Architectural and engineering firms in IRS crosshairs

The U.S. Tax Court (T.C.) issued an opinion, applicable nationwide, in Harper v. Commissioner (TC Memo 2023-57 May 10, 2023, item 53 on docket). The T.C. found that creating architectural and engineering (A&E) construction designs does indeed meet the definition of a “business component” – one of the threshold tests for qualified research.

Specifically, Harper described 24 separate services as well as five development stages: job bid, conceptual design, design development, documentation and construction. Further, Harper described research activities as follows: “Each project was undertaken to develop unique solutions to a combination of various aspects spanning the disciplines of architectural, civil, structural, mechanical, electrical and plumbing engineering, among others,” and (the taxpayer) “faced many uncertainties regarding the final design resulting from the unique combinations of all project requirements.”

Subsequently, almost one year after Harper, on May 6, 2024, the Eighth Circuit Court of Appeals (Eighth Circuit) issued an opinion in Meyer, Borgman & Johnson, Inc. (MBJ) v. Commissioner (of the IRS), No. 23-1523, May 6, 2024. MBJ is another A&E entity who filed for research and development (R&D) tax credits for development work performed under contract to create new building designs.

The Eighth Circuit, with jurisdiction in Minnesota, Iowa, Missouri, Arkansas, North Dakota, South Dakota and Nebraska, determined the contracts were for design services, were all lump sum/firm fixed price and MBJ met the rights test. Sound familiar? Not so fast, as the Eighth Circuit then looked at the contracts to see if they were indeed research contracts.

MBJ agreed to perform its services adhering to professional skill and care as well as complying with pertinent building codes and regulations. The Eighth Circuit determined that performing to a general standard of care does not equate to meeting the test of a contract being “contingent on the success of the research” and thus considered to be paid for the product or result of the research. The Eighth Circuit cited the