The Eight Circuit Affirmed the Tax Court's Decision; Taxpayer's research was "funded," rendering it ineligible for research tax credits.

By Emily Flemmer | Manager, Research & Development Tax Credits

In the case of Meyer, Borgman & Johnson, Inc. v. Commissioner No. 23-1523 (8th Cir. May 6, 2024), the U.S. Court of Appeals for the Eighth Circuit upheld the Tax Court’s decision denying research tax credits to a structural engineering firm because the taxpayer’s research was deemed to be “funded.” Below is a summary of the Eighth Circuit’s decision:

KBKG Insight:

The taxpayer, a structural engineering firm, sought research tax credits totaling approximately $190,000 for expenses related to creating construction documents for structural designs in building projects. However, the IRS denied these credits. The Tax Court ruled in favor of the IRS, stating that the taxpayer’s research was considered “funded” within the meaning of section 41(d)(4)(H). This provision indicates that if research is funded by a grant, contract, or another entity, the taxpayer is not eligible for research tax credits associated with that research.

The taxpayer argued that its right to payment for research was not funded because it was “contingent on the success of the research” under Treas. Reg. section 1.41-4A(d)(1). They claimed that under their contracts, they had to create designs that met specific criteria and complied with codes and regulations, and that payment was contingent on fulfilling those requirements. The taxpayer highlighted provisions permitting termination due to significant non-performance, such as “This Agreement may be terminated by either party upon not less than seven days’ written notice should the other party fail substantially to perform in accordance with the terms of this Agreement through no fault of the party initiating the termination.”

However, both the Tax Court and the Eighth Circuit disagreed with the taxpayer’s interpretation. They found that while the contracts involved economic risk, payment was not contingent on the success of the research itself. The contracts primarily focused on design services, and the taxpayer agreed to adhere to professional standards. However, compliance with codes and regulations, or meeting a general standard of care does not command success. According to the Tax Court, none of the contracts explicitly or implicitly indicated that payment was dependent on the success of the taxpayer’s research and were therefore disqualified.

Additionally, the taxpayer argued that inspection, acceptance, and quality assurance provisions in their contracts, as well as multiple project phases with client approval, meant payment was contingent on the success of the research. However, the courts found these provisions lacked the specificity required to qualify as contingent payments. Particularly, as exemplified in Fairchild Industries, Inc. v. United States, 71 F.3d 868 (Fed. Cir. 1996), the taxpayer successfully obtained research tax credits because it was required to achieve success at every stage of its research to receive payment.

Ultimately, the Eighth Circuit upheld the Tax Court’s decision, denying research tax credits to the taxpayer. The case highlights the importance of understanding the nuanced criteria for research and development tax credits and documenting research activities appropriately.

About the Author

Emily Flemmer | Manager – Research & Development Tax Credits

Emily Flemmer is a Manager with KBKG working for the Research and Development (R&D) Tax Credit department. She has over seven years of consulting experience providing federal and state R&D credit services to companies in a variety of industries. Her relevant industry experience includes but is not limited to software development, retail, aerospace and defense, manufacturing, automotive, and pharmaceuticals. Read More