Tax Court denies taxpayer’s research credit claim


The Tax Court ruled in Leon Max v. Commissioner (T.C. Memo. 2021-37) that certain activities of a clothing manufacturer were not investigative and did not rely on science or engineering and so did not qualify for the research credit.

For activities to constitute qualified research, there is a four-part test under Section 41(d) in which the activities must be all of the following:

  • Conducted for one of the permitted purposes
  • Technological in nature
  • Intended to discover information to eliminate uncertainty
  • Constituting the process of experimentation.

A taxpayer must satisfy all four parts of the test to qualify for research credit.

The taxpayer in Leon Max was a clothing designer company that followed a structured nine-step process to conceptualize, design, and develop new garments. The taxpayer claimed it faced uncertainties, such as how to cut and drape printed fabrics, fabric choices, thread sizes, fabric shrinkage, and the final fit of the garment. To eliminate uncertainty, the taxpayer claimed that it performed activities which relied on principles of material science, textile engineering, and chemistry. This included performing in-house quality assurance testing to evaluate the design of the garments. The taxpayer performed labeling tests, colorfastness tests, strength tests, and safety tests to ensure that the fabric and garments met quality standards, customer requirements, and industry standards. If fabrics did not pass these tests, the taxpayer would not use them in its garments.

The Tax Court concluded that the four-part test criteria under Section 41(d) was not met, finding that the activities were not investigative in nature because they were common solutions to common problems; and the solutions were well-known and understood within the fashion industry. The taxpayer’s efforts were spent perfecting the aesthetics of the garments rather than the functional purpose. Further, the activities performed did not fundamentally rely on science or engineering, and the testing was more akin to quality control, which is excluded from the definition of qualified research.

The case illustrates the importance of documenting research activities in terms of the four-part test, and reinforces that research related to style, taste, cosmetic, or seasonal design factors does not meet the permitted purpose test.



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