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Phoenix Design Group v. Commissioner (Dec. 2024)
In December 2024, the U.S. Tax Court issued a pivotal opinion in Phoenix Design Group, Inc. v. Commissioner that should serve as a wake-up call to every company claiming the R&D tax credit. The court disallowed credits across multiple engineering projects and imposed a 20% accuracy-related penalty, citing a lack of contemporaneous documentation and no demonstrable process of experimentation under §41(d). While Phoenix Design Group was not our client, this ruling underscores the high bar taxpayers must clear to substantiate credits and the significant financial consequences of failing to do so.
Definition: Work must relate to developing a new or improved product, process, technique, invention, formula, or software for the taxpayer.
What examiners look for: Clear mapping of activities to a business component and evidence of intended improvement.
PDG outcome: Many activities were routine design or adaptation, not tied to new or improved components.
Definition: Research must be undertaken to resolve uncertainty about capability, method, or design at the outset.
What examiners look for: Documentation showing technical uncertainty existed, not just business or economic unknowns.
PDG outcome: Relied on standard calculations and historical data; no credible demonstration of real technical uncertainty.
Definition: Work must involve a systematic process such as modeling, simulation, or testing where alternatives are evaluated to resolve uncertainty.
What examiners look for: Evidence of iterative testing, hypothesis formation, and evaluation of results.
PDG outcome: The firm’s six-stage design process was linear, not iterative. The court held that performing routine calculations on available data does not constitute experimentation because the necessary information was already known.
Definition: Activities must fundamentally rely on principles of physical or biological sciences, engineering, or computer science.
What examiners look for: Documentation of how scientific or engineering principles were applied.
PDG outcome: Some activities lacked evidence of reliance on engineering principles.
If an entire project does not qualify, the IRS and courts may “shrink back” to the most significant subcomponent to test eligibility. For example, if a hospital project fails, a single HVAC system design could be examined. In Phoenix Design Group, the court noted the rule but could not apply it due to inadequate documentation.
Qualified activities include:
Non-qualified activities include:
The Tax Court sustained a 20% accuracy-related penalty under IRC §6662. This ruling reinforces that poor documentation not only disallows credits but also creates additional tax exposure.
No. Without iterative, documented testing, design is insufficient.
Generally no, unless coupled with technical uncertainty and experimentation.
No. The court required contemporaneous, project-level records.
Only that portion may qualify. The shrinking-back rule may apply if properly supported.
