Trinity Industries, Inc. v. United States[1]

Little Sandy Coal Company v. Commissioner of Internal Revenue[2]

Background and Facts

In the cases of Little Sandy Coal Company v. Commissioner of Internal Revenue and Trinity Industries, Inc. v. United States, the courts provided useful guidance in helping taxpayers understand the substantially all rule, as well as the need for proper documentation when claiming R&D Tax Credits. Both Little Sandy and Trinity built vessels and claimed the R&D Tax Credit, in which the IRS took exception, citing insufficient process of experimentation, and inadequate documentation. Specifically, 26 C.F.R. § 1.41-4(a)(6) states “In order for activities to constitute qualified research under section 41(d)(1), substantially all of the activities must constitute elements of a process of experimentation that relates to a qualified purpose. The substantially all requirement of section 41(d)(1)(c) and paragraph (a)(2)(iii) of this section is satisfied only if 80 percent or more of a taxpayer’s research activities, measured on a cost or other consistently applied reasonable basis…” Trinity must show that 80% of the activity on each “first in class” ship constituted a process of experimentation in order to capture the qualified research expenditures (QREs) for those projects.

The documentation presented by Trinity was far from ideal due to several reasons:

  • Trinity was retroactively gathering data from 10-15 years prior;
  • Data was previously maintained data on systems no longer in use; and
  • Hurricane Katrina destroyed most other records. 

Little Sandy had better documentation but lacked specificity in tying allocations of the engineering and management teams to specific projects.

Additionally, documentation in Little Sandy and Trinity did not provide granular detail to allow the companies to shrink-back to the next largest business component that met the substantially all rule. This meant that Little Sandy’s and Trinity’s vessels were reviewed with an all or nothing approach regarding qualification of activities and expenditures.

Holding and Implications


During the district court trial, the court reviewed 6 first in class ships. The ships ranged from completely new designs to “cafeteria-style mix and match combinations of existing elements”. After reviewing the research and development activities related to the 6 vessels, the court ruled that only 2 ships met the substantially all threshold. 

  • The Mark V – Very innovative and at the time of building, nothing like the Mark V existed in the world. The Court found that 80% of the overall costs for the Mark V were incurred in a process of experimentation.
  • The Dirty Oil Barge – First double hull ship design for Trinity, which required the heating systems and piping be completely redesigned. The Court found that 80% of the overall costs for the Mark V were incurred in a process of experimentation.
  • XFPB – Patrol boat with speed and occupancy requirements. The Court declined to qualify that the XFPB met the 80% threshold, but the Court acknowledged there was significant process of experimentation throughout. Trinity was not entitled to any QREs for the project.
  • T-AGS 60 – Some qualified research occurred, but most of the ship was not new. Trinity was not entitled to any QREs for the project.
  • Crew Rescue Boat – This project consisted of mainly integrating preexisting pieces, which was not particularly challenging for Trinity. Trinity was not entitled to any QREs for the project.
  • Hurley Dredge – Only refined design provided to Trinity from the Corps of Engineers. Trinity was not entitled to any QREs for the project. 

While the Court acknowledged that Trinity performed qualified research and development activities on all ships, without proper documentation that allowed Trinity to shrink back to only the novel components of a particular ship, 4 of 6 ships were removed from consideration for the R&D Tax Credit. 

Little Sandy

The court looked at two specific projects, the Project 720 (Apex tanker) and Project 730 (dry dock). Both undertakings were projects of first impression for Little Sandy. Additionally, the court noted that Little Sandy used extensive computer 3D modeling and engineering calculations when developing the designs for the two projects. However, the court looked at the production workers (fabricators) as supporting research activities and not being engaged in qualified research activity.

This distinction is critical to how the substantially all rule is calculated per project. The court in Little Sandy declined to take the production workers allocated wages as a qualified research expenditure (QRE), and in determining whether the petitioner met the substantially all rule, subtracted the production works QREs from the numerator while leaving their wages in the denominator along with other project expenses. This resulted in both the Apex tanker and dry dock projects failing to meet the substantially all rule.

While this case is pending appeal, it should be noted that qualified research expenses and qualified research activities are separate items, and both have substantially all tests. Qualified research activities are determined first, from which qualified research expenses flow. Additionally, when determining if the substantially all rule for qualified research activities is met, Treas. Reg. §1.41-4(a)(6) only mentions excluding the substantially all rule for qualified research expenses. This presumably means that both types of qualified services, engaged in qualified research and direct supervision or direct support of research activities which constitute qualified research, should be taken into account when determining whether the substantially all rule for qualified activities is met.

When claiming the R&D Tax Credit, the need for both contemporaneous design and accounting documentation are paramount. At MASSIE R&D Tax Credits we specialize in identifying proper substantiation documentation in addition to working with your team to improve real time documentation retention practices. The MASSIE Method reduces the burden faced by tax teams and subject matter experts at the close of a year and provides a clear roadmap to successfully claiming the R&D Tax Credit.

[1] Trinity Industries, Inc. v. United States, 691 F.Supp2d 688 (N.D. Tex 2010)

[2] Little Sandy Coal Company v. Commissioner of Internal Revenue, 2021 TC Memo 15


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