On June 16, 2026, the U.S. Tax Court issued its decision in Adrian D. Smith and Nancy W. Smith, et al. v. Commissioner, T.C. Memo. 2026-50; a case that offers a useful reminder of how closely the IRS and the courts scrutinize research credit claims involving contract work, and why the details of a contract can matter as much as the science behind it.
The Backstory
The case centered on Adrian Smith + Gordon Gill Architecture, LLP (AS+GG), a firm known for designing some of the world’s tallest and most complex buildings. Between 2008 and 2010, AS+GG claimed research credits under Internal Revenue Code Section 41 for the engineering-intensive work behind several major international projects, including thermodynamic, geotechnical, and microclimate research tied to supertall tower designs. Those credits flowed through to the firm’s partners, who claimed them on their personal returns.
The IRS audited the returns, disallowed the credits, and issued deficiency notices. The partners took the case to Tax Court. By the time of trial, the parties had narrowed the dispute to a sample of six major projects, and the IRS had already conceded that AS+GG’s work satisfied the four-part test for qualified research. That left two questions for the Court: whether the research was excluded “funded research” under Section 41(d)(4)(H), and whether the partners’ 2008 compensation was reasonable under Section 174(e).
The Funded Research Question
Research paid for by a client isn’t automatically disqualified from the credit, but it can be treated as “funded,” and therefore excluded, unless two conditions are met: payment to the business has to be contingent on the research actually succeeding, and the business has to retain substantial rights to use what it develops.
The taxpayers argued that recent developments in administrative law, specifically the Supreme Court’s Loper Bright decision, should invalidate the long-standing Treasury regulation used to define “funded” research. The Court disagreed, holding that prior case law interpreting the regulation remains good law under principles of statutory precedent, and declined to disturb the existing framework.
Applying that framework to the six sample contracts, the Court drew a distinction that’s worth sitting with: there’s a difference between being paid for “successful performance,” meaning payment tied to hitting specific technical benchmarks, and being paid for “proper performance,” meaning payment tied to delivering work under a general professional standard of care. AS+GG was paid on a percentage-of-completion and hourly basis regardless of whether its research ultimately worked, which meant the financial risk sat with the clients, not the firm. On that basis, the Court found all six contracts failed the “contingent on success” test.
The substantial rights analysis had more mixed results. On two projects, the client contracts gave the client full ownership of the resulting work product, with no right for AS+GG to reuse or exploit it, so the firm retained no substantial rights there. On the other four projects, AS+GG kept copyrights or licenses allowing it to reuse and market the research, which the Court held was enough to satisfy the substantial rights requirement, even without exclusivity. Because those four projects failed the funding test but passed the rights test, the taxpayers were allowed to claim partial credits on them, calculated under the regulation’s partial-credit provision.
The Reasonable Compensation Question
The second issue was whether the partners’ 2008 compensation, deducted as part of the firm’s research expenditures, was reasonable under Section 174(e). Because the case was appealable to the Seventh Circuit, the Court applied that circuit’s “independent investor test” rather than a traditional multi-factor analysis. Under that test, compensation is presumed reasonable if an outside investor would still be earning an attractive return after that compensation is paid. Here, even the IRS’s own expert calculated a return on equity of roughly 939%, and the Court ruled the compensation reasonable on that basis alone.
Why This Matters Beyond Architecture
This case wasn’t about cost segregation, but it lands squarely on ground CSSI knows well: the R&D tax credit, and the documentation and contract language that determine whether a credit survives an audit. A few takeaways apply broadly to any business claiming the credit for contract-based or client-funded work:
Payment structure matters more than most businesses realize. If a contract ties payment to hitting defined technical milestones, that can look like the client is bearing the research risk. If payment is tied to general professional performance, hours worked, or percentage of completion, the business is more likely to be treated as bearing that risk itself, which supports the credit.
Contract language on ownership and reuse rights is not boilerplate. Whether a business can claim a credit for client-funded research can come down to a single clause about who owns the resulting work product and whether the business can reuse it elsewhere. Businesses negotiating contracts with an eye toward R&D credit eligibility should treat those provisions as deliberate decisions, not afterthoughts.
Credits aren’t all-or-nothing. AS+GG lost on two projects and won partial credits on four, based entirely on contract terms for otherwise similar work. That’s a good illustration of why a project-by-project review, rather than a blanket assumption, is the right way to evaluate a research credit position.
The CSSI Approach
This is exactly the kind of nuance CSSI’s engineering-based methodology is built to navigate. Properly substantiating an R&D credit means looking past the technical work itself to the underlying contracts, payment structures, and rights involved in every project claimed. That level of documentation is what allows a credit to hold up if it’s ever examined.
As always, the credit available to any specific business depends on the facts of its contracts and projects, and results should be confirmed through a proper analysis rather than assumed from a single case.
Talk to a Specialist
If your business does contract research and you’re not sure whether your current documentation would hold up to this level of scrutiny, CSSI’s specialists can walk through your situation. Request a free analysis to see where your R&D credit position actually stands.
