Thoughts on the Eighth Circuit Decision in Meyer, Borgman & Johnson

The Eighth Circuit Court of Appeals affirmed the District Court in Meyer, Borgman & Johnson, Inc. v. Commissioner (8th Circuit, May 6, 2024). MBJ, a structural engineering firm, created construction documents for building projects. Without revisions to future contracts, this decision likely drove the final nail in the coffin for taxpayers like MBJ and others who enter one-off contracts and try to claim the R&D tax credit.

Shifting Court Views on Funded Research

Historically, taxpayers conducting research under fixed-fee contracts did not have to worry about the IRS raising a funding issue. That changed in 2015 with Geosyntec Consultants, Inc. v. United States and Dynetics, Inc. & Subsidiaries v. United States. In both cases, the courts found the research was funded.

The courts began focusing on contract language. They emphasized that payment was not contingent on the success of the research. A brief moment of hope came in Populous Holdings, Inc. v. Commissioner, 2019 WL 13032526, at *2 (T.C. Dec. 6, 2019), where the Tax Court ruled in favor of the taxpayer. But in November 2020, the Tax Court in Meyer, Borgman & Johnson, Inc. v. Commissioner of Internal Revenue, Docket No. 7805-16. stated, “None of the contracts expressly or by clear implication make payment contingent on the success of MBJ’s research.”

IRS Response and Field Impact

After this decision, IRS Counsel issued a Field Attorney Advice (FAA 20223401F) on November 12, 2021. Once issued, any negotiation or attempt to resolve the issue in the field stopped. In one exam I handled, involving a taxpayer who claimed credits for designing custom conveyor systems, the IRS disallowed the claim entirely. A manager I know well admitted there was nothing he could do under this new guidance.

Further Reinforcement in Grigsby

Another setback came in United States v. Grigsby, 86 F.4^th 602, 618 (5^th Cir. 2023). The court again ruled the taxpayer’s research was funded. The judges made two important points. First, they explained that taxpayers improperly conflated “contracts for products or services” with payments contingent on successful research. Second, and more critical, they rejected the argument that fixed-price contracts are inherently risky and therefore not funded.

The Standard for Unfunded Research

Now that MBJ has lost its appeal, it seems unlikely that taxpayers will succeed with claims based on similar contract structures. Even though this is a relatively new IRS position, the cases often point back to Fairchild Industries, Inc. v. United States, 71 F.3d 868,874 (Fed. Cir. 1996) as the standard for unfunded research.

In Fairchild, the contract with the U.S. Air Force contained more than 1,000 pages of technical specifications. The taxpayer had to meet strict design, construction, quality, and performance standards. They carried risk for each line item until the Air Force accepted the final product. This degree of risk made the research unfunded in the eyes of the court.

Looking Ahead

The open question is how many specifications or performance guarantees will be enough to qualify as unfunded research in the future. Few taxpayers may want to agree that they will not be paid unless the customer approves every specification and accepts the research deliverable.

Time will tell. Eventually, a taxpayer will revise their contracts to test this standard again. When that happens, another round of disagreement will begin. Such is the world of R&D tax credit litigation.

Have questions? We’d love to talk. 

Stephen Whiteaker, CPA

As MASSIE’s Director of Controversy, Stephen specializes in audit risk assessment and quality review. His proficiency in navigating complex tax law makes him an essential resource in addressing tax technical challenges for clients. His exten...