Navigating the Evolving Landscape of R&D Tax Credits: Mostly A Tough Year for Taxpayers
For companies claiming the Research & Development (R&D) tax credit, recent court rulings have largely reinforced the IRS’s strict stance—except for one taxpayer-friendly decision. Over the past year, multiple cases have clarified key aspects of eligibility, documentation, and the "funded research" rule, with most outcomes favoring the IRS. Here’s what you need to know.
1. Meyer, Borgman & Johnson, Inc. v. Commissioner (May 6, 2024)
TL;DR: If your research is "funded," you’re out of luck for the credit.
Why It Matters: The Eighth Circuit affirmed that if research expenses are reimbursed by clients or third parties, they do not qualify for the R&D credit under Section 41(d)(4)(H). This ruling reinforces the need for businesses to carefully assess their contracts and payment structures when claiming the credit.
2. Kapur et al. v. Commissioner (March 26, 2024)
TL;DR: No shortcuts—expect scrutiny on every project.
Why It Matters: The Tax Court ruled that companies cannot limit IRS review to a few hand-picked projects, even if those projects were used in a statistical sample to estimate R&D credits. This means taxpayers must ensure they have solid documentation for all claimed activities, not just a representative subset.
3. Phoenix Design Group, Inc. v. Commissioner (December 23, 2024)
TL;DR: Not all engineering work qualifies—experimentation is key.
Why It Matters: This case reaffirmed that routine engineering work without a process of experimentation does not meet the IRS definition of qualified research. Engineering and design firms must clearly demonstrate uncertainty and systematic testing to support their claims.
4. Smith v. Commissioner (December 18, 2024)
TL;DR: A rare win for taxpayers on the "funded research" issue.
Why It Matters: The Tax Court denied the IRS’s motion for summary judgment, allowing the taxpayer to argue that their research was not truly "funded." This case provides some hope that not all client-funded work is automatically ineligible and that there is room to argue case-specific nuances.
What This Means for Taxpayers Claiming the Credit
With one taxpayer-friendly decision against a backdrop of unfavorable rulings, companies must be more diligent than ever. Here are three key takeaways:
Scrutinize Contracts: Ensure your agreements don’t indicate that research costs are reimbursed, as this could disqualify your claim.
Maintain Thorough Documentation: Be prepared to substantiate every claimed project with detailed records of uncertainty, experimentation, and expenses.
Understand the IRS’s Perspective: The IRS continues to challenge R&D claims, particularly for engineering and design firms. Careful claim preparation is essential to withstand audits.
As these cases show, the IRS remains aggressive in its enforcement, making it more important than ever for businesses to work closely with tax professionals to ensure compliance and maximize their credit potential. Not all R&D tax credit providers are built the same. Many do amazing, substantive work, but many simply don’t have a clue. And frankly aren’t even built to have a clue. The common mantra is “keep it simple stupid”, play the audit lottery on the backend, and collect their 20%. You deserve better.
See what getting simple substance looks like with Better Credits. Book a call or “skip the call” here.
