimentation rather than routine engineering.

As an LLC taxed as a partnership (a flow-through entity), the firm is eligible for the Michigan state credit against its withholding tax liability. After ensuring all engineering hours logged by their Troy-based staff are accurately tracked and segregated from non-qualified drafting time, the firm files its tentative claim by the statutory deadline. Upon receiving the proration adjustment notice from the Treasury, the firm’s partners seamlessly reduce their periodic withholding payments by their allocated share of the finalized credit.

Detailed Analysis: Federal R&D Tax Credit Requirements

The federal R&D tax credit, established under Internal Revenue Code (IRC) Section 41 and linked inherently to the expense deduction rules of IRC Section 174, forms the bedrock of corporate innovation subsidies in the United States. The regulatory environment governing these sections has experienced extreme volatility, culminating in the passage of the One Big Beautiful Bill Act (OBBBA) in July 2025, which radically altered the compliance and financial landscape for 2025, 2026, and beyond.

IRC Section 41: The Statutory Framework and the Four-Part Test

To qualify for the federal R&D tax credit, a taxpayer must demonstrate that their research activities meet the rigid statutory definition of “qualified research.” This requires satisfying a four-part test that must be applied separately to each business component—defined as a product, process, computer software, technique, formula, or invention held for sale, lease, or license, or used by the taxpayer in their trade or business.

1. Permitted Purpose (The Business Component Test): The research must be undertaken for the purpose of discovering information that is intended to be useful in the development of a new or improved business component. The improvement must relate to functionality, performance, reliability, or quality. Research undertaken merely for aesthetic or cosmetic improvements does not qualify.
2. Elimination of Uncertainty: The taxpayer must undertake activities to discover information that eliminates technical uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the business component, or the appropriate design of the component.
3. Process of Experimentation: Substantially all of the research activities must constitute elements of a process of experimentation for a qualified purpose. This is generally interpreted to mean that 80% or more of the activities must involve a systematic process of identifying the uncertainty, formulating one or more hypotheses, testing and analyzing those hypotheses (through modeling, simulation, or physical prototyping), and refining or discarding the hypotheses based on the results.
4. Technological in Nature: The process of experimentation must fundamentally rely on principles of the hard sciences, specifically physical or biological sciences, engineering, or computer science. Research based on the social sciences, arts, or humanities is strictly excluded.

In addition to meeting the four-part test, the expenses incurred must be categorized as Qualified Research Expenses (QREs). Section 41(b) defines QREs as the sum of in-house research expenses (wages for direct research, direct supervision, and direct support, as well as supplies consumed in the R&D process) and a specified percentage of contract research expenses paid to third parties.

IRC Section 174 and 174A: Expensing vs. Capitalization

Historically, IRC Section 174 provided taxpayers the option to immediately deduct research and experimental (R&E) expenditures in the year they were incurred, providing a vital cash flow mechanism for innovative firms. However, the Tax Cuts and Jobs Act (TCJA) of 2017 fundamentally disrupted this system. For tax years beginning after December 31, 2021, the TCJA mandated that all specified R&E expenditures be capitalized and amortized over five years for domestic research and fifteen years for foreign research. This capitalization requirement artificially inflated taxable income and created severe liquidity constraints for R&D-intensive businesses.

The enactment of the One Big Beautiful Bill Act (OBBBA) in July 2025 represented a massive legislative pivot. The OBBBA introduced IRC Section 174A, which restored the ability to fully and immediately deduct domestic R&E expenditures for tax years beginning after December 31, 2024.

To address the capitalized costs trapped on balance sheets from 2022 to 2024, the IRS issued Revenue Procedure 2025-28, which outlines complex transition mechanisms and accounting method changes. For large businesses, the guidance provides an automatic method change allowing taxpayers to elect to accelerate the deduction of remaining unamortized domestic research costs, spreading the recovery entirely in 2025 or ratably over 2025 and 2026.

Conversely, qualified small businesses—defined under the Section 448(c) gross receipts test as having average annual gross receipts of $31 million or less over the prior three years—were granted a unique retroactive option. These small businesses may elect to apply Section 174A retroactively to 2022, 2023, and 2024 by filing amended returns, unlocking immediate cash refunds. This election must be made comprehensively across all open applicable years by the strict deadline of July 6, 2026.

IRC Section 280C: Coordination of Credits and Deductions

To prevent taxpayers from receiving a “double benefit” on the same dollar of R&D spending, IRC Section 280C(c) requires coordination between the Section 41 credit and the Section 174A deduction. Taxpayers generally have two options. The first option is to claim the full, gross research credit but subsequently reduce their domestic R&E expense deduction by the exact amount of the credit claimed, which effectively increases taxable income.

The alternative is to make an annual, irrevocable election under Section 280C(c)(3) to claim a “reduced credit.” Under this election, the taxpayer calculates the gross credit and then reduces it by the maximum corporate tax rate, but they are permitted to retain their full R&E expense deduction. With the OBBBA’s restoration of immediate expensing, the value of the upfront deduction is significantly magnified, leading tax strategists to anticipate that the vast majority of corporations will opt for the reduced credit election to preserve their full Section 174A deductions.

Enhanced Compliance: Form 6765 and Section G

As the financial magnitude of R&D tax incentives has expanded, the IRS has drastically increased its scrutiny of claims to combat perceived abuse. This heightened enforcement is codified in the restructuring of IRS Form 6765 (Credit for Increasing Research Activities). Starting with the 2026 tax year (for returns filed in 2027), the IRS has made the completion of Section G mandatory for the majority of corporate taxpayers.

Section G fundamentally alters the reporting burden by shifting from aggregate expense reporting to granular, project-level documentation. Taxpayers must list up to 50 of their largest business components that generate at least 80% of their total QREs. For each component, the taxpayer must categorize the type of component (product, process, or software), describe the specific technical information sought, and provide an exact allocation of wages, supplies, and contract research expenses dedicated solely to that project.

The IRS has provided limited safe harbors from Section G. Specifically, qualified small businesses electing the payroll tax credit under IRC Section 41(h) are exempt. Additionally, taxpayers whose total QREs (determined at the controlled group level) are $1.5 million or less, and whose average annual gross receipts are $50 million or less, may omit Section G when filing an original return. For all other enterprises, the failure to contemporaneously track employee time and supply costs by individual project will result in the inability to validly file Form 6765.

Detailed Analysis: Michigan State R&D Tax Credit Requirements

While the federal landscape shifted under the OBBBA, the state of Michigan undertook its own legislative overhaul to remain competitive in the national race for technological investment. Recognizing that Michigan had been operating at a competitive disadvantage since the expiration of the Michigan Business Tax (MBT) R&D incentives in 2012, the state legislature mobilized to pass comprehensive reform. Signed into law by Governor Gretchen Whitmer on January 13, 2025, House Bills 5100 and 5101 (Public Acts 186 and 187 of 2024) established a robust, refundable R&D tax credit effective for tax years beginning on or after January 1, 2025.

Eligibility, MQREs, and the Base Amount

The Michigan credit is fundamentally an incremental incentive, designed to reward companies that increase their research spending within the state rather than merely subsidizing baseline operations. To qualify, a business must incur Michigan Qualified Research Expenses (MQREs) that exceed a predefined historical base amount.

Michigan intelligently streamlined compliance by defining MQREs through a direct reference to the federal definition of qualified research expenses under IRC Section 41(b). Consequently, wages, supplies, and contract research costs that qualify for the federal credit will generally qualify for the state credit, subject to one critical geographic limitation: the underlying research activities must be physically conducted within the borders of Michigan. Expenses incurred for out-of-state research are strictly excluded from the calculation.

The base amount serves as the threshold for the incremental reward. Michigan defines the base amount as the average annual amount of MQREs incurred by the taxpayer during the three calendar years immediately preceding the calendar year for which the credit is being claimed. Notably, unlike the federal Alternative Simplified Credit (ASC) which reduces the base amount by 50%, Michigan requires taxpayers to exceed the full 100% of their historical three-year average before the higher incremental credit rates apply. If a business is a new entity or had no prior MQREs in the state, the base amount is zero, allowing them to claim the credit on all current-year expenses.

Credit Tiers, Caps, and University Collaboration

To balance the desire to attract massive corporate investment with the need to support local startups—while protecting the state’s fiscal budget—the legislature constructed a tiered credit system based on employee headcount and instituted a hard statewide cap. The total aggregate amount of all R&D credits that the Department of Treasury can award to all claimants is strictly limited to $100 million per calendar year.

The unadjusted credit is calculated using a bifurcated rate structure:

The University Collaboration Bonus: A unique feature of the Michigan legislation is its explicit intent to bridge the gap between academic theory and commercial application. Taxpayers of any size can claim an additional 5% bonus credit on MQREs incurred pursuant to a formal, written collaboration agreement with a qualifying Michigan research university. A qualifying institution is defined as a public university under the state constitution or an independent nonprofit college located in Michigan. This bonus credit is capped at an additional $200,000 per year per taxpayer, meaning a large business could theoretically secure up to $2.2 million, and a small business up to $450,000 in total state credits.

Administration: Tentative Claims and Proration Mechanics

The administrative mechanics of claiming the Michigan R&D credit are highly specific and completely detached from the standard tax return filing process. To secure the credit, an eligible Corporate Income Tax (CIT) taxpayer or a flow-through entity (such as an S-corporation or partnership subject to withholding) must first submit a “tentative claim” identifying their unadjusted credit amount.

This tentative claim must be filed through the Michigan Treasury Online (MTO) portal. The deadlines are rigid and absolute: for R&D expenses incurred during the 2025 calendar year, all claimants (including fiscal-year filers) must submit their tentative claims no later than April 1, 2026. For expenses incurred in 2026 and all subsequent years, the deadline accelerates to March 15 of the following year. The Department of Treasury has explicitly stated that tentative claims will not be accepted after the statutory deadline, and no extensions will be granted. Furthermore, because these claims are used to manage the statewide budget, they must be calculated using actual, finalized expenses, not estimates.

Once the application window closes, the Treasury aggregates all tentative claims. If the total unadjusted claims exceed the $100 million cap, the Treasury will apply statutory proration provisions to systematically reduce the allowed credit for claimants. The Treasury will then issue a tentative claim adjustment notice to taxpayers. Only after this notice is received can a C-corporation claim the finalized, adjusted credit on its CIT return, or a flow-through entity claim the credit on its annual withholding tax return (Form 5081) and reduce its periodic withholding payments accordingly.

A critical planning consideration for Michigan businesses is the state’s decoupling from the federal OBBBA. While the federal government now allows immediate expensing under Section 174A, Michigan’s corporate income tax code continues to require the five-year capitalization and amortization of R&D costs. Consequently, businesses will report higher state taxable income compared to federal taxable income. The refundable nature of the new Michigan R&D credit serves as an essential strategic tool to offset this unfavorable state-level timing difference.

Detailed Analysis: Federal Tax Court Jurisprudence and IRS Guidance

The statutory language of IRC Section 41 provides the foundation for the R&D credit, but the actual boundaries of eligibility are continually defined and reshaped by the United States Tax Court and federal appellate courts. Recent enforcement trends indicate a highly aggressive posture by the IRS, transitioning from challenging the calculation methodologies to fundamentally attacking the qualification of the underlying research activities. Taxpayers must structure their R&D initiatives and documentation protocols in strict accordance with these recent judicial precedents.

Little Sandy Coal v. Commissioner (2023): Redefining “Substantially All”

The case of Little Sandy Coal Company, Inc. v. Commissioner represents one of the most consequential R&D tax decisions in recent history. The taxpayer, the parent of a shipbuilding company, claimed credits for the design and construction of 11 first-in-class vessels. The IRS disallowed the credits, and the Tax Court upheld the denial. The taxpayer appealed to the Seventh Circuit Court of Appeals, which affirmed the denial primarily due to the taxpayer’s failure to provide a principled, contemporaneous method to track employee time and substantiate which specific activities constituted experimentation.

However, the Seventh Circuit’s opinion provided a massive, taxpayer-favorable clarification regarding the “substantially all” rule. Under Section 41, 80% or more of a taxpayer’s research activities must constitute elements of a process of experimentation. During the trial, the IRS argued a restrictive interpretation: that hours spent by employees conducting “direct supervision” and “direct support” of research should be placed in the denominator of the fraction (total research activities) but excluded from the numerator (experimentation activities), making it mathematically nearly impossible for many firms to reach the 80% threshold.

The Seventh Circuit explicitly rejected the IRS and Tax Court’s construction. The appellate court ruled that costs associated with the direct support and direct supervision of research activities can constitute elements of a process of experimentation and are eligible for inclusion in both the numerator and the denominator, provided the costs qualify as deductible R&E under Section 174.

Simultaneously, the court firmly closed a loophole regarding the “novelty” of a product. The taxpayer had argued that because the vessels were entirely new, the entire construction process was inherently experimental. The court rejected this heuristic, stating that the novelty of a business component does not automatically satisfy the substantially all test; taxpayers must prove that the activities themselves represent systematic experimentation, regardless of the final product’s innovation level.

Meyer, Borgman & Johnson, Inc. v. Commissioner (2024): The Funded Research Trap

The Eighth Circuit’s decision in Meyer, Borgman & Johnson, Inc. (MBJ) v. Commissioner serves as a stark warning to engineering, architecture, and contracting firms. MBJ, a structural engineering firm, sought R&D credits for the creation of complex construction documents and structural designs. The IRS denied the credits, invoking the “funded research” exclusion under IRC Section 41(d)(4)(H), which dictates that research funded by any grant, contract, or another person is ineligible for the credit.

Under Treasury Regulations, research is only considered “unfunded” (and thus eligible) if the payment to the researcher is contingent upon the success of the research, and the researcher retains substantial rights to the results. MBJ operated under fixed-price contracts, arguing that this inherently transferred economic risk to them; if their designs failed local building codes, they would have to bear the cost of redesigning, and thus payment was contingent on success.

The Eighth Circuit vehemently disagreed, affirming the Tax Court’s denial. The court scrutinized the contract language and found that MBJ was paid to deliver design services that met general professional standards, not to achieve a specific, successful research outcome. The contracts lacked explicit clauses demanding MBJ refund the client if specific technical benchmarks were missed. The court established a rigid standard: being paid for time, effort, and standard deliverables—rather than for the successful resolution of a scientific unknown—constitutes funded research. The absence of explicit terms placing the risk of research failure squarely on the taxpayer proved fatal to the claim.

Phoenix Design Group, Inc. v. Commissioner (2024): The Standard for Technical Uncertainty

Decided in late 2024, Phoenix Design Group, Inc. v. Commissioner further tightened the documentation requirements for engineering firms. Phoenix Design Group (PDG), a multidisciplinary firm focused on mechanical, electrical, plumbing, and fire protection (MEPF) systems, claimed credits across 238 projects. Due to the volume, the Tax Court reviewed a sample of three projects.

The court ruled entirely in favor of the IRS, denying the credits and heavily penalizing PDG with accuracy-related penalties. The fatal flaw in PDG’s claim was a failure to satisfy the “Elimination of Uncertainty” and “Process of Experimentation” prongs of the four-part test. PDG followed a standard six-stage design process common in the construction industry, gathering requirements, creating block diagrams, and adjusting designs to comply with building codes.

The court ruled that this process represented routine engineering, not qualified research. Crucially, the court found that PDG failed to identify specific technological uncertainties at the outset of the projects. General uncertainty about design challenges or how to route HVAC ducts to comply with architectural constraints is insufficient. The Tax Court precedent now demands that taxpayers must contemporaneously document the specific scientific or technological questions they intend to answer before beginning development, and clearly log the specific design alternatives that were systematically evaluated to resolve those questions.

Smith v. Commissioner: A Glimmer of Hope for Structured Contracts

While Meyer, Borgman & Johnson and Phoenix Design Group paint a bleak picture for engineering and architectural claims, the ongoing case of Smith v. Commissioner offers a strategic roadmap for survival. In Smith, shareholders of an architectural design firm claimed credits for ambitious projects, including the Kingdom Tower in Saudi Arabia. The IRS attempted to use the Meyer precedent to achieve a summary judgment, arguing the research was funded because the firm faced no financial risk and relinquished substantial rights.

However, the Tax Court denied the IRS’s motion for summary judgment, allowing the case to proceed to trial. The taxpayer successfully countered the IRS by pointing to highly specific contract terms that explicitly tied milestone payments to the approval of complex research phases, and leveraged foreign copyright laws to argue they retained a substantial stake in the intellectual property. This ruling indicates that courts will respect claims from the architecture and engineering sectors if the taxpayers proactively craft contingency-laden contracts that explicitly link payment to research outcomes and meticulously document their risk retention.

Final Thoughts

The confluence of the One Big Beautiful Bill Act at the federal level and Public Acts 186 and 187 in Michigan represents a historic financial inflection point for innovative enterprises located in Troy. The restoration of immediate expensing under IRC Section 174A vastly improves corporate liquidity by removing the punitive five-year amortization schedule, while Michigan’s new $100 million refundable credit program provides vital relief for state-level timing disconnects and aggressively incentivizes university partnerships.

However, as demonstrated by the relentless IRS scrutiny surrounding Form 6765 Section G and the strict judicial standards established in Little Sandy Coal, Meyer, Borgman & Johnson, and Phoenix Design Group, these financial rewards are strictly reserved for taxpayers who elevate their compliance standards. Companies must implement rigorous, contemporaneous documentation protocols to capture specific technical uncertainties before a project begins, accurately track employee time to satisfy the “substantially all” requirement, and strategically align their legal contracts to prove economic risk. By mastering the intersection of these complex regulatory frameworks, the diverse industries operating within Troy’s Golden Corridor can heavily subsidize the technological advancements required to maintain their dominance in the global market.

The information in this study is current as of the date of publication, and is provided for information purposes only. Although we do our absolute best in our attempts to avoid errors, we cannot guarantee that errors are not present in this study. Please contact a Swanson Reed member of staff, or seek independent legal advice to further understand how this information applies to your circumstances.