Meyer, Borgman & Johnson, Inc. v. Commissioner of Internal Revenue

May 6, 2024 | Benton, United States Court of Appeals for the Eighth Circuit Judge | Docket No. 23-1523

 

Short Summary

Meyer, Borgman & Johnson, Inc. (MBJ), a structural engineering firm, challenged the Commissioner of Internal Revenue’s denial of about $190,000 in research tax credits, arguing that its work creating structural designs qualified as “qualified research.” The main issue was whether MBJ’s research was “funded” by client contracts, which would disqualify the expenses from the credit. Both the Tax Court and the U.S. Court of Appeals determined that MBJ’s contracts did not make payment depend on the actual success of the research, meaning the research was funded. As a result, MBJ was not eligible for the tax credits, and the court’s judgment went against them 

Key Issues

• Was MBJ’s research “qualified research” under tax law? 

  The court needed to decide if MBJ’s structural design work met the definition of “qualified research” as set out in the tax code, which requires the research to be technological and useful for developing a new or improved business component. 

• Was the research “funded” by clients, making it ineligible for the credit? 

  The main dispute was whether MBJ’s research was “funded” through client contracts. Tax law excludes research from the credit if it is paid for by another party, unless payment is contingent on the research’s success. 

• Did MBJ’s contracts make payment dependent on the success of the research? 

  The court examined if MBJ only got paid when its research was successful, which would mean the research was not “funded” and would qualify for the credit. The contracts’ terms around inspection, acceptance, and quality assurance were closely reviewed to answer this question. 

Primary Holding 

The court ultimately decided that MBJ did not qualify for the research tax credit because its contracts with clients made the research “funded” under tax law, meaning the company was paid for providing professional design services rather than for the successful outcome of its research. The court reasoned that MBJ’s contracts did not make payment truly contingent on achieving specific research results, but instead required only compliance with general professional standards and building codes. Because payment was not directly tied to the success of the research, the expenses did not meet the requirements for the tax credit, and the judgment was affirmed against MBJ. 

Specific Rulings

1. Was MBJ’s research “qualified research” under tax law? 

   • Ruling: The court did not dispute that MBJ’s work could be considered technological and potentially useful for developing business components. However, this was not the deciding factor in the case. 
   • Reasoning: The real issue wasn’t whether MBJ’s work fit the definition of “qualified research.” Instead, the focus was on how the research was funded, since funded research is excluded from the tax credit. The court accepted that the research could have qualified if it wasn’t for the funding question
     
     

2. Was the research “funded” by clients, making it ineligible for the credit? 

   • Ruling: Yes, the court ruled that MBJ’s research was funded by its clients and was therefore ineligible for the credit.
   • Reasoning: If a company’s research is paid for by another party (such as a client), it is considered “funded” and cannot qualify for the tax credit—unless the payment depends on the research’s success. MBJ’s contracts did not meet this exception, so their research was classified as funded.
     
     

3. Did MBJ’s contracts make payment dependent on the success of the research? 

   • Ruling: No, the court found that MBJ’s payment was not truly contingent on the success of its research.
   • Reasoning: The court looked at MBJ’s contracts and saw that payment was based on delivering design services and meeting general professional standards—not on the actual success or acceptance of the research results. The contracts did not require MBJ to refund payments if their work did not meet certain benchmarks, nor did they tie payment to specific successful outcomes. In short, MBJ was paid for its time and work, not for producing successful research results, so the research was considered funded.

Helpful Takeaways for Taxpayers 

• Review Contract Terms Carefully. 

  If you want to qualify for research tax credits, your contracts should make payment clearly dependent on the successful outcome of the research—not just on completing services or meeting general professional standards. 

• Tie Payment to Research Outcomes. 

  For work to qualify for the R&D credit, consider including contract terms that require successful completion of defined research goals or milestones before payment is made. 

• Define Success and Acceptance Criteria. 

  Clearly outline what constitutes “success” in the research, and build in acceptance or rejection provisions based on those criteria. 

• Understand the “Funded Research” Rules. 

  Research paid for by clients or other parties is generally not eligible for the R&D credit unless payment is truly contingent on successful results. Be proactive in addressing this in contract negotiations. 

• Keep Thorough Documentation. 

  Maintain comprehensive records of your research activities, contract terms, and any communications about performance standards or payment conditions.