Geosyntec Consultants, Inc. v. United States

April 15, 2013 | Dave Lee Brannon, U.S. Magistrate Judge | Southern District of Florida | Docket No. 9:12-cv-80334

 

Short Summary

Geosyntec Consultants, Inc. is an engineering firm that works with both public and private clients on environmental and infrastructure projects. The company filed a lawsuit against the United States after the IRS denied its claim for over $1.6 million in federal research tax credits. The heart of the dispute was whether the research Geosyntec performed for clients under certain contracts could qualify for the credit. Or whether those projects were “funded” by their clients; meaning Geosyntec wouldn’t be eligible for the tax benefit. The court reviewed the details of Geosyntec’s contracts and ultimately sided with the government, ruling that because Geosyntec’s clients agreed to pay for the research regardless of the outcome, the work counted as funded research. This meant Geosyntec could not claim the research tax credits for those particular projects. 

Key Issues

• Was Geosyntec’s research “funded” by its clients under federal tax law? 

  The first major issue was whether the research work Geosyntec performed for its clients was considered “funded” within the meaning of the federal tax code. Under IRS rules, research is “funded” if a third party, such as a client or government agency, agrees to pay for it, which would make those expenses ineligible for the research tax credit. The court had to analyze if the payments Geosyntec received from its clients fit this definition and whether the company could rightfully claim the tax credit for those projects. 

• Did Geosyntec or its clients bear the financial risk if the research failed? 

  Another central question was about financial risk: who shouldered the loss if the research didn’t work out? The court needed to look at the contract terms to decide whether Geosyntec only received payment if the research was successful, or if the clients paid for the work no matter the result. If Geosyntec took on the risk of failure; meaning they would not get paid unless the project succeeded, the research could qualify for the credit. But if clients paid regardless of outcome, the work was seen as funded and not eligible. 

• How do the details of the contracts affect whether the research counts as “funded”? 

  The final key issue was how the specific language and structure of Geosyntec’s contracts lined up with IRS rules on “funded research.” The court had to examine things like payment schedules, requirements for deliverables, and any conditions tied to performance. This meant interpreting whether the contracts required a successful outcome before payment, or if Geosyntec was guaranteed to be paid simply for performing the research, regardless of the results. The answer to this question would determine whether the tax credits could be claimed. 

Primary Holding

The court decided that Geosyntec was not entitled to claim the federal research tax credit for the projects in question because the research was considered “funded” by its clients. The court’s main reasoning was that under the contracts, Geosyntec’s clients were required to pay for the research regardless of whether the work was successful or produced the desired results. This meant Geosyntec did not bear the financial risk if the research failed, their clients did. According to IRS rules, when a company is paid for research work no matter the outcome, the research is considered “funded” and is not eligible for the credit. The court carefully reviewed the contract terms and found that Geosyntec’s payment was not tied to the success of its research, but rather to simply performing the work. For these reasons, the court affirmed that Geosyntec could not receive research tax credits for these projects. 

Specific Rulings 

1. Whether Geosyntec’s Research Was “Funded” by Clients 

   • Ruling: The court determined that the research work Geosyntec performed under its contracts with both the Delaware Solid Waste Authority (DSWA) and Waste Management, Inc. (WM) was “funded” by these clients. As a result, Geosyntec was not allowed to claim the federal research tax credit for these projects.
   • Reasoning: The court carefully examined the contract terms and found that Geosyntec’s clients agreed to pay for the research work regardless of whether the research was successful or led to the results the clients were hoping for. In other words, Geosyntec would receive payment simply for carrying out the work described in the contracts, even if the research did not meet its intended goals. The court explained that, according to IRS regulations, if a company is paid for research without any connection to the project’s success, the research is considered “funded” by the client. This is important because, under the law, only research that is not funded by an outside party is eligible for the tax credit. The court also pointed out that Geosyntec did not bear the financial risk of failure; if the research didn’t work, the clients still had to pay. 
     
     

2. Interpretation of Contract Terms under IRS “Funded Research” Rules 

   • Ruling: The court concluded that the language in Geosyntec’s contracts did not require successful results or the client’s acceptance of deliverables as a condition for payment. Instead, the contracts made payment dependent simply on Geosyntec completing the agreed-upon tasks.
   • Reasoning: In its analysis, the court focused on several details within the contracts. First, there was no clause stating that payment would only be made if the research achieved certain outcomes or was accepted by the client after inspection. Instead, the contracts stated that as long as Geosyntec performed its services according to professional standards and submitted the necessary invoices, it would be paid. The clients could dispute invoices for things like errors or lack of documentation, but not simply because the research failed to deliver the hoped-for result. Unlike some contracts that tie payment to specific milestones or deliverables that must be accepted by the client, these agreements guaranteed payment if the work was performed. The court emphasized that this arrangement clearly fits the IRS definition of “funded research”; where a third party finances the research without requiring a particular result.

Helpful Takeaways for Taxpayers 

• Review Contract Terms Carefully Before Claiming the R&D Tax Credit 

  This case shows that the specific wording and payment structure in your contracts matter a great deal when it comes to qualifying for the research tax credit. If your contract states that you will be paid simply for performing research work, no matter what the outcome is, then the IRS is likely to treat that research as “funded” by your client, making it ineligible for the credit. Before claiming the R&D tax credit, always review your contracts to check if payment is tied to achieving a successful result or delivering a specific innovation. This can be the difference between a valid claim and a costly denial. 

• Bear the Financial Risk to Secure the Tax Credit 

  The court made it clear that to claim the R&D tax credit, a business must truly bear the risk that the research might not succeed. If your company gets paid only if it achieves certain results, you are taking on financial risk; exactly what the IRS looks for in credit-eligible research. On the other hand, if your contracts guarantee payment just for effort, even if the research fails, the work will likely be considered “funded” and won’t qualify. Structuring contracts so that payment is contingent on success, rather than just activity, increases your chances of receiving the credit. 

• Carefully Document How Payment Depends on Research Outcomes 

  Proper documentation is critical. If your contract or supporting paperwork does not clearly state that payment is contingent upon achieving specific research outcomes or milestones, you risk having your credit claim denied. Ambiguous or generic contract language can work against you, even if your actual business practice is more rigorous. To avoid misunderstandings with the IRS, make sure your contracts and invoices show a clear link between payment and research success, not just completion of work. 

• Consult With Tax Professionals Before Finalizing Contracts 

  The rules around “funded research” and the R&D tax credit are complex and highly technical. Consulting with a tax advisor or legal professional before signing any contract involving research or development work is a smart move. They can help you spot any red flags in your contracts and suggest adjustments to language or payment terms that may protect your eligibility for valuable tax incentives. Getting advice early in the process is much easier and cheaper than trying to fix problems later if the IRS challenges your claim. 

• Regularly Reassess Eligibility When Contract Terms or Business Models Change 

  Business practices and contract formats evolve over time, especially as you take on new types of projects or work with different clients. This case is a reminder to periodically review your eligibility for the research tax credit. Not just once, but whenever there are changes to your contracts or business model. What worked for a previous project may not apply to a new one, so keeping your contracts and credit claims in sync can help you avoid surprises during an audit and ensure you’re always making the most of available tax benefits.