From Blueprint to the Courtroom, the Harper Case is a Win for Design Firms

Written by Katherine Johnson, Esq. Updated Jun 6, 2023.


For several years, CTI has championed construction companies’ eligibility for the credit for increasing research activities (“R&D tax credit”) under Section 41. We have worked with numerous construction companies to successfully identify, calculate, and substantiate the credits. The most recent tax court opinion lends support to the qualification of many aspects of design-build construction projects.

The Case

The US Tax Court recently issued a memorandum decision in Harper v. United States, denying the Internal Revenue Service’s (IRS) motion for summary judgment. This litigation has been in progress since 2016. The Harpers, a husband and wife, filed a petition for reconsideration after a notice of deficiency related to claimed R&D tax credits under Section 41 as well as a net operating loss (NOL) issue related to their business, Harper Construction Co. (HCC).

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The IRS’s motion for summary judgment follows a remand from the US Court of Appeals, Ninth Circuit based on jurisdictional issues. The IRS previously won its motion to dismiss the Harpers’ claim, arguing that the Harpers’ “failed to exhaust their administrative claim for research tax credits” because the Harpers did not satisfy the “specificity requirement” under 26 U.S.C. 7422. The Ninth Circuit found that the IRS had waived the specificity requirement as a result of its “substantive examination and final denial on the merits” of the refund claim during its more than four-year-long audit with “over a hundred thousand pages of documentary support.”

In the instant motion, the IRS filed a motion for summary judgment on the basis that the projects claimed as part of HCC’s research credit failed the business component portion of the four-part test necessary to qualify for the R&D tax credit. Under Section 41, a business component is “any product, process, computer software, technique, formula, or invention which is to be—(i) held for sale, lease, or license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”

The IRS put forward four alternative arguments in support of this contention, summarized by the court:

  1. The buildings and facilities constructed by HCC never belonged to HCC, yet only these structures (and not the designs created by HCC) were “new or improved.”
  2. HCC’s designs were not “products,” as that word is intended in the statute, but rather “tangible manifestation[s] of construction services.”
  3. Neither HCC’s designs nor the facilities it constructed were ever “held for sale” by HCC.
  4. HCC did not “use” its designs in the sense intended by the statute, because Congress meant for taxpayers’ use of business components to be “meaningful” and so “affect the way a business operates to some degree.” Respondent alleges that “HCC’s day-to-day operations were not changed by its designs.”

With the IRS as the moving party, the court construed all available factual support in a light most favorable to the Harpers. The court detailed HCC’s project development lifecycle, including the five key stages: “job bid, conceptual design, design development, documentation, and construction,” as well as activities such as “Design Management,” “Green Building Reviews,” “LEED [Leadership in Energy and Environmental Design] Project Analysis & Registration/Certification,” “Schematic Estimates,” “Value Engineering,” and “USGBC [U.S. Green Building Council] LEED Certification Management” that are typical of the projects HCC included in its research claim.

The court found that the IRS’s assertion that HCC’s designs for the claimed projects were not “new or improved” was not supported by the record as “HCC evidently engaged in a lengthy, multistep process of conceptual design and design development for each project, resulting in novel ideas and iterative improvements to them.”

While the court agreed that the designs are not “products” within the meaning of Section 41, the court explained that they could fall under an alternative business component, such as “processes, techniques, or invention”, as part of HCC’s business. Further, the court rejected the IRS’s argument that the designs were not used in a “meaningful way,” refusing to expand the definition of the word “use” to require ongoing application in the business. Finally, on the issue of whether HCC or the Harpers owned the buildings during the development and construction, the court found conflicting evidence in the record and did not resolve this issue based on the other findings.

The litigation remains ongoing, and we will provide updates as the case proceeds if the court publishes additional opinions.

What's next for construction?

Seeing the court recognize the technical elements of design and construction projects and suggest the potentially qualified business components for this industry is encouraging. In recent years, auditors have taken an increasingly critical view of construction as it relates to R&D tax credits, and the court’s guidance regarding fulfilling the business component portion of the analysis is a positive step.

This affirms our position that general contractors, as well as other firms, who engage in design, are conducting qualified research activities, and thus have qualified expenditures. However, documenting these activities and identifying accompanying expenses remains complex. It is critical to partner with a firm that understands these qualified activities and the documentation available to best support a taxpayer’s R&D tax credit claim. Contact CTI today and let our team of R&D experts work to maximize your credit and help you gather, produce, and maintain a substantiation package tailored to satisfy the latest case law and regulatory changes.



Research & Development Tax Credit Guide

Topics: R&D Tax Credit, Legal News, Federal

Katherine Johnson, Esq

Written by Katherine Johnson, Esq

Katherine (Kate), is the Director of Strategy and Business Operations and provides thought leadership on new and emerging areas of tax law and incentives for CTI’s clients. Through her professional experience, she has overseen hundreds of Research & Development (R&D) and Employee Retention Credit (ERC) studies as well as defended clients in matters before the IRS. Kate earned her J.D. from the University of Arizona and received her undergraduate degrees from Southern Methodist University.