Mark Betz & Christine Betz

United States Tax Court

T.C. Memo. 2023-84

MARK BETZ AND CHRISTINE BETZ,
Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,
Respondent

DENNIS LINCOLN AND JULIA LINCOLN,
Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,
Respondent

—————

Docket Nos. 21587-18, 21588-18. Filed July 6, 2023.

—————

Ps in these consolidated cases are shareholders in C,
an S corporation that designs and supplies air pollution
control systems. As of 2014, C had extensive institutional
knowledge and experience in supplying systems that met
the specifications of customers in manufacturing
industries. On its 2014 information return, C claimed a
research credit under I.R.C. § 41 in connection with 19
projects. C claimed the research credit in connection with
both the costs of producing the systems it supplied and the
wages it paid to certain of its employees for activities
performed in connection with the projects. C did not use a
time-tracking system for its employees’ activities and thus
estimated the amounts of employee time spent performing
qualified services. On their personal federal income tax
returns for 2014, Ps claimed a flowthrough of the credit and
later carried forward the remaining portion of the credit to
their 2015 and 2016 returns.

Served 07/06/23
 2

[*2] Held: For all 19 projects, Ps failed to carry their
burden of establishing that the products were pilot models.
Accordingly, C’s purported qualified research expenditures
(QREs) for costs of production failed to satisfy I.R.C.
§ 41(d)(1)(A) and were not creditable.

Held, further, for all 19 projects, Ps failed to carry
their burden of establishing that the wages of certain of C’s
employees were incurred in connection with the
performance of qualified services. Accordingly, C’s
purported QREs for wages were not creditable.

Held, further, for five of the projects, C did not retain
substantial rights in the results of its research under its
applicable contracts with its customers. Accordingly, C’s
purported QREs for those five projects were incurred in
connection with funded research within the meaning of
I.R.C. § 41(d)(4)(H) and were not creditable.

Held, further, Ps are liable for accuracy-related
penalties under I.R.C. § 6662(a) for tax years 2014, 2015,
and 2016.

—————

John H. Dies, Jeffrey E. Falvey, Jeremy M. Fingeret, Jefferson H. Read,
and Matthew S. Reddington, for petitioners.

Jonathan E. Behrens, Frederic J. Fernandez, Eugene A. Kornel, and
Richard L. Wooldridge, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge: These cases involve a section 41 1 research credit
claimed by an S corporation engaged in the business of designing and
supplying air pollution control systems that eliminate harmful airborne
manufacturing byproducts. The issues for decision are (1) whether

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure.
 3

[*3] petitioners, the groups of which include the sole shareholders of the
S corporation, are entitled to a research credit of $501,531 for tax year
2014 and (2) whether petitioners are liable for accuracy-related
penalties for tax years 2014, 2015, and 2016. We hold for respondent on
both issues.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The
Stipulations of Facts and the attached Exhibits are incorporated herein
by this reference. Petitioners resided in Illinois when they timely filed
their Petitions.

I. Catalytic Products International, Inc.

Catalytic Products International, Inc. (CPI), was founded in 1969
by Erwin Betz. In 2014 CPI was a subchapter S corporation, with the
shares owned equally (50%) by Erwin Betz’s children, petitioner Mark
Betz (Mr. Betz) and petitioner Julia Lincoln (Ms. Lincoln). As of
January 2, 2014, CPI’s board of directors comprised Mr. Betz, Ms.
Lincoln, petitioner Dennis Lincoln, and Matthew Lincoln. In 2014 CPI
used an accrual method of tax accounting.

Beginning in 1987, when Mr. Betz joined the company, CPI
transitioned its business away from manufacturing catalysts for
installation in air pollution control systems, instead becoming a
designer and supplier of custom-built air pollution control systems,
primarily catalytic and thermal oxidizers.

II. Oxidizer Basics

In 2014 CPI supplied both catalytic and thermal oxidizers, which
each eliminate certain environmentally hazardous airborne
manufacturing byproducts. We will refer to these byproducts as volatile
organic compounds (VOCs) as a convenient shorthand. 2 Catalytic
oxidizers are designed to convert VOCs into carbon dioxide and water
vapor via a process of chemical reaction between the VOCs and a

2 Our use of the term may not necessarily reflect whether the byproducts

discussed herein are VOCs within the technical meaning of regulations issued by the
Environmental Protection Agency (EPA). See 40 C.F.R. § 51.100(s) (2023).
 4

[*4] catalyst. 3 Thermal oxidizers are designed to achieve the same
result but do so by using a burner to generate extremely high heat to
incinerate VOCs, rather than using a catalytic conversion process.
There are three separate subtypes of thermal oxidizers:
(1) direct/straight, (2) recuperative, and (3) regenerative.

A direct/straight thermal oxidizer uses a simplistic burner to heat
a combustion chamber; process air containing VOCs passes through the
system and oxidizes when encountering the high temperatures. A
recuperative thermal oxidizer adds to the concept by using a stainless-
steel heat exchanger to preheat process air, which provides for increased
energy efficiency. 4 This heat exchanger usually consists of a shell and
tube structure that operates by intaking clean, postcombustion air into
an exterior shell that transfers heat to interior tubes carrying the
process air. A regenerative thermal oxidizer instead uses a heat
exchanger comprising ceramic media beds, which retain heat at an even
higher rate and thus allow for increased energy efficiency. Regenerative
thermal oxidizers operate by intaking process air through the media,
then reversing the postcombustion air back through the media, thus
retaining the heat. Because of their energy efficiency, the issue of
overtemperature, where the system’s temperature rises too high and
degrades the heat exchanger, is a particular problem for regenerative
thermal oxidizers. Designs of regenerative thermal oxidizers typically
use a hot gas bypass, which diverts high temperature air out of the
system in order to reduce temperature. As of 2014, regenerative
thermal oxidizers were the most common type of oxidizer used in
manufacturing industries.

A few general considerations go into the choice of a type of
oxidizer system and its basic design. One consideration is the
aforementioned energy efficiency: Oxidizers can use considerable
volumes of natural gas in operating the burners that heat the air. For
cost-conscious customers, an oxidizer with reduced volume or
performance but increased thermal efficiency (i.e., where high

3A catalyst is a substance that triggers a chemical reaction but is not itself
consumed in that chemical reaction. A common example is the catalytic converter in
an automobile, which converts the VOCs present in the exhaust into carbon dioxide
and water.
4 To illustrate the concept, heat exchangers are typically used as part of the

heating process in residential gas furnaces. Furnaces use a burner to generate hot gas
within a heat exchanger chamber; cold air then encounters the now-heated outer walls
of the heat exchanger and becomes hotter before being distributed throughout the
residence.
 5

[*5] temperature is maintained without significant use of fuel-
consuming burners) might be optimal. Another basic consideration is
the concentration and type of VOCs generated by the customer’s
manufacturing process; for certain VOCs, a catalytic reaction is less
effective than a thermal one or would degrade the catalyst over time.
Certain types of VOCs may also require a higher operating temperature
or residence time to oxidize, which would affect the sizing of components
and increase upfront costs.

Another consideration is whether the customer’s manufacturing
process airflow contains other particulates or chemicals that could affect
the oxidizer’s performance. For instance, if the process airflow
contained silicone, oxidization would generate silicone dioxide (i.e.,
sand), which could accumulate and plug an oxidizer. Finally, the
location and layout of a customer’s manufacturing process plays a role.
Space constraints at the facility may dictate the choice and sizing of
various components, while extreme temperatures or heavy winds may
require additional insulation or structural support features for outdoor
components.

III. CPI’s General Process

In 2014 CPI’s business model was as follows. First, CPI would
either solicit or be contacted by a prospective customer. If unfamiliar
with the customer, CPI personnel would sometimes visit the customer’s
facility to review their manufacturing process and measure what VOCs
were being generated. Customers would often provide CPI with the
necessary specifications about the process airflow at the customer’s
facility, such as the volume of process airflow, the type of VOCs
generated, and the airflow temperature. If the customer was unable to
provide specifications, CPI personnel or a third party would sometimes
test and measure the airflow at a jobsite.

CPI personnel considered an oxidizer’s design to be largely
dictated by three basic considerations: (1) the necessary level of
destruction efficiency; (2) the process air flow volume; and (3) the
particular VOCs generated. 5 Once this information was available, CPI
personnel would begin assembling a project proposal. CPI personnel
would input the particular VOCs and airflow volumes at issue into a
computer spreadsheet (known internally at CPI as Bessy), which would

5 Destruction efficiency is the percentage of the VOC concentration in the

process air that is destroyed by the oxidizer.
 6

[*6] then output calculations breaking down how the VOCs would
oxidize, including the lower explosive limit (LEL) and heat value of the
airflow exhaust. 6 Based on the particular VOCs at issue and the airflow
volume, CPI personnel would then calculate the necessary sizes of the
various components, such as burners and fans, by using standardized
spreadsheets or performing simple hand calculations.

Next, the now-sized components would be incorporated into a
general arrangement design drawing and a process and instrument
diagram (P&ID). 7 On the basis of the prepared drawings, CPI personnel
would solicit bids from subcontractors about the potential cost of
assembly. With an estimated cost of assembly in hand and the size of
the components preliminarily calculated, CPI personnel would come up
with a quoted price for the customer and assemble a project proposal.
In the project proposal, CPI would recommend a particular type of
oxidizer based on the applicable characteristics of the process airflow
and describe its various components and features. Generally, the initial
project proposal provided by CPI to the customer was not the final
version. Customers often requested changes to the proposal, such as
increases in the guaranteed efficiency of the oxidizer, additional
guarantees or warranties, or revisions to terms and conditions.

Once a final proposal was accepted by a customer and purchase
and sale orders exchanged, additional design drawings would be
prepared, reviewed, and completed for various components of the
oxidizer. The project would then be passed on to a project manager, who
would begin issuing purchase orders to suppliers (for various
components of the oxidizer) and to subcontractors (for fabrication and
assembly). CPI maintained ongoing relationships with a number of
suppliers and subcontractors. CPI would engage a subcontractor,
typically PRE-Heat, Inc., to fabricate the physical structure of the
system, which was generally composed of heavy, welded steel, and to
assemble the components of the system. CPI would purchase
components from suppliers, who would then directly provide those

6 LEL indicates the lowest concentration of an airborne compound that is
capable of exploding in the presence of an open ignition source. If an airflow is
measured at a high percentage of LEL, that airflow is at greater risk of igniting;
National Fire Prevention Association standards generally dictate that a number above
25% of LEL is an unsafe level.
7 A general arrangement drawing portrays the physical structure of the

assembled oxidizer, while a P&ID details how airflow, gas, and electrical signals
interact with components of the system.
 7

[*7] components to the fabricating subcontractor to be assembled as
part of the oxidizer. For the exhaust stack, CPI would usually engage a
separate subcontractor, typically IVI North, Inc., to fabricate the stack.
On some projects, the subcontractor would take on greater design
responsibility. For instance, PRE-Heat would typically handle the
design for heat exchangers, inputting data from the particular facility
into a proprietary program in order to determine the appropriate sizing.

CPI personnel would also begin designing the electrical control
system of the oxidizer. Using the P&ID drawing, CPI engineers would
create an electrical schematic drawing for the control panel, showing the
placement of the various inputs and outputs into the system and the
requisite horsepower. Finally, CPI engineers would program a sequence
of operations into the control system to automate its various functions.
CPI would engage a subcontractor, typically Quantum Design, Inc., to
build the control system panel and enclosure for the oxidizer.

While fabrication was ongoing, CPI personnel would sometimes
conduct quality control inspections on the work of the fabricating and
electrical subcontractors, to ensure that the fabrication conformed to
CPI’s design drawings. Sometimes revisions would be made to an
oxidizer’s design over the course of a project in response to feedback from
either a subcontractor or the customer. Once an oxidizer was completed,
CPI personnel would typically oversee assembly of a system at the
fabrication subcontractor’s facility; the oxidizer would then be freight
shipped to the customer’s facility. At the customer’s facility, CPI would
either install the system itself or have personnel present to supervise
the installation. After physical installation, CPI startup personnel
would spend time at the facility, programming the control system and
conducting further quality testing to ensure that components conformed
to CPI’s design drawings and operated without issues. Finally, a third
party would generally conduct testing on the oxidizer for purposes of
compliance with environmental regulations. On some occasions, a
tested oxidizer would perform below the destruction efficiency
guarantee made by CPI, which would contractually require CPI to make
additional repairs or modifications to the oxidizer.

IV. The Alliantgroup Study

Alliantgroup L.P. is a tax consultancy and lobbying firm which,
inter alia, maintains a research credit group that specializes in
promoting section 41 credits and assisting taxpayers with all stages of
claiming the credit. On February 20, 2015, Ms. Lincoln executed an
 8

[*8] engagement letter for Alliantgroup to conduct an R&D tax credit
study for CPI and to provide audit defense. The engagement letter
stated that Alliantgroup would bill at a blended hourly rate of $375; the
billed fees were capped so as not to exceed 25% of the combined state
and net federal research credits identified by Alliantgroup. Initially,
Alliantgroup requested from CPI a list of employees with job details, job
costing reports, Forms W–2, Wage and Tax Statement, and payroll
records for 2010 through 2013, and CPI’s federal and state tax returns
for 2010 through 2013. On April 2, 2015, an Alliantgroup representative
emailed Ms. Lincoln a list of CPI projects that they wished to discuss
during an upcoming site visit to CPI; the list comprised 18 projects. 8

On April 8, 2015, Alliantgroup personnel visited CPI’s facility;
during the visit, Alliantgroup personnel interviewed Messrs. Betz and
Harmsen and Ms. Lincoln. On April 9, 2015, Alliantgroup personnel
emailed Mr. Harmsen and Ms. Lincoln a spreadsheet based on their
discussions, which purported to allocate certain percentages of the 2014
wages paid to CPI’s employees to 19 CPI projects. The interviews with
Messrs. Betz and Harmsen were the source of the underlying allocation
percentages in the spreadsheet. In 2014 CPI did not have a system that
tracked employee time. On April 10, 2015, an Alliantgroup employee
emailed to Ms. Lincoln a pro forma Form 6765, Credit for Increasing
Research Activities, with calculations for a potential research credit for
CPI. The pro forma Form 6765 listed $1,983,647 as the amount of wages
for qualified services and $5,732,211 for the cost of supplies, which
amounted to a gross credit of $771,586 and a net credit of $501,531.

On October 26, 2015, an Alliantgroup employee provided Ms.
Lincoln with a project summary report for the research credit study,
which concluded that CPI was qualified to claim a section 41 credit. 9 On
December 10, 2015, Mr. Betz and Ms. Lincoln signed a copy of the
completed study, under a field entitled “Employees Verifying
Information.” In the study, Alliantgroup identified 19 projects with
associated qualified research expenditures. The completed study again
stated that CPI had paid or incurred $1,983,647 in qualifying wage
expenditures and $5,732,211 in qualifying supply expenditures, for a
total of $7,715,858 of QREs. With respect to wage expenditures, the
completed study stated that Alliantgroup had allocated percentages of

8The DuPont La Porte project, for which qualifying research expenditures
(QREs) were eventually claimed, was not listed in this email.
9 As we discuss in further detail below, both CPI and petitioners had timely

filed their respective tax returns for tax year 2014 in April 2015.
 9

[*9] CPI’s employees’ wages paid or incurred for qualified services as
follows: 10

Employee Name 2014 R&D % Tax Year 2014 Tax Year 2014
Salaries QREs
G.B. 80% $55,424 $55,424
Betz, Mark 80% 823,231 823,231
F.C. 80% 49,022 49,022
C.D. 83% 69,328 69,328
S.F. 82% 39,172 39,172
Harmsen, Scott 88% 179,302 179,302
C.H. 63% 104,297 65,707
R.J. 80% 80,863 80,863
C.J. 60% 15,209 9,125
E.M. 82% 48,050 48,050
B.O. 60% 58,000 34,800
J.O. 90% 21,038 21,038
Shaver, Robert 80% 341,534 341,534
L.S. 90% 20,706 20,706
T.S. 60% 40,186 24,112
R.T. 80% 40,992 40,992
B.W. 50% 39,038 19,519
J.Y. 90% 24,466 24,466
T.Z. 86% 37,255 37,255
Total n/a $2,087,113 $1,983,647 11

For 17 of the employees, Alliantgroup allocated percentages of wages to
particular projects; the wage QREs of those 17 employees totaled
$818,882 (i.e., roughly 41% of the claimed wage QRE total).

10 For brevity’s sake, we exclude from the table the CPI employees that
Alliantgroup determined performed no qualified services in 2014. Aside from petitioner
Mr. Betz and Messrs. Harmsen and Shaver, both of whom testified at trial, we will use
initials to refer to particular CPI employees.
11 The wage QREs identified by Alliantgroup in fact amount to a total of

$1,983,646; we can safely attribute the one-dollar discrepancy from the listed amount
to rounding error.
 10

[*10] Alliantgroup purported to allocate the wages of two employees,
Messrs. Betz and Shaver, evenly across all 19 projects; the wage QREs
of Messrs. Betz and Shaver totaled $1,164,765 (i.e., roughly 59% of the
claimed wage QRE total).

With respect to supply QREs, Alliantgroup personnel reviewed
CPI’s internal accounting records for each project. With respect to the
base period, Alliantgroup personnel interviewed Mr. Betz and Ms.
Lincoln and reviewed accounting statements from 1984, 1985, 1986, and
1987 in order to determine whether CPI had gross receipts and QREs
for those tax years. Alliantgroup ultimately calculated a fixed base
percentage of 3.02% and average annual gross receipts of $23,782,532.
Using those calculations, Alliantgroup again concluded in the study that
CPI was entitled to a research credit of $771,586, calculated without an
election under section 280C.

V. CPI Employees

In the study, Alliantgroup determined that 19 CPI employees
performed qualified services. We provide brief job descriptions for each
of those employees.

A. Mr. Betz

In 2014 petitioner Mark Betz was the vice president of
engineering for CPI. Mr. Betz’s primary responsibilities were wide
ranging and included both working with customers on the sales side and
doing application engineering.

B. Mr. Shaver

In 2014 Robert (Scott) Shaver was the vice president of sales for
CPI. Mr. Shaver’s primary responsibilities included heading up the
sales team, soliciting customers, and being involved at the outset in
CPI’s chemical application engineering. Mr. Shaver left his employment
with CPI sometime in 2016.

C. Mr. Harmsen

In 2014 Scott Harmsen was the director of engineering for CPI.
Mr. Harmsen’s primary responsibility was supervising the engineering,
drafting, and processing personnel at CPI, as well as being lead chemical
application engineer. Sometime after 2014 Mr. Harmsen was promoted
 11

[*11] to president of CPI and remained in that position as of the dates
of trial in these cases.

D. R.J.

In 2014 R.J. was a senior electrical engineer for CPI. R.J.’s
primary responsibility was designing the electrical systems and
programming the control systems for CPI’s oxidizer systems.

E. C.D.

In 2014 C.D. was an electrical designer for CPI. C.D.’s primary
responsibility was largely identical to R.J.’s and involved designing the
electrical controls and programming the control systems for CPI’s
oxidizer systems.

F. S.F.

In 2014 S.F. was a design detailer for CPI. S.F.’s responsibilities
included creating and modifying design drawings and making
guidelines for CPI’s systems.

G. T.Z.

In 2014 T.Z. was an engineering manager for CPI. T.Z.’s primary
responsibilities consisted of reviewing all the design drawings,
supervising the draftsmen, and managing the schedule and construction
by the fabrication subcontractors.

H. L.S.

In 2014 L.S. was a fabrication specialist for CPI. L.S.’s
responsibilities consisted of overseeing and coordinating with the third-
party fabricators, which included soliciting bids, reviewing design
drawings, and conducting quality audits.

I. Messrs. G.B. & R.T.

In 2014 G.B. and R.T. were each draftsmen for CPI. G.B. was
generally responsible for installation design, including preparing
ductwork, steel, and location drawings. R.T. was generally responsible
for drawing designs, project management, and sourcing components
from suppliers.
 12

[*12] J. Messrs. F.C., E.M., J.O., & J.Y.

In 2014 F.C., E.M., J.O., and J.Y. were each project managers for
CPI. All four of these individuals’ primary responsibilities were
interacting with the customer, reviewing and approving drawings and
calculations, and ensuring delivery of an oxidizer to the customer’s
facility. J.O. left his employment with CPI during 2014.

K. Messrs. C.H., C.J., B.O., T.S., and B.W.

In 2014 C.H., C.J., B.O., T.S., and B.W. were each sales engineers
(i.e., salespeople) for CPI. Their responsibilities included putting
together initial calculations in proposals delivered to customers and
generally soliciting new customers.

VI. The Projects at Issue

A. 3M Hutchinson (#13-07520)

During the years at issue 3M Company (3M) and CPI had an
ongoing commercial relationship, which was reflected in a Master
Equipment Supply & Services Agreement (master agreement), effective
August 4, 2010. Clause 8.3 of the master agreement provided that

Seller may create drawings, illustrations, instructions,
maintenance information, and other materials that relate
to the Equipment, and if Seller retains ownership of any
such materials, then Seller grants 3M the perpetual,
unrestricted right to use, copy, and distribute those
materials for 3M’s internal use.

Clause 10.2 provided that CPI “maintains all of its proprietary rights
related to its products and manufacturing processes, including all
product components and pre-existing product designs.” Clause 10.2 next
stated that

3M owns all tangible and intellectual property rights in
any goods, equipment (including the Equipment),
apparatus, documents, drawings, computer software and
artwork which 3M provides to Seller, Seller creates at 3M’s
 13

[*13] expense, or Seller creates using 3M Confidential
Information (“3M Rights”).[12]

Clause 10.2 continued, stating in relevant part that with respect
“to any property subject to 3M Rights, Seller: (a) hereby assigns to 3M
or its designated affiliate all of Seller’s rights, including, without
limitation, all intellectual and tangible property rights and (b) will
deliver that property to 3M when Seller has finished using it to fulfill
Order(s) under the Agreement.” Finally, clause 12 provided that “[a]ny
claim or dispute arising from or relating to the Equipment or the
Agreement will be: (a) governed by the laws of the State of Minnesota . . .
without regard to its conflict of laws provisions.” The terms of the
master agreement governed all of CPI’s projects for 3M, including 3M
Hutchinson.

During the years at issue 3M manufactured sticky notes at a
facility in Hutchinson, Minnesota. Before engaging CPI, 3M had used
an aging regenerative thermal oxidizer at the Hutchinson facility, which
it had determined to replace. As part of the bidding process on the
project, on June 25, 2013, 3M provided CPI with an extensive and
detailed list of required specifications for a 30,000 standard cubic feet
per minute (SCFM) regenerative thermal oxidizer. The specifications
provided for a 99% destruction efficiency. The specifications provided
measurements for the minimum and maximum airflow volume and
solvent rate at the facility and identified the VOC emissions as “a
combination of methanol, ethyl acetate, IPA, toluene, and other common
solvents.”

The 3M Hutchinson project was the first regenerative thermal
oxidizer designed by CPI. 13 However, Mr. Harmsen was experienced in
working with regenerative thermal oxidizers from prior employment,
and he handled the applications engineering on the project. 3M
recommended particular suppliers to use for the various components of
the oxidizer; for a number of other components, 3M also provided specific
brands and sizes to be included. Mr. Harmsen generally considered the
specifications to be typical. Several of the specifications required by 3M

12 Clause 10.1 separately defined “3M Confidential Information” as including
“all Orders placed by 3M, 3M Materials, 3M Equipment, the terms of the Agreement,
the Parties’ relationship, and any other information about how 3M makes or sells
products or conducts its business.”
13 Before the 3M Hutchinson project, CPI supplied regenerative thermal

oxidizers to customers but engaged other engineers to design them.
 14

[*14] were atypical for CPI, such as using two burners instead of one,
including manual lifts in the system, and providing for a control
enclosure that could contain a desk. The specifications also stated that
3M was “concerned with residue build-up on the forced draft fan wheel
or other internal parts” and provided two options—an induced draft
process fan with a mixing box or a forced draft process fan with a preheat
system—to address this concern in the design. 14

In July 2013 after questions by other parties bidding on the
project, 3M issued a revised set of specifications. CPI then provided 3M
with an initial proposal for an oxidizer system; after reviewing CPI’s
proposal, 3M requested that several more clarifications and revisions be
incorporated into the design. In August 2013 CPI submitted a revised
proposal for a regenerative thermal oxidizer, which 3M accepted. The
proposal included additional technical specifications for various
components of the oxidizer. The proposal also included a 99%
destruction efficiency performance guarantee. In September 2013 3M
and CPI exchanged purchase and sale orders. The final payment terms
were a total price of $1,135,840. CPI then engaged IVI North to
fabricate and supply an exhaust stack for the system and engaged PRE-
Heat to fabricate and supply the oxidizer system.

In late October 2013 G.B. completed an initial general
arrangement drawing and an initial P&ID drawing for the oxidizer. In
December 2013 C.D. completed initial electrical schematic diagrams for
a control panel. CPI engaged Quantum Design to fabricate a main and
remote control panel and enclosure for the oxidizer and Lantec to supply
a ceramic heat exchanger. In December 2013 CPI issued a purchase
order to AirPro Fan & Blower Co. (AirPro) for a 300 horsepower booster
fan, described as arrangement 3B; AirPro then submitted design
drawings for a booster fan to CPI for approval, which were in turn
approved by 3M’s engineering department. In April 2014, after
reviewing CPI’s electrical schematic drawings, 3M’s electrical engineers
discovered some discrepancies from the voltage provided for in the
specifications. CPI then issued a change order to Quantum Design for
some revisions to the control panel.

In April 2014 S.F. completed a general arrangement drawing for
the oxidizer system, which was checked by J.Y. By the time S.F.

14 The difference between the two types of fans is a simple one: Induced draft

fans provide negative pressure (i.e., pull) while forced draft fans provide positive
pressure (i.e., push).
 15

[*15] completed the general arrangement drawing, minor changes had
already been incorporated into the drawing in prior revisions made in
both 2013 and 2014. Those changes included (1) adding an additional
walkway to the front of the system for accessing the gas trains;
(2) adding davit cranes to the front of the system in order to lift
components; and (3) reworking the design of the gas trains.

Ultimately, CPI installed the system at the Hutchinson facility,
with Mr. Harmsen and F.C. on site to supervise the installation. In
January 2015 testing was performed on the system under actual process
conditions at the Hutchinson facility. The testing demonstrated that the
system was not satisfying the destruction efficiency performance
guarantee. Eventually, CPI discovered a gap under a poppet valve,
which it resolved by welding a ring into place to eliminate the gap. In
May 2015 3M informed Mr. Harmsen that the oxidizer had been
measured as satisfying 99%+ destruction efficiency.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 16

[*16] Component Cost

Barometric damper $4,025

Booster fan (moved VFD sales est to electrical) 89,971

Burner 11,178

Ceramic media 43,862

Combustion air piping 9,451

Combustion blower 4,455

Component location 1,624

Control house 44,995

Ductwork 3,441

Electrical loose parts 5,767

Electrical panel (sales est includes VFD from BF) 91,955

Exhaust stack 50,370

Gas piping 24,461

Gas train 40,619

Hotside bypass damper 15,451

Internal assembly combustion chamber 13,995

Internally insulated ductwork 14,500

Mechanical loose parts 1,156

Total $471,275
 17

[*17] B. Akzo Nobel (#13-07645)

During the years at issue Akzo Nobel Coatings, Inc. (Akzo Nobel),
manufactured industrial paint at a facility in Huron, Ohio. At the
facility, Akzo Nobel used reactors and tanks for mixing paint, which
emitted some limited VOC byproducts such as xylene, a paint dilutant.
For 30 years Akzo Nobel had used a direct thermal oxidizer to destroy
VOCs. In 2013 Akzo Nobel put out a request for bids on a new oxidizer,
to which CPI responded. CPI personnel visited the Huron facility, met
with Akzo Nobel personnel, and learned the specifications for the
project. CPI personnel then entered the specifications into a
spreadsheet, which output a potential size of 8,000 SCFM; ultimately,
CPI determined that the size would be 6,000 SCFM. J.O. was the project
manager, while Mr. Harmsen was the applications engineer for the
project.

In December 2013 CPI provided a proposal to Akzo Nobel for a
regenerative thermal oxidizer, sized at 6,000 SCFM and with 95%
thermal efficiency. The proposal included a 98% destruction efficiency
performance guarantee. Akzo Nobel responded by sending to CPI a
confirmation of purchase order for the supply and installation of a
regenerative thermal oxidizer, for a total price of $271,000. CPI then
engaged Lantec to fabricate and supply multilayer ceramic media and
PRE-Heat to fabricate and supply the oxidizer system and various
components. Akzo Nobel and CPI personnel conducted a joint hazard
study of the oxidizer to assist Akzo Nobel personnel in learning the
equipment and understanding the safety protocols involved in operating
the oxidizer. As a result of the hazards study, CPI made some minimal
changes to the design of the electrical control system.

In January 2014 R.J. prepared electrical schematic drawings for
the oxidizer’s control panel. On February 7, 2014, Mr. Harmsen and
J.O. visited the Huron facility to meet with Akzo Nobel personnel. At
the meeting, Mr. Harmsen took notes on various potential issues and
sketched out a basic diagram of what the oxidizer would look like. In
his notes, Mr. Harmsen identified several potential issues, including
how fire suppression would be tied into the system and how to design
the ductwork and new dampers. CPI determined to include in the
design a flame arrestor, a component that would prevent flame
transmission. 15 CPI personnel later entered specifications into a

15 A flame arrestor is a failsafe component that impedes airflow and thus

essentially prevents a potential explosion from continuing past the arrestor’s location.
 18

[*18] supplier’s sizing program, which output the potential model and
size for a flame arrestor component. Given the basic requirements of
the system, J.O. and other CPI personnel calculated the appropriate size
for various other components, including a media bed, burners, and a
fresh air damper.

CPI engaged MK Systems, Inc., to design and supply a booster
fan for the oxidizer. CPI engaged Quantum Design for the fabrication
of a control panel enclosure for the oxidizer, to be based on CPI’s drawing
set. On February 26, 2014, R.T. visited PRE-Heat’s facility to inspect
the fabrication of the oxidizer; in a checklist, R.T. signed off on a number
of different elements of the oxidizer and noted that other elements were
still work-in-progress.

On March 13, 2014, R.T. visited PRE-Heat’s facility to inspect the
fabrication. In March 2014 R.T. prepared a general arrangement
drawing for the oxidizer, which was checked by Mr. Harmsen. This
drawing incorporated revisions stemming from CPI’s having determined
what booster fan and combustion blower would be included in the
system. R.T. subsequently revised the general arrangement drawing of
the oxidizer in order to change the customer connection and to add a
handrail and access ladder, respectively, in response to a request from
Akzo Nobel.

Akzo Nobel performed the installation of the oxidizer at the
Huron facility, with CPI personnel supervising. In September 2014 a
third party performed emissions testing on the oxidizer and determined
that oxidizer’s destruction efficiency was on average 97.93%, just below
the 98% performance guarantee provided by CPI. As part of its
warranty, CPI sent service technicians to the facility to potentially make
adjustments. Ultimately, CPI resolved the issue by conducting its own
testing and measuring that the parts per million (PPM) of methane in
the exhaust was only 1.41—well below the alternate efficiency
guarantee of 25 ppm from CPI’s proposal. 16

As part of the research credit study, Alliantgroup also calculated
that the following supply costs were qualified research expenditures:

16 This was likely due to the low sample size of VOCs at issue, which made it

difficult to reach 98% at a given point because of the measuring issues.
 19

[*19] Component Cost

Engineering add-ons $2,086

Booster fan 8,564

Burner 1,822

Ceramic media 4,410

Combustion air piping 1,194

Combustion blower 3,681

Ductwork 78

Electrical boxes 1,296

Electrical loose parts 16,212

Electrical panel 39,906

Exhaust stack 14,634

External assembly combustion chamber 90,240

Fresh air damper 2,994

Gas train 7,502

Internal assembly combustion chamber 10,088

Mechanical loose parts 1,186

Total $205,894

C. HA International (#13-07615)

During the years at issue HA International, LLC (HAI),
maintained a manufacturing plant in Oregon, Illinois. At the plant, HAI
produced frac sand, a chemically infused sand that is used by the
natural gas industry in the process of hydraulic fracturing (known more
familiarly as fracking). A number of hazardous chemicals, including
 20

[*20] phenolic resins, furfuryl alcohol, hexamine, and ammonia, were
injected into the sand in order to make it useful for fracking purposes.

HAI contacted CPI about potentially designing two oxidizers, as
HAI’s scrubber equipment at the time was ineffective and had led to an
enforcement issue with the EPA. C.J. was staffed as the sales engineer
on the project. In early 2013 CPI employees did initial emissions testing
at HAI’s plant. CPI employees tested the air exhaust of the plant and
observed HAI’s manufacturing process. In an emissions study, dated
April 18, 2013, CPI concluded that HAI’s current scrubber equipment
was failing to achieve the required 98%+ efficiency and that the jobsite
had a number of issues, including a lack of proper ventilation and the
buildup on equipment surfaces of resin containing VOCs. The emissions
study also measured a number of different VOCs present in the process
airflow, including formaldehyde, phenol, and methanol.

CPI personnel determined that recuperative thermal oxidizers
would be more appropriate than catalytic ones because of the loose sand
generated by HAI’s manufacturing process, which could degrade a
catalyst, and HAI’s use of chemical compounds that were less
susceptible to catalytic conversion. CPI personnel determined that
recuperative thermal oxidizers would allow the loose sand to accumulate
in the bottom of the machine (where it could later be cleaned out)
without interfering with performance, whereas other oxidizers would be
negatively affected by the sand. Considering the VOCs present, CPI
personnel also determined that airflow’s percentage of LEL, as
measured, was sufficiently high that the airflow into the oxidizer should
be diluted. Accordingly, CPI included in the design a fresh air dilution
valve, a fresh air damper, and a safety system to guard against the risk
of explosion. In order to accommodate the existing water scrubber, CPI
included a duct heating system that would evaporate any water vapor
from the scrubber.

In November 2013 CPI delivered to HAI a revised proposal for the
design of two 13,700 SCFM recuperative thermal oxidizers with 99%
VOC destruction efficiency, with C.J. listed as the sales engineer. The
proposal included the assumed VOC characteristics and levels of the
process airflow. The proposal stated, inter alia, that the basis of CPI’s
recommendation was “its experience gained through +30 units in the
sand resin coating industry.” The referenced “+30 units” that CPI had
previously designed were oxidizers installed for customers using resin-
coated sand to coat automotive components. The proposal also discussed
several of the relevant design characteristics. In relevant part, the
 21

[*21] proposal stated that CPI proposed “to preheat the exhaust gases
from the scrubber prior to entering the ductwork,” in order to “elevate
the saturated air stream well above the condensate threshold to help
reduce both water and resin buildup prior to the pollution control
equipment.” Accordingly, the proposal also stated that CPI would
supply a direct fired duct heater system designed to heat the water
vapor from the scrubber exhaust. Finally, the proposal included a 99%
VOC destruction efficiency performance guarantee.

Also in November 2013 HAI issued a purchase order to CPI for
the oxidizer, with attached terms and conditions and a total price of
$1,898,750. Clause 14 of the terms and conditions, entitled “Intellectual
Property Rights,” stated as follows:

HA is entitled to all documents, drawings, specifications,
calculations and other information carriers with respect to
the performance of the activities of Contractor under the
Order. HA will be solely entitled to all intellectual property
rights (including patents) created during the performance
of the obligations under the Order. In case the intellectual
property rights are with both Contractor and HA,
Contractor will assure and guarantee that HA has a full
license to use these without any conditions for an indefinite
period of time.

Clause 20 of the terms and conditions stated that the terms would “be
construed in accordance with the laws of the State of Ohio without
application of its conflict of laws provisions.” On November 18, 2013,
CPI issued to HAI a sales order for the oxidizer.

In early January 2014 G.B. completed an initial general
arrangement drawing for the oxidizer. R.J. completed a P&ID drawing
for the oxidizer as well as electrical schematic drawings for a control
panel. CPI engaged PRE-Heat to fabricate and assemble the thermal
oxidizer and other components and Quantum Design to fabricate two
control enclosures. On April 17, 2014, Quantum Design issued to CPI a
project scope change form, noting several changes, including an
increased enclosure size in order to accommodate an air conditioner.

After fabrication was completed, the oxidizer parts were shipped
to HAI’s facility for installation. In June and July 2014 R.J. and another
CPI employee conducted quality inspections on the oxidizer’s electrical
systems and oversaw startup.
 22

[*22] After installation, testing of the oxidizer revealed another issue
in which several tubes in the heat exchanger overheated because of
inadequate airflow. CPI resolved the issue by replacing and rewelding
the tubes and then replacing the baffles installed with a different air
splitting component, in order to achieve better airflow uniformity.
Testing of the oxidizer also revealed that vibration within the oxidizer
had ruptured some pressure release valves. CPI resolved the issue by
cutting down the length of the damper blades, which were causing the
excess vibration.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 23

[*23] Component Cost

Booster fan $45,330

Burner 10,378

Combustion air piping 11,883

Combustion blower 3,914

Duct heater 44,986

Electrical panel 39,960

Exhaust stack 18,690

Gas train 30,443

Heat exchanger 283,951

Internal assembly combustion chamber 44,952

Mechanical loose parts 861

Seal air blower 1,833

Seal air blower piping 633

Total $537,813

D. 3M Hartford (#13-07611)

During the years at issue, 3M manufactured different types of
tape at a facility in Hartford City, Indiana. 3M initially contacted CPI
to assist in replacing a failing heat exchanger in one of their existing
thermal recuperative oxidizers. The production process at the Hartford
facility emitted VOC byproducts such as heptanes and hexanes. These
VOCs were attached to silicone molecules, which presented an issue, as
oxidizing the VOCs would trigger the formation of silicone dioxide (i.e.,
sand) that needed to be cleaned out of the oxidizer. Upon examination
of the existing oxidizer, CPI personnel determined that the system was
beyond the point of failure and recommended that 3M replace it. C.H.
was the sales engineer on the project.
 24

[*24] As with the Hutchinson project, 3M provided extensive
specifications and required criteria for a potential oxidizer, including the
maximum exhaust temperature, type of VOCs at issue, and required
destruction efficiency. CPI personnel considered the process airflow
volume specification provided by 3M to be lower than the minimum
airflow needed for the oxidizer. Accordingly, CPI personnel determined
to include in the design a recirculation duct that would recycle cleaned
air from the exhaust stack back to the process inlet to achieve the
necessary minimum airflow.

In November 2013 CPI submitted a proposal to 3M for a
recuperative thermal oxidizer, which it described as a Quadrant SRS-
Silicone Series. The proposal included the process airflow
characteristics, as provided by 3M, such as the VOCs at issue and the
range of concentrations. The proposal stated, in relevant part, that the
proposal was based on the system’s “ability to offer assured destruction
without worry about Silicone plugging while offering the lowest
maintenance costs and highest uptime reliability.” The proposal also
stated that the system was “designed to minimize the effects of SiO2
build up for fast and efficient cleanout,” by including ports to
“accommodate future inspections and cleaning” out of the SiO2
particulate. The proposal included a standardized page discussing the
problem of silicone dioxide and stating that the Quadrant SRS Silicone
Series thermal oxidizer had been developed “to provide an economical
answer to the disastrous effects of SiO2.” CPI had developed the
Quadrant SRS Silicone Series over a period of years and considered it to
be a unique, proprietary technology that it could market to the specific
industry of manufacturers using silicone coating. Also in November
2013 CPI issued a sales order to 3M for the thermal oxidizer, for a total
price of $1,569,700. The terms of the master agreement governed CPI’s
contract with 3M on the Hartford project.

CPI personnel, including Mr. Betz, ran a number of calculations
as to the sizing of components, such as the combustion blower and the
burners. In December 2013 G.B. completed an initial general
arrangement drawing for the oxidizer, which was checked by J.Y. In
February 2014 R.J. completed a P&ID drawing for the oxidizer. CPI
engaged PRE-Heat for the fabrication and supply of the recuperative
oxidizer system and components. In April 2014 R.J. completed control
enclosure schematic drawings for the oxidizer. CPI engaged Quantum
Design for the fabrication of control panel enclosures for the oxidizer,
based on CPI’s drawing set.
 25

[*25] In June 2014 3M provided CPI with revised information about the
process airflow volume, which allowed CPI personnel to make the
recirculation duct component smaller. Also in June 2014 Mr. Harmsen
contacted a 3M representative to provide notice of a scope change; 3M
personnel had become concerned that the sand particulate would affect
the booster fan, so CPI proposed to change to a radial blade fan that
could handle the particulate. Also in June 2014 CPI personnel visited
PRE-Heat to inspect the progress on the fabrication, at which point the
oxidizer was nearly finished. After installation at the Hartford City
facility, the oxidizer passed third-party compliance testing.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 26

[*26] Component Cost

Booster fan $49,746

Burner 23,226

Combustion air piping 615

Ductwork 521

Electrical loose parts 2,047

Electrical panel 64,452

External assembly combustion chamber 10,002

Field assembly 10,239

Gas train 45,880

Heat exchanger 43,710

Hot side bypass damper 19,539

Seal air blower 9,864

Barometric relief damper 4,392

Total $284,233

E. C&D Zodiac (#13-07583)

During the years at issue, Zodiac Aerospace Composites &
Engineered Materials (C&D Zodiac) manufactured composites for
commercial aircraft at a facility in Marysville, Washington. C&D
Zodiac’s manufacturing process generated VOC byproducts such as
phenol and formaldehyde. In 2013 Messrs. Betz and Harmsen visited
the Marysville facility to measure flow rates and then delivered to C&D
Zodiac an engineering study stating that their existing oxidizer had
insufficient volume. Before submitting a proposal to C&D Zodiac, Mr.
Harmsen input the measured values into a spreadsheet, which output
the potential BTUs per pound and pounds per hour of potential VOCs in
the process airflow, which would in turn determine the necessary size of
 27

[*27] the oxidizer. Using various process airflow measurements, Mr.
Harmsen determined that the oxidizer size would be smaller than he
had anticipated and thus would allow for a more efficient heat
exchanger and avoid the need for a hot gas bypass. C.H. was the sales
engineer on the project.

In October 2013 CPI submitted a proposal for a 9,400 SCFM
regenerative thermal oxidizer. The proposal described the VOC levels
and characteristics of the process airflow. The proposal also included a
98% destruction efficiency performance guarantee. Also in October 2013
CPI issued a sales order to C&D Zodiac for the thermal oxidizer, for a
total price of $374,500. On November 4, 2013, the CPI project team,
which included Messrs. Betz, Harmsen, J.O., and C.H., held an internal
kickoff meeting to discuss the project and particular elements of the
oxidizer design. At the meeting, Mr. Harmsen discussed the inclusion
of a duct heater in the design, in order to heat the process air to an extent
sufficient to avoid buildup of resin condensation in the ducts.

CPI engaged Quantum Design to fabricate and supply a control
panel enclosure for the oxidizer. In late November 2013 J.O. exchanged
emails with David Foster, the project manager at C&D Zodiac,
regarding minor changes to the design drawings. At J.O.’s request, Mr.
Foster provided the earthquake rating for the Marysville area, which
had to be accounted for in the design of the exhaust stack. In late
November 2013 J.O. prepared an initial general arrangement drawing
and a P&ID drawing for the oxidizer and emailed them to Mr. Foster for
approval. After reviewing the drawing set, Mr. Foster informed J.O.
that the P&ID drawing’s placement of the Marysville facility’s print
room was inaccurate and should be updated. In December 2013 the
P&ID drawing was revised per C&D Zodiac’s comments.

CPI engaged Lantec to fabricate and supply multilayer ceramic
media, PRE-Heat to fabricate and supply a regenerative thermal
oxidizer and various components, and IVI North to fabricate and supply
an exhaust stack. In December 2013 C.D. completed initial electrical
schematic drawings for a control panel. On February 16, 2014, R.T.
visited PRE-Heat to inspect the oxidizer and media assembly and poppet
valve housing. On February 26 and March 13, 2014, R.T. again visited
PRE-Heat to inspect various components in the fabrication process.

In March 2014 R.J. provided Quantum Design with updated
electrical schematic drawings to be revised in order to comply with third-
party certification standards. CPI engaged Quantum Design to have its
 28

[*28] technicians travel to PRE-Heat’s facility and make additional
revisions to the control system to meet certification standards. During
installation at the Marysville facility, CPI discovered that the control
panel enclosure door was too close to the booster fan; CPI moved the
control panel enclosure over to resolve the issue.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 29

[*29] Component Cost

Booster fan $22,668

Burner 2,165

Ceramic media 13,200

Combustion air piping 1,693

Combustion blower 3,418

Electrical boxes 1,298

Electrical loose parts 1,317

Electrical panel 68,456

Exhaust stack 19,835

External assembly combustion chamber 6,202

Field assembly 163

Fresh air damper 3,134

Gas train 7,059

Internal assembly combustion chamber 18,595

Engineering add-ons 1,781

Total $170,984

F. Teva (#14-07808)

During the years at issue, Teva Pharmaceuticals USA (Teva)
operated a pharmaceutical facility in Salt Lake City, Utah. In 2014
Teva was in the process of installing a new manufacturing line that
required pollution control, pursuant to EPA standards. The primary
VOC byproduct of Teva’s manufacturing process was ethanol.

CPI was invited to bid on the project and determined that a
catalytic oxidizer would be optimal. CPI personnel reached this
 30

[*30] determination partly because of the limited space at Teva’s
facility. Teva also provided CPI with specifications about the
characteristics of the airflow exhaust at the Salt Lake City facility. In
April 2014 CPI submitted a proposal for a catalytic oxidizer, described
as a Vector series. The proposal included extensive specifications and a
performance guarantee that total VOC concentration would be reduced
by at least 98%. The proposal also stated that the system would include
a self-cleaning ceramic guard bed; after discussions with Teva, CPI had
determined that the guard bed would be necessary to protect the
catalyst from other particulates in the facility’s airflow. T.S. was the
sales engineer on the project.

In May 2014 Teva and CPI exchanged purchase and sale orders
for the catalytic oxidizer, for a total price of $217,600. The purchase
order attached Teva’s standard terms and conditions; clause 14 provided
that CPI would “not use, sell, loan or publicize any of the tools,
specifications, blueprints, designs or artwork supplied or paid for by
Buyer for the fulfillment of this order without Buyer’s written consent.”
Similarly, clause 15 provided that “[a]ll tools, dies, molds, printing
plates, mechanical, etc. created for use on this order shall be the
property of Buyer, and Buyer may withdraw them from Sellers’s
premises on demand in writing.”

CPI personnel calculated the size of components, such as the
catalyst bed chamber, the exhaust stack, and the burners, using the
information about the process airflow provided by Teva. CPI engaged
PRE-Heat for the fabrication and assembly of a heat exchanger, exhaust
stack, and various other components. In June 2014 C.D. completed
electrical schematic drawings for a control panel enclosure.
Subsequently, CPI engaged Quantum Design to fabricate and supply a
control panel and enclosure based on CPI’s drawings. From June to
October 2014 CPI purchased a number of physical components and
materials from vendors, with shipping typically made to PRE-Heat.

PRE-Heat completed fabrication and assembly of the oxidizer, at
which point CPI personnel visited its facility to conduct “a final quality
audit.” The quality audit included dye penetrant testing of the oxidizer
body and testing of the control system. The oxidizer was then shipped
to Teva’s facility in Salt Lake City. Teva personnel installed the oxidizer
at the Salt Lake City facility, with CPI personnel present to supervise.
After installation, the oxidizer’s heat exchanger was preheating too
high. CPI resolved this issue by modifying the control system in order
to introduce additional fresh air into the process to bring down the
 31

[*31] temperature via a damper on the inlet side of the system fan. The
system later passed its third-party compliance testing.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:

Component Cost

Booster fan $8,959

Burner 1,960

Catalyst – 8800 = ECO#1 3000 11,880

Combustion air piping 1,170

Combustion blower 1,441

Electrical panel 25,626

Exhaust stack 1,141

Fresh air damper 2,744

Gas train 8,323

Heat exchanger 56,666

I Asbly combustion chamber 15500 = ECO#1 500 6,200

PIT Sitrans 963

Tee damper 3,107

Total $130,178

G. Mitsubishi (#14-07899)

During the years at issue. Mitsubishi Electric Automotive
America, LLC (Mitsubishi), operated a facility in Mason, Ohio, that
manufactured motor starters and other engine components for engine
suppliers. Mitsubishi’s manufacturing process generated the chemical
styrene as a VOC byproduct. Mitsubishi’s existing 12,000 SCFM
catalytic oxidizer system had been supplied by CPI 14 years earlier. The
 32

[*32] catalytic oxidizer had been experiencing a buildup of condensates
in recent years, creating a maintenance problem and reducing the
system’s capacity to approximately 10,000 SCFM. Mitsubishi requested
that CPI provide suggestions for a larger (either 35,000 or 25,000
SCFCM), more efficient, and maintenance-friendly oxidizer, as it
planned to expand the Mason facility. Using the two potential airflow
volumes, Mr. Harmsen performed simple calculations for the potential
size of several components.

In July 2014 CPI submitted a revised proposal for either a 35,000
or a 25,000 SCFM regenerative thermal oxidizer. The proposal
described the process airflow as “styrene with a heat content of
approximately 17,000 BTU/lb.” The proposal also included a 98%
destruction efficiency performance guarantee. In August 2014
Mitsubishi sent CPI a purchase order for the 35,000 SCFM oxidizer, for
a total price of $675,750. Mr. Betz prepared a P&ID drawing for the
oxidizer that was based on CPI’s existing knowledge of the Mitsubishi
facility and Mitsubishi’s expansion plans. C.D. completed initial
electrical schematic drawings for a control panel. S.F. completed an
initial general arrangement drawing for the oxidizer.

CPI engaged Lantec to fabricate and supply multilayer ceramic
media, Quantum Design to fabricate and supply the control panel
enclosure of the oxidizer, and both Global Fab and PRE-Heat to fabricate
and supply various components of the oxidizer. CPI engaged a general
contractor located near Mitsubishi to perform the installation of the
system at the facility, under the supervision of Messrs. Harmsen and
E.M.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 33

[*33] Component Cost

Booster fan $31,537

Burner 44,333

Ceramic media 47,880

Combustion air piping & weather hood 2,710

Combustion blower 3,484

Electrical loose parts 2,112

Electrical panel – SEE EXCEL for details 31,067

Exhaust stack 21,870

Fresh air damper 4,142

Gas train 11,500

Mechanical loose parts 3,328

BF outlet exp jnt 967

BF VFD NEMA 1 250HP w/disconnect 15,543

Engineering add-ons 4,484

Ex stack exp jnt 1,377

Poppet valve assemblies 26,849

Total $253,183

H. 3M Monrovia (#14-07784)

During the years at issue 3M manufactured silicone rubber
gasketing for the aerospace industry at a facility in Monrovia,
California. Before engaging CPI, 3M used an existing recuperative
thermal oxidizer supplied years earlier by a different oxidizer
contractor. As of 2013 that oxidizer was no longer meeting California
environmental regulatory standards. In February 2013 3M provided
 34

[*34] CPI with an extensive and detailed list of required specifications
for a 12,000 SCFM recuperative thermal oxidizer. The specifications
included the requirements that the oxidizer “include design features
necessary for cleaning of SiO2 dust from the heat exchanger and
combustion chamber”. The specifications also provided information
about the process airflow, including minimum and maximum airflow
rates, temperatures, solvent rates, and the VOC at issue (toluene).

In April 2014 CPI submitted a revised proposal, which 3M
accepted via a purchase order, for a total price of $1,277,400. The final
proposal stated that CPI would supply 3M with a silicone recuperative
oxidizer from CPI’s Quadrant SRS product line. The proposal also
included a 99% destruction efficiency performance guarantee. CPI also
provided 3M with general arrangement and P&ID drawings for the
oxidizer. The terms of the master agreement governed CPI’s contract
with 3M on the Monrovia project. Mr. Harmsen was the lead
applications engineer on the project and assisted with project
management.

3M had informed CPI personnel that the oxidizer would need to
meet California state law requirements with respect to its emissions. In
particular, the specifications provided by 3M noted the requirement for
low nitrogen oxide-emitting burners. In May 2014 G.B. completed an
initial general arrangement drawing for the oxidizer, which was checked
by F.C. In June 2014 CPI personnel input the provided specifications
into a spreadsheet, which output a possible size for the burner. CPI also
submitted its design drawings to a third party, Larson Engineering, Inc.
(Larson), for review; Larson reviewed the drawings for the purpose of
determining whether they complied with California requirements with
respect to seismic activity. Also in June 2014 Larson issued a report
certifying the drawings as acceptable. Similarly, CPI submitted the
design drawings to a different third-party engineer who performed
calculations and made suggestions as to how the stack could comply with
California requirements. In July 2014 R.J. prepared electrical
schematic drawings for the oxidizer. Ultimately, after consulting with
Maxon Corp., CPI’s typical burner supplier, CPI personnel included a
low emissions burner in the design. In August 2014 CPI submitted to
3M several design drawings, including the general arrangement
drawing, for approval.

CPI engaged IVI North to fabricate and supply an exhaust stack,
PRE-Heat to fabricate and supply the oxidizer and various components,
and Quantum Design to modify the existing control panel enclosure and
 35

[*35] fabricate a new control panel. In July 2014 R.J. completed
electrical schematic drawings for a control panel enclosure. In
September 2014 CPI and 3M conducted a joint process hazard analysis
(PHA), to review the design drawings and relevant possible safety issues
at the Monrovia facility. Mr. Harmsen and F.C. participated on CPI’s
side. As a result of the PHA, CPI made several design changes to the
design drawings.

In February and March 2015 CPI submitted to 3M additional
revised design drawings for approval. After assembly was completed,
the oxidizer was installed at the Monrovia facility by a third-party
contractor, under the supervision of F.C. At some point after
installation, an inspection of the oxidizer by 3M found that the cone
installed around the burners was cracking and failing; pursuant to the
contractual warranty, CPI repaired the problem.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 36

[*36] Component Cost

Barometric relief damper $8,011

Burner 7,565

Combustion air blower 7,777

Combustion air piping 38,183

Control house 33,866

Davit arm 2,724

Ductwork 5,425

Electrical panel 54,920

Exhaust stack 62,068

Field assembly 12,927

Filter box 14,996

Filter box dampers 21,649

Gas train 30,690

Hardware & gasket 1,988

Heat exchanger 352,290

Process booster fan 50,352

Seal air blower 5,929

Total $711,360

I. Celanese (#14-07852)

During the years at issue, Celanese Corp. (Celanese)
manufactured ethylene-vinyl acetate beads for use in other chemical
manufacturing processes at a facility in Edmonton, Alberta, Canada.
 37

[*37] The manufacturing process generated VOC byproducts of acetic
acid, ethylene, vinyl acetate, and naphtha.

In August 2013 Celanese issued to CPI terms and conditions for
a project, which included a clause 11 entitled “Rights in Deliverables;
No License.” Clause 11 stated that CPI agreed “that any deliverables or
other work product arising from the Services shall be the property of
and owned by Celanese, and shall be considered Confidential
Information hereunder.” Clause 11 further stated in relevant part that
CPI “hereby assigns to Celanese any and all (a) inventions, discoveries
or improvements thereof, patentable or otherwise” and “(b) all other
copyright and derivatives, trade secret and other proprietary rights that
arise out of the performance of the Services or that are applicable to any
deliverables under the Purchase Order.” Clause 11 further stated that
any deliverables that are eligible for copyright protection “shall be
considered “work made for hire” and Celanese will be considered the
author of such work.” Finally, clause 11 provided that, in the event that
such deliverables were “deemed for any reason not to be a work for hire,”
CPI “hereby assigns all rights, title and interest in the copyright of such
work” to Celanese.

Next, clause 12 provided restrictions on Confidential Information,
requiring CPI to “hold the Confidential Information in strictest
confidence” and “not disclose the Confidential Information, or cause or
allow it to be disclosed to any third party or use the Confidential
Information for any purpose other than as expressly contemplated by
the Purchase Order. Clause 12 provided that CPI could “not disclose
any Confidential Information to any third party . . . unless and until
Celanese has furnished written consent.”

In December 2013 WorleyParsons, an engineering firm retained
by Celanese to supervise the project, provided CPI with an extensive
report detailing the specifications and requirements for the oxidizer.
The report stated that Celanese required a regenerative thermal
oxidizer with destruction efficiency of 98%; the report also provided a
design basis for the oxidizer, which provided a number of relevant
measurements and calculations (including a minimum winter
temperature of −46 degrees Celsius and the various concentrations of
VOCs in the airflow), and a drawing setting out the process flow for the
oxidizer. The report also provided a list of Celanese’s preferred vendors
for the various components and control systems. In addition, Celanese
provided CPI with copies of (1) its standard engineering practices for
 38

[*38] control systems; (2) standard maintenance procedures for bolted
joint assembly; and (3) electrical specifications.

CPI began work on a proposal. CPI identified several potential
issues, for example, the extreme winter temperatures in Edmonton,
which might require design changes. Using the information provided by
Celanese and WorleyParsons, CPI personnel input the provided VOC
levels into Bessy spreadsheets, which calculated that the LEL of the
airflow would be 4.2%. 17 That low LEL allowed CPI to omit a hot gas
bypass from the design. Similarly, CPI personnel entered the provided
specifications into a spreadsheet, which output the appropriate size of
the fan components. With respect to the gas train component, on
January 8, 2014, Mr. Betz emailed a representative at Maxon to ask
about how to design the component for use in a minimum temperature
of −50.8 degrees Fahrenheit. The Maxon representative responded that
CPI should try to work with the customer to have the component meet
−45 or −40 degrees Fahrenheit minimum temperatures instead, because
of the difficulty in supplying components that met such low
temperatures.

In May 2014 CPI submitted a revised proposal to Celanese. In
the proposal, CPI stated that it “accepts Celanese terms and conditions
8-1-2013 with the termination language detailed on page 36 of this
proposal.” The proposal also stated in relevant part that the system was
being “designed for outdoor installation and a temperature rating of −40
[degrees] C (−40 [degrees] F) [sic].” In June 2014 Celanese issued a
purchase order to CPI for the oxidizer, for a total price of $897,000. 18

In July 2014 S.F. completed an initial general arrangement
drawing for the project, which was checked by F.C. Also in July 2014,
R.J. completed P&ID drawings for the oxidizer. CPI engaged Quantum
Design to fabricate a control panel enclosure, Lantec to supply a ceramic
heat exchanger, and IVI North to fabricate and supply an exhaust stack
for the system, including “[e]ngineering and design (fabrication
drawings).” In August 2014 R.J. completed initial electrical schematic

17 CPI personnel also entered different combinations of VOCs at higher
volumes into several alternative Bessy spreadsheets to account for a possible worst-
case scenarios, which resulted in an 8% LEL.
18 In February 2015, Celanese issued a change order, memorializing an

additional $33,000 in unplanned services to be performed by CPI. Those services
largely related to an apparent misunderstanding between the parties as to the scope
of CPI’s work on the electrical system.
 39

[*39] drawings for a control panel. R.J. later requested that Quantum
Design complete the final design drawings for the electrical schematics,
in part because CPI’s work was being closely scrutinized by
WorleyParsons. Quantum Design provided CPI with a quote to design
the control enclosure for the oxidizer. Under its terms Quantum Design
would provide engineering design and drawings “using CPI provided
standard templates and nameplates.” As the project progressed,
WorleyParsons and Celanese requested revisions to the design, which
CPI incorporated. In September 2014 R.J. traveled to Canada for
meetings with Celanese representatives; in those meetings, Celanese
requested a number of changes to the design of the control panel, which
R.J. conveyed to Quantum Design.

As of early February 2015 the oxidizer was not yet assembled or
installed. Celanese had informed CPI that it needed to meet Canadian
building code standards for the control house component of the system,
which delayed the project; eventually CPI and Celanese agreed to
purchase a control house in Canada and have CPI pipe and wire it to
meet the Canadian standards. In early April 2015 R.J. prepared a
document that described the details of the control house. At some point
thereafter, the oxidizer was installed at the Celanese facility by a third-
party contractor. In March 2016 the oxidizer system underwent third-
party emissions testing and failed the efficiency requirements. As with
the 3M Hutchinson project, CPI discovered that a poppet valve was
failing to seal and sent a service technician to fix it.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 40

[*40] Component Cost

Booster fan $22,056

Burner 6,416

Ceramic media 32,106

Cold face support 89,288

Combustion air piping 1,680

Combustion blower 4,894

Control house 4,936

Electrical loose parts 7,196

Electrical panel 95,371

Exhaust expansion joint 837

Exhaust stack 43,550

Fresh air damper, pneu. act. 4,255

Gas train 4,382

Isolation damper, pneu. act. 5,801

Manual balancing damper 1,344

Mechanical loose parts 2,732

Media chamber 28,408

Poppet housing 25,261

Poppet valve assemblies 23,044

Total $403,556
 41

[*41] J. Smalley (#14-07658)

During the years at issue, Smalley Steel Ring Co. (Smalley)
manufactured heat-treated fasteners for aircraft engines at a facility in
Lake Zurich, Illinois. Smalley’s heat-treating process generated oil and
grease byproducts that burned off into visible smoke. Before contacting
CPI, Smalley relied upon condenser equipment, evocatively known as
Smog-Hogs, which intake and cool smoke-filled air, causing the oil and
grease droplets to condense, before then releasing the cleaned air back
into the manufacturing area. However, the condenser process created
an oil byproduct that could leak, presenting a potential quality and
maintenance problem that Smalley wished to avoid. CPI personnel
visited the jobsite, took measurements of the airflow, and ran tests.
Because of the variety of chemical compounds CPI found present at the
site and constraints on using blowers at the site, CPI determined that a
thermal oxidizer with a vertical combustion chamber would be
optimal. 19

In December 2013, after completing onsite measurements, CPI
submitted a proposal for an 800 SCFM direct thermal oxidizer,
described as a “smoke abatement” system, which Smalley accepted. The
proposal stated, in relevant part, that the system would convert the oil
smoke and mist emissions to carbon dioxide and water vapors, creating
a “cleaner, more maintenance-free abatement system.” Also in
December 2013 Smalley sent CPI a purchase order for the oxidizer, for
a total price of $153,500; the purchase order attached terms and
conditions. Clause 6 of the terms and conditions provided:

Seller will keep confidential all information, drawings,
specifications or data furnished by Buyer and shall not
divulge or use such information, drawings, specifications or
data for the benefit of any third person or entity or for any
purpose other than the performance of this Order. Except
as required for the performance of this Order, Seller will
not make copies or permit copies thereof to be made
without the prior written consent of Buyer; Seller will,
upon completion of this Order, return such information,
drawings, specifications and data to Buyer and make no
further use, either directly or indirectly, of any such data

19 A vertical combustion chamber is essentially akin to a chimney, in which hot

air is induced to rise upward.
 42

[*42] or of any information derived therefrom without obtaining
Buyer’s prior written consent.

Clause 10 of the terms and conditions provided in relevant part:

Unless Buyer and Seller otherwise agree in writing, the
following provisions shall apply to any tools, tooling,
patterns, equipment, materials or other properties used in
the manufacture of the Goods for Buyer or in the
performance of this Order, that are either supplied to
Seller by Buyer or have been acquired by Seller and
specifically paid for by Buyer. All such properties
(including scrap) shall hereafter be referred to as “Buyer-
Owned Property”. (a) Seller shall have the right to use
Buyer-Owned Property without payment for usage as
required in the performance of this Order or other work for
Buyer, but shall not use Buyer-Owned Property in the
performance of any other work without prior written
approval of the Buyer. Title to all Buyer-Owned Property
shall at all times remain with Buyer. Title to all Buyer-
Owned Property which is procured or manufactured by
Seller for Buyer shall be fully invested in Buyer upon
payments for same by Buyer.

In January 2014 CPI personnel collected samples of the oil
condensation, coated a steel sample with the condensation, and then
placed the sample in a furnace at the Smalley facility, in order to observe
at what temperature the smoke emissions from the condensation were
no longer present. CPI personnel also entered specifications into
spreadsheets and performed calculations in order to size components,
such as the combustion chamber and the burners. Also in January 2014
R.J. completed electrical schematic drawings for a control panel. The
control system was designed to automatically turn the burners on and
off according to whether Smalley’s heat furnaces were generating visible
smoke emissions. CPI engaged Quantum Design to fabricate a control
panel enclosure and Modern Equipment Co. (Modern Equipment) to
fabricate and assemble the oxidizer. After the oxidizer was assembled,
a quality audit conducted by CPI personnel revealed that Modern
Equipment had not followed CPI’s drawings closely enough, leading to
some components’ needing to be reassembled by CPI personnel. CPI
personnel then installed the oxidizer at the Smalley facility. After
installation, CPI personnel modified the control system’s sequence of
 43

[*43] operations to account for the system’s delay in responding to
measured temperatures.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:

Component Cost

Burner $1,462

Combustion air piping 1,356

Combustion blower 1,374

Electrical panel 10,504

Gas train 2,337

Total $17,033

K. Isola I—IR (#14-07607)

During the years at issue Isola Laminate Systems Corp. (Isola)
manufactured plastic and fiberglass boards at a facility in Chandler,
Arizona. That manufacturing process generated VOC byproducts such
as various plasticizers and phenolic resin. Before engaging CPI, Isola
used an older thermal oxidizer (supplied previously by CPI) that had
caught fire and was no longer achieving the necessary destruction
efficiency.

In October 2013 CPI submitted a proposal for replacing various
components of the oxidizer. The proposal provided extensive
specifications for the oxidizer, including sizes and manufacturers for the
various components, and provided a 99% destruction efficiency
guarantee. The proposal specifically noted that the design would
incorporate several enhancements that had “proved very successful” on
similar recent oxidizers. Finally, the proposal noted that the
replacement components would “maintain the same footprint as the
original making the installation as seamless as possible and providing
little disruption to the process.” After some revisions, Isola accepted
CPI’s proposal. In November 2013 Isola sent CPI a purchase order for
the thermal oxidizer equipment, for a total price of $480,000.
 44

[*44] CPI personnel performed calculations to determine the sizing of
components, such as the combustion chamber and the burner. After
sizing the fan component, CPI sought to reduce the risk of resins’
catching fire by engaging a subcontractor to make a hinged fan that
could be easily cleaned. After installation, CPI encountered an issue
where a leg of the system had incurred some shell fracturing due to heat.
CPI resolved this by reinforcing the leg. The system passed its third-
party compliance testing and was accepted by the customer.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:

Component Cost

Booster fan $11,931

Burner 8,976

CO#1 EXP JT MB 22,656

Combustion blower 3,562

Compressed air piping 487

Electrical boxes 553

Gas train 6,986

Mechanical loose parts 293

Total $55,444

L. Isola II—SR (#14-07890)

At this plant, located at the same facility as the Isola I project,
Isola manufactured coating for plastic and fiberglass boards. CPI
determined that a self-recuperative thermal oxidizer, in which the heat
exchanger is separated from the combustion chamber, would be optimal.
In June 2014 Mr. Betz completed an initial P&ID drawing for the
oxidizer. In June 2014, CPI sent Isola a revised proposal for a 6,000
SCFM recuperative thermal oxidizer. The proposal described the
applicable VOCs as including acetone, MEK, butanol, PM, PMA, and
PNB and described the maximum air temperature and maximum VOC
 45

[*45] concentration of the process airflow. The proposal provided a 99%
destruction efficiency performance guarantee. C.H. was the sales
engineer on the project.

In July 2014 Isola and CPI exchanged purchase and sale orders
for the thermal oxidizer, for a total price of $628,200. CPI personnel
performed calculations as to the sizing of components, such as the
combustion chamber and the burners. CPI revised their sizing
calculations and design several times because of the system’s potentially
not fitting in the allocated space of Isola’s facility. In September 2014
R.T. completed an initial general arrangement drawing for the oxidizer,
which was submitted to Isola for approval on September 22, 2014. CPI
engaged PRE-Heat to fabricate and supply the oxidizer system
(including an exhaust stack) and engaged Quantum Design to fabricate
and supply the control panel enclosures. After installation of the
oxidizer by the customer, CPI’s supervising startup technicians
discovered an air pressure issue that required modifications to the
control system programming.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 46

[*46] Component Cost
(3) VFD’s $5,953
BF DPS & enclosure 307
BF inlet PSH 1,175
BF inlet PT & enclosure 880
BF outlet EXP J S/S 912
Booster fan NON insulated 10,982
Ceramic saddle 6,164
Cleanout platform and ladder 8,610
Flame safety 681
Fresh air damper & actuator 18” 4,993
Hx DPS 245
Inlet plenum w/door 3,851
Insulated inlet 14,381
Isolation dampers & act (2) 26” 7,823
Oxidizer fabrication 176,210
Oxidizer fasteners 1,206
PLC 29,760
Pre-filter 149
Press control dampers & act (2) 22” 9,440
Primary heat exchanger 55,602
Secondary heat exchanger 25,096
Secondary Hx EXP joint 3,356
Secondary Hx PIT 1,125
Secondary Hx TE 76
Thermocouples 253
Burner 10,258
Gas train 5,593
Manual shut off valve 260
Seal air blower (heat exchanger) 2,701
Engineering add-ons 79
Exhaust stack ECO #1 11,553
Total $399,674
 47

[*47] M. Goodyear Lawton (#14-07925)

During the years at issue, the Goodyear Tire & Rubber Co.
(Goodyear) operated a tire manufacturing facility in Lawton, Oklahoma.
As of 2014 Goodyear used an older regenerative thermal oxidizer at the
Lawton facility, which had been experiencing regular repair issues with
its heat exchanger because of clogging from talcum powder used in the
manufacturing process. The primary VOC byproduct of the Lawton
facility was ethanol.

CPI was invited to submit a proposal to replace the existing
oxidizer. In August 2014 CPI submitted a revised, final proposal for a
50,000 SCFM regenerative thermal oxidizer for a total price of $827,500,
described as a TRITON system, which Goodyear accepted. The proposal
memorialized the characteristics of the process airflow at the Lawton
facility, including temperature, volume, heat content, and type of VOC.
The proposal also stated that the process airflow would be ducted to an
existing mixer dust system to filter out particulate before it reached the
oxidizer inlet. Finally, the proposal included a 98.5% destruction
efficiency performance guarantee. Goodyear accepted the proposal.

After the acceptance of the proposal, Mr. Harmsen determined
that a more expensive, plug-resistant type of ceramic heat exchanger
might be optimal for the project, as it would allow particulate to more
easily pass through. Mr. Harmsen proposed the different heat
exchanger to Goodyear, which agreed to incorporate it into the design at
a higher cost. In September 2014 C.D. prepared an initial P&ID
drawing, which was checked by F.C. Also in September 2014 S.F.
prepared an initial general arrangement drawing for the oxidizer, which
was also checked by Mr. Costanzo.

CPI engaged IVI North to fabricate and supply various
components of the oxidizer and Lantec to supply the multilayer ceramic
media component. After fabrication was completed, Goodyear hired a
crew to install the oxidizer itself at the Lawton facility. In August 2015
Goodyear contacted CPI to inform them that the oxidizer had failed
performance testing, reaching only 93% destruction efficiency. CPI
resolved the issue during a subsequent inspection.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 48

[*48] Component Cost

Booster fan $38,657

Burner 3,396

Ceramic media 2,936

Cold face support 103,840

Combustion air piping 575

Combustion blower 2,202

Control house 19,135

Electrical panel 45,642

Exhaust stack 80,275

Fresh air damper 5,302

Gas train 11,292

Mechanical loose parts 8,026

Media chamber 4,884

Poppet housing 35,496

Poppet valve assemblies 30,848

Exhaust stack expansion joint 1,195

System insulation & paint 55,000

Total $448,702

N. Wenner (#14-0800)

During the years at issue Wenner Bread Products, Inc. (Wenner),
manufactured artisanal bread at a site in Baltimore, Maryland. During
testing for Clean Air Act compliance, Wenner discovered that its
specialized yeasts were emitting high levels of ethanol when in the
 49

[*49] baking ovens. Wenner did not have a pollution control system in
place and thus contacted CPI for a quote. Wenner provided CPI with
specifications about the airflow and ethanol quantities. After reviewing
the specifications, CPI determined that a catalytic optimizer would be
appropriate, because of the high heat release caused when burning
ethanol.

In September 2014 CPI submitted a proposal for a 3,000 SCFM
catalytic oxidizer. The proposal included the assumed ethanol
concentrations of the process airflow from the baking ovens. The
proposal stated that the system would incorporate a ceramic monolith
catalyst, which would, in relevant part, provide the ability to “wash” the
catalyst. The proposal also stated the system would incorporate a
ceramic guard, in order to capture fats, oils, and greases before they
reached the catalyst, which would “greatly increase catalyst life by
prohibiting active surface area being coated with airborne droplets and
particulate.” Finally, the proposal included a 98% destruction efficiency
performance guarantee. In October 2014 CPI and Dennis Engineering
Group LLC (Wenner’s engineering consultant) entered into a sales
agreement for the purchase and sale of the oxidizer, for a total price of
$281,700. C.H. was the sales engineer on the project.

CPI personnel input the provided VOC levels into a Bessy
spreadsheet, which calculated that the LEL of the airflow would be
9.68%. Because of the high heat release in the process airflow, CPI thus
determined to include a hot gas bypass that vented air directly to the
stack and thus avoided excessively preheating the heat exchanger. CPI
personnel performed calculations in order to determine the optimal size
of various components, including the fan, burner, exhaust stack, and
fresh air damper.

In October 2014 C.D. completed electrical schematic drawings for
a control panel and CPI engaged Quantum Design to fabricate a control
panel and enclosure. In December 2014 R.T. completed an initial
general arrangement drawing. CPI engaged PRE-Heat to fabricate and
assemble the oxidizer system. Once it was assembled, CPI personnel
conducted a quality audit of the oxidizer at PRE-Heat’s facility, before
the oxidizer was shipped to the Wenner facility. CPI personnel
supervised the installation of the system at Wenner’s facility. The
system successfully passed emissions compliance testing by a third
party.
 50

[*50] As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 51

[*51] Component Cost

BF outlet exp jnt $534

BF VFD 1,623

Booster fan 13,945

Burner 3,286

Catalyst 15,540

Catalyst – guard bed 1,400

Combustion air piping & weather hood 1,060

Combustion blower 1,523

Combustion chamber 62,714

Ductwork 4,550

Electrical panel – SEE EXCEL for details 23,890

Exhaust stack 2,468

Fresh air damper 1,723

Gas train 5,907

Heat exchanger 5,143

Mechanical loose parts 4,858

Tee damper 13,613

Total $163,778

O. East Balt (#14-07950)

During the years at issue East Balt Commissary, Inc. (East Balt),
operated a bakery facility that specialized in making hamburger buns
for McDonald’s restaurants. East Balt engaged CPI to resolve issues
related to ethanol emissions produced by the baking ovens, which had
 52

[*52] been identified as a violation of the Clean Air Act. Mr. Betz was
the lead applications engineer on the project, and C.H. was the sales
engineer. CPI began its initial bid proposal by visiting East Balt’s
facility in order to measure the airflow and temperature from the baking
oven exhaust. CPI personnel determined that a catalytic oxidizer was
the appropriate system for the facility, in part because catalytic
conversion was fairly effective with respect to ethanol.

In August 2014 CPI submitted a revised proposal for the design
of a catalytic oxidizer, described as a Vector-5. The proposal described
the baking oven exhaust as being assumed to be 2,343 and 2,560 SCFM
for the two baking ovens, with ethanol at 15–25 lb/hr as the VOC
byproduct. The proposal provided a 98% destruction efficiency
performance guarantee. The proposal also stated that the oxidizer
would include a “ceramic guard bed” downstream from the burner but
before the catalyst, which would be “optimum for ensuring all fats, oils,
and greases are in vapor phase prior to that catalyst.” The guard bed
would thus “greatly increase catalyst life by prohibiting active surface
area being coated with airborne oil droplets and particulate.” In
September 2014 East Balt and CPI exchanged purchase and sale orders
for the oxidizer, for a total price of $571,500.

In September and October 2014 C.D. completed electrical
schematic drawings for a control panel enclosure. In October 2014 R.T.
completed an initial general arrangement drawing for the oxidizer. In
October 2014 C.D. completed an initial P&ID drawing for the oxidizer.
CPI engaged Quantum Design to fabricate the control panel enclosure
and PRE-Heat to fabricate and assemble the oxidizer. During the
fabrication stage of the oxidizer, the EPA informed East Balt that a
system that dispersed air exhaust at a higher elevation would be
necessary. CPI extended the exhaust stack design and added structural
support in order to prevent it from collapsing in the event of high winds.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 53

[*53] Component Cost

Booster fan $16,832

Burner 466

Catalyst 31,280

Combustion air piping 1,086

Combustion blower 210

Electrical panel 26,052

Expansion joints 2,560

Fresh air damper 4,612

Gas train 7,810

Hardware and gasket 196

I Asbly combustion chamber 58,747

PIT Sitrans 896

Tee damper 20,898

Total $171,646

P. M&W Ireland (#14-07718)

During the years at issue M&W Group (M&W) was the general
contractor at an Intel Corp. facility in Leixlip, Ireland, which
manufactured computer chips and wafers. The primary byproduct of
the manufacturing process was liquid ammonium fluoride.

In January 2014 CPI sent a proposal to M&W for a “Trimix Waste
Water Treatment System.” The proposal stated in relevant part that
“this proposal captures the request made during our January 6, 2014
conference call, for CPI to provide an exact copy to the current TRIMIX
system that was recently completed.” The proposal closely followed
specifications provided by Intel. The proposal made some site-specific
 54

[*54] modifications to the previous TRIMIX system design, some of
which were made in order for the system to meet European product
standards. Those modifications generally involved finding components
from Europe that were equivalent to components that CPI had used in
the previous TRIMIX system design and then making some sizing
adjustments to conform to the differing components. For the project,
CPI personnel used a general arrangement design drawing for an
ammonia removal system, originally drawn on September 25, 2009. The
system was designed to first adjust the pH of the ammonium fluoride in
order to separate out the fluoride from the ammonia. From there, the
ammonia would be removed from the liquid stream into the air by an air
stripper, with the process airflow then being blown into a catalytic
oxidizer and converted to nitrogen oxides. The airflow would next
encounter a secondary “selective reduction catalyst,” which would
convert the nitrogen oxides into regular nitrogen.

In February 2014 M&W sent to CPI a purchase order for the
oxidizer system and components, for a total price of $3,836,100. CPI
engaged PRE-Heat to fabricate and assemble various components of the
system. CPI engaged Murphy Matson O’Sullivan, an Irish engineering
consulting firm, to determine the location of the oxidizer’s foundation
and calculate the necessary depths for anchoring the system. This was
a relevant aspect of the design, because the Leixlip facility experienced
high winds. Using information provided by M&W as to the gallons per
minute and VOC concentration range, CPI personnel entered
specifications into a spreadsheet to determine the potential size of
components and the system’s energy requirements. CPI submitted
design drawings to M&W, which provided comments and asked for
certain modifications. Ultimately, the system was installed at the
Leixlip facility and passed performance testing.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 55

[*55] Component Cost

Booster fan – parts $160,974

Loose ship – parts 51,776

Oxidizer – parts 247,629

S4 – parts 48,648

Spares – parts 79,563

Sparge – parts 121,614

Stripper/Eff pump – parts 34,580

TRIMIX – parts 19,774

Total $764,559

Q. Enterprise (#14-07851)

During the years at issue Enterprise Products Partners L.P.
(Enterprise) operated a natural gas production facility in Rifle,
Colorado. Enterprise had two existing 20,000 SCFM regenerative
thermal oxidizers that were experiencing an operational problem where
ice built up on the system’s inlet during cold temperature periods in the
winter. Before 2014 CPI had developed a solution to the problem of
extreme temperature, by which airflow was recirculated back to the fan
inlet in order to prevent condensation and freezing from low
temperatures. CPI personnel had written an article about this solution;
personnel at Enterprise read the article and then asked CPI to visit its
facility and inspect its oxidizer system.

At Enterprise’s request, Messrs. Betz and Harmsen visited the
Rifle facility to inspect the regenerative thermal oxidizers in use there.
Enterprise also provided Mr. Harmsen with the general arrangement
design drawing for one of the existing oxidizers. On January 2, 2014,
Mr. Harmsen provided Enterprise with a report on the operations of the
regenerative thermal oxidizers, including the characteristics of the
process airflow. The report identified some pin hole leaks in the current
system and described inadequacies with the process air fan inlet design,
hot gas bypass damper, and fresh air fan. The report described how the
 56

[*56] existing hotside bypass dampers, which had failed multiple times,
differed from CPI’s standard hotside bypass damper. The report
recommended that Enterprise install a hot gas bypass recirculation
system, as designed by CPI, and an internally insulated VOC hot gas
bypass. The report also included a version of the general arrangement
drawing, which Mr. Harmsen had modified by pasting in the ductwork
component from a previous project, in order to represent how the
oxidizers could circulate fresh air without temperature issues at the
inlet of the oxidizer.

In June 2014 CPI sent Enterprise a proposal for the supply of
(1) two designed hot air recirculation systems and (2) two internally
insulated VOC hot gas bypasses. The proposal described the hot gas
bypass recirculation system as intended to “maintain 300 F inlet
temperatures and allow for more accurate control and adjustment to
process changes” and “keep the inlet side of the RTO above the acid dew
point and prevent freeze ups.” The proposal described the VOC hot gas
bypass as intended to “direct clean hot air directly into the exhaust stack
to de-rate the thermal efficiency of the Oxidizer.” Also in June 2014,
Enterprise sent CPI a purchase order for the components, for a total
price of $435,000; the purchase order attached terms and conditions.
Clause 16 of the terms and conditions was entitled “Data Ownership”
and provided the following:

Buyer shall, at all times, be the owner of all information
and materials resulting from Supplier's services, including
sketches, layouts, negatives, photographs, designs,
blueprints, and specifications relating thereto, and of the
work product of all services furnished or performed under
this order, including all creative ideas included therein, by
Supplier or any subcontractor of Supplier in connection
with this order. Upon the completion, or in the event of the
cancellation or termination of this order, all copies of such
information, materials, and work product shall be returned
and delivered to Buyer by Supplier. Buyer may copy or
reproduce any and all such information, materials, and
work product for any and all purposes and may use the
same in any and all media as often as it may so desire. No
copies or reproductions thereof shall be made or retained
by Supplier except as authorized in writing by Buyer.

Clause 17 was entitled “Confidentiality” and stated that “[n]o
information relative to this order concerning the purchase or use of
 57

[*57] goods or services may be published or disseminated by Supplier
without the Buyer’s prior written consent.”

In September 2014 G.B. prepared an initial general arrangement
drawing, which copied the general arrangement design of the existing
oxidizer and added the proposed components. CPI engaged Global Fab
to fabricate and assemble various aspects of the components. The
components were installed at the Rifle facility at some point in 2015.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:

Component Cost

Blower $52,653

Damper & ductwork 158,370

Total $211,023

R. DuPont La Porte (#14-07831)

During the years at issue, E.I. DuPont de Nemours & Co.
(DuPont) operated a chemical manufacturing facility in La Porte, Texas.
The manufacturing process at the facility generated VOCs such as
methyl methacrylate and acetic acid. CPI determined that a direct
thermal oxidizer would be optimal.

In May 2014 CPI sent DuPont a revised proposal, which DuPont
accepted. The proposal was more detailed than was CPI’s normal
practice and included extensive specifications for the various
components of the system. The proposal included a 99.9% destruction
efficiency performance guarantee. The proposal stated that the system
would incorporate “a low emissions burner specially designed to process
mixed gases” which would be sized for 6 million BTU/hour. Also in May
2014 CPI issued a sales order to DuPont for the thermal combustor,
which noted that no fabrication would begin until approval
documentation was received from DuPont. The sales order was for a
total price of $769,900.

Ultimately, CPI purchased a high intensity fuel-gas burner for
the system. DuPont provided CPI with the VOC levels for two particular
process airflows at the La Porte facility. CPI personnel input the
 58

[*58] provided VOC levels for the first airflow, primarily consisting of
methanol and acetates, into a Bessy spreadsheet, which calculated that
the LEL of the airflow would be 62.5%. CPI personnel then input the
provided VOC levels for the second airflow, primarily consisting of
nitrogen from a tank farm at the facility, into a Bessy spreadsheet,
which calculated that the LEL of the airflow would be 330.4%. Because
of the high LEL, CPI personnel determined that the oxidizer would need
to burn the process airflow directly, without mixing it with additional
oxygen. CPI personnel entered the provided specifications into another
spreadsheet to determine the sizing of components, such as the process
fan.

In August 2014 R.T. completed an initial general arrangement
drawing for the system, which was checked by F.C. The extremely large
size of the exhaust stack was somewhat unusual for CPI and was outside
their design capability. Accordingly, CPI engaged IVI North to both
design and fabricate a stack to a number of provided sizing and feature
specifications.

With respect to the electrical system, CPI was responsible for
designing only the burner control and management system, with the
remainder of the oxidizer’s operations being programmed by DuPont
into its existing control system at the La Porte facility. The design of
the burner control system went through an extensive design review with
DuPont. R.J. started from CPI’s standardized P&ID drawings but
eventually made a number of revisions at DuPont’s request. The process
of revising CPI’s standardized designs for the various components of the
system was similarly extensive, with DuPont offering multiple
revisions. The oxidizer was installed by DuPont at the La Porte facility
at some point in 2015 or 2016 and subsequently passed third-party
compliance testing.

As part of the research credit study, Alliantgroup did not include
any supply costs associated with the DuPont project in its qualified
research expenditures calculations.

S. Reclaimed Energy (#14-07981)

During the years at issue Superior Oil Co., Inc.’s Reclaimed
Energy Division (Reclaimed Energy) operated a facility in Connersville,
Indiana. At the facility, Reclaimed Energy recycled used chemical
solvents from other manufacturing processes and distilled them down to
clean elements. Because of that business model, Reclaimed Energy’s
 59

[*59] process involved a wide variety of VOCs. Reclaimed Energy was
a longtime customer of CPI and, in 2014, already used two CPI-supplied
catalytic oxidizers at its facility. Because of that customer relationship,
CPI already had a significant amount of institutional knowledge and
information about the Connersville facility and the process airflow. CPI
personnel determined that the existing catalytic oxidizers lacked
sufficient capacity during high VOC emission periods.

CPI personnel determined that a new regenerative thermal
oxidizer would be appropriate, sized at 15,000 SCFM. In September
2014 CPI submitted a proposal for a 15,000 SCFM regenerative thermal
oxidizer, described as a Triton 15.95. The proposal included the
characteristics of the process airflow, including the volume,
temperature, heat value, and maximum estimated VOC load. The
proposal also included a 98% destruction efficiency performance
guarantee. Reclaimed Energy then sent to CPI a purchase order for the
oxidizer, for a total price of $449,800. Using the known characteristics
of Reclaimed Energy’s process airflow, Messrs. Betz and Harmsen
calculated the sizes of various components, such as the fan and fresh air
damper, basing them upon the volume, air pressure, and inlet
temperature. In October 2014 Mr. Betz completed a P&ID drawing for
the oxidizer; the P&ID drawing was based on a previous one completed
for Reclaimed Energy with modifications. Also in October 2014 S.F.
completed an initial general arrangement drawing for the oxidizer,
which was checked by T.Z.

CPI engaged Lantec to fabricate and supply the multilayer
ceramic media component, Global Fab to fabricate and assemble various
components of the oxidizer, and IVI North to fabricate and supply an
exhaust stack. In October and November 2014 C.D. completed various
electrical schematic drawings. In November 2014, Quantum Design
made a number of suggested revisions to the drawings, to which CPI
agreed. CPI then engaged Quantum Design to fabricate and supply the
control panel and enclosures. In early 2015 S.F. and other CPI
employees completed a number of other design drawings for components
of the oxidizer. A number of components of the oxidizer were ordered
from suppliers in 2015. Ultimately, the oxidizer was installed by
Reclaimed Energy at the Connersville facility at some point in 2015.

As part of the research credit study, Alliantgroup calculated that
the following supply costs were qualified research expenditures:
 60

[*60] Component Cost
BF outlet exp joint $681
BF VFD 6,060
Booster fan 17,124
Burner 1,097
Ceramic media 22,695
Cold face support 8,798
Combustion air piping 5,112
Combustion blower 2,450
Duct from CC to stack 3,349
Electrical loose parts 1,260
Electrical panel 37,407
Exhaust stack 41,085
Exhaust stack flex 875
Fresh air damper, pneu. act. 4,142
Gas train 11,765
Hardware and gaskets 3,076
Hot gas bypass damper – insulated 13,088
Inlet transition duct 979
Mechanical loose parts 3,918
Media chamber 92,627
Poppet housing 19,019
Poppet valve assemblies 35,270
Total $331,877

VII. Tax Reporting

On April 20, 2015, CPI filed a Form 1120S, U.S. Income Tax
Return for an S Corporation, for tax year 2014. On Form 6765 for tax
year 2014 CPI reported a research credit of $501,531 under section 41
after electing a reduced credit under section 280C(c). 20 Schedules K–1,
Shareholder’s Share of Income, Deductions, Credits, etc., were issued to
petitioners Mark Betz and Julia Lincoln, reporting $250,765 as a
research credit on line 13. On April 15, 2015, petitioners Mark and
Christine Betz and petitioners Julia and Dennis Lincoln jointly filed
Forms 1040, U.S. Individual Income Tax Return, for tax year 2014. On
their Form 3800, General Business Credit, Mr. and Mrs. Betz reported

20 CPI also claimed a deduction of $171,489 for research and development.
 61

[*61] a research credit of $250,766, of which they claimed $128,898 on
line 54 of their Form 1040. On their Form 3800, Mr. and Mrs. Lincoln
reported a research credit of $250,765, of which they claimed $122,651
on line 54 of their Form 1040.

Mr. and Mrs. Betz jointly filed Form 1040 for tax year 2015. On
Form 3800 they reported a carryforward of the research credit of
$104,708, of which they claimed $58,198 on line 54 of their Form 1040.
Mr. and Mrs. Lincoln jointly filed a Form 1040 for tax year 2015. On
Form 3800 they reported a carryforward of the research credit of
$129,682, of which they claimed $31,718 as part of their other credits
total on line 54 of their Form 1040.

Mr. and Mrs. Betz jointly filed Form 1040 for tax year 2016. On
Form 3800 they reported a carryforward of the research credit of
$46,510, of which they claimed $43,780 on line 54 of their Form 1040.
Mr. and Mrs. Lincoln jointly filed Form 1040 for tax year 2016. On Form
3800 they reported a carryforward of the research credit of $97,964, of
which they claimed $32,866 on line 54 of their Form 1040.

The 2014 Form 1120S and the 2014, 2015, and 2016 Forms 1040
for both couples were prepared by the accounting firm Porte Brown LLC.
Jeffery R. Smiejek, a partner at Porte Brown, signed all seven returns
as preparer. Porte Brown prepared the original underlying Form 6765,
which reported the section 41 credit, by transcribing the numbers from
the pro forma Form 6765 that Alliantgroup delivered to petitioners on
April 10, 2015. On November 2, 2015, Alliantgroup emailed Porte
Brown a brief memo describing the research credit’s requirements and
attaching spreadsheets with the claimed wage and supply costs.

VIII. The Notices of Deficiency and Petitions

On July 26, 2018, respondent issued to petitioners Mark and
Christine Betz a notice of deficiency, which made the following
determinations:

Year Deficiency Penalty § 6662

2014 $128,898 $25,779.60

2015 58,198 11,639.60

2016 43,780 8,756.00
 62

[*62] On July 26, 2018, respondent also issued to petitioners Julia and
Dennis Lincoln a notice of deficiency, which made the following
determinations:

Year Deficiency Penalty § 6662

2014 $121,083 $24,216.60

2015 31,718 6,343.60

2016 32,866 6,573.20

Each couple timely filed a Petition with this Court.

OPINION

I. Jurisdiction and Burden of Proof

Where a notice of deficiency issued to an S corporation
shareholder includes adjustments to both S corporation items and other
items unrelated to the S corporation, we have jurisdiction to determine
the correctness of all adjustments in the shareholder-level deficiency
proceeding. See Johnson v. Commissioner, No. 19973-18, 160 T.C., slip
op. at 11 (Jan. 25, 2023) (citing Winter v. Commissioner, 135 T.C. 238,
245–46 (2010)). We thus have jurisdiction to determine the correctness
of both respondent’s adjustments to petitioners’ pro rata shares of CPI’s
claimed research credit and any other determinations in the notices of
deficiency.

The Commissioner’s determinations as expressed in the notice of
deficiency are presumed correct, and the taxpayer bears the burden of
proving that they are erroneous. Rule 142(a)(1); Welch v. Helvering, 290
U.S. 111, 115 (1933); VHC, Inc. v. Commissioner, 968 F.3d 839, 841 (7th
Cir. 2020), aff’g T.C. Memo. 2017-220. Credits are a matter of legislative
grace, and taxpayers must demonstrate their entitlement to credits
claimed. See Feigh v. Commissioner, 152 T.C. 267, 270 (2019) (citing
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)); see also United
Stationers, Inc. v. United States, 163 F.3d 440, 443 (7th Cir. 1998).
Petitioners have neither alleged nor established that they meet the
requirements of section 7491(a) as necessary to shift the burden of proof
to respondent on any factual issues.
 63

[*63] II. Section 41 Research Credit

A. Basic Structure

Section 38 provides taxpayers with a current-year business credit
that includes a credit for research expenses as determined under section
41(a). Section 41(a)(1) specifies that the research credit shall be an
amount equal to 20% of the excess of the taxpayer’s qualified research
expenses (QREs) over the base amount. QREs are limited to amounts
“paid or incurred by the taxpayer during the taxable year in carrying on
any trade or business.” 21 § 41(b)(1); see § 7701(a)(25). QREs may be
either in-house research expenses or contract research expenses.
§ 41(b)(1). In-house research expenses include (1) “any wages paid or
incurred to an employee for qualified services performed by such
employee” and (2) “any amount paid or incurred for supplies used in the
conduct of qualified research.” Id. para. (2)(A)(i) and (ii). Qualified
services are defined as either (1) “engaging in qualified research” or (2)
“engaging in the direct supervision or direct support of research
activities which constitute qualified research.” Id. subpara. (B); see
Treas. Reg. § 1.41-2(c) (defining “direct supervision” and “direct
support”). If at least 80% of the services an employee performed during
the taxable year were qualified services, then the taxpayer may treat
100% of that employee’s wages as being paid or incurred for qualified
services. Treas. Reg. § 1.41-2(d)(1) and (2).

To constitute qualified research, a research activity must satisfy
a four-part statutory test. § 41(d)(1). If the research activities
corresponding to a particular product as a whole fail to satisfy the four-
part test, we may re-apply the test to subsets of the product. See Treas.
Reg. § 1.41-4(b)(2) (providing the “shrinking-back rule”). Several
statutory exclusions, see § 41(d)(4), set forth categories of activities that
are excluded from the definition of qualified research (and thus cannot
be creditable), see § 41(d)(1) (flush language) (“[Qualified research] does
not include any activity described in paragraph (4).”); see also Eustace v.
Commissioner, 312 F.3d 905, 908 (7th Cir. 2002) (“Sections 41(d)(1) and
(d)(4) are independent rules, which deserve, and have received,
independent constructions.”), aff’g T.C. Memo. 2001-66, 81 T.C.M.

21 For an accrual method taxpayer such as CPI, a liability is incurred and taken

into account for the taxable year in which (1) all the events have occurred that establish
the fact of the liability; (2) the amount of the liability can be determined with
reasonable accuracy; and (3) economic performance has occurred with respect to the
liability. See VECO Corp. & Subs. v. Commissioner, 141 T.C. 440, 459 (2013); see also
§ 461(h); Treas. Reg. § 1.461-1(a)(2)(i).
 64

[*64] (CCH) 1370. One such exclusion provides that “[a]ny research
related to the adaptation of an existing business component to a
particular customer’s requirement or need” is excluded from the
definition of qualified research. § 41(d)(4)(B).

The base amount for purposes of section 41 is equal to the product
of the average of the taxpayer’s annual gross receipts for the four
preceding years, multiplied by a fixed-base percentage. 22 § 41(c)(1). The
fixed-base percentage is generally the percentage calculated by dividing
(1) the taxpayer’s aggregate QREs for tax years beginning after
December 31, 1983, and before January 1, 1989, by (2) the taxpayer’s
aggregate gross receipts for those same tax years. Id. para. (3)(A). The
fixed-based percentage cannot exceed 16%. Id. subpara. (C). The base
amount cannot be less than 50% of the QREs for the credit year. Id.
para. (2).

In the case of an S corporation, the amount of a claimed section
41 credit is allocated among the shareholders pro rata. See Treas. Reg.
§ 1.41-7(a)(1)(i); see also §§ 1366(a)(1)(A), 1377(a)(1). Each S corporation
shareholder may then claim the section 41 credit on his or her income
tax return in an amount “equal to the amount of tax attributable to that
portion” of the taxable income “allocable or apportionable” to their
shareholder interest. § 41(g). To the extent an S corporation
shareholder’s pro rata portion of the section 41 credit for the taxable
year exceeds this limitation, that shareholder may carry forward the
unused amount of credit to a future taxable year. Id. subsec. (g).

B. Substantiation Principles

Section 6001 requires, inter alia, that taxpayers keep records in
compliance with the rules and regulations prescribed by the Secretary
of the Treasury. Accordingly, taxpayers are required to “keep such
permanent books of account or records . . . as are sufficient to establish
the amount of gross income, deductions, credits, or other matters
required to be shown” on a tax return. Treas. Reg. § 1.6001-1(a). With
respect to the research credit, the taxpayer specifically “must retain
records in sufficiently usable form and detail to substantiate that the
expenditures claimed are eligible for the credit.” Treas. Reg. § 1.41-4(d).
To substantiate wages paid or incurred for qualified services, the
taxpayer need not necessarily maintain and produce contemporaneous

22 Respondent did not address petitioners’ calculation of the base amount in his

posttrial briefing, and we thus deem that issue conceded.
 65

[*65] time-tracking records for its employees. See Union Carbide Corp.
& Subs. v. Commissioner, T.C. Memo. 2009-50, 97 T.C.M. (CCH) 1207,
1268 (“[Treasury Regulation § 1.41-4(d)] does not require that a
taxpayer substantiate its research credit claim with any particular types
of documents . . . .”), aff’d, 697 F.3d 104 (2d Cir. 2012); Fudim v.
Commissioner, T.C. Memo. 1994-235, 67 T.C.M. (CCH) 3011, 3012
(accepting “testimony and other evidence in the record” as basis for
Cohan rule estimate of time spent in performing qualified services
(citing Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930)); see also
United States v. McFerrin, 570 F.3d 672, 679 (5th Cir. 2009).

However, we do not apply the Cohan rule to estimate wages paid
or incurred if the taxpayer fails to make a threshold showing that a
particular employee performed activities that constituted qualified
services with respect to a business component. See Shami v.
Commissioner, 741 F.3d 560, 568 (5th Cir. 2014) (“[T]he Cohan rule is
not implicated unless the taxpayer proves that he is entitled to some
amount of tax benefit[;] [i]n the context of the § 41 credit, a taxpayer
would do so by proving that its employee performed some qualified
services.”), aff’g in relevant part T.C. Memo. 2012-78; Moore v.
Commissioner, T.C. Memo. 2023-20, at *11 (“Even if some of
[employee’s] activity on these three products was qualified research, we
have no basis for estimating how much of his time was so spent.”); see
also Mendes v. Commissioner, 121 T.C. 308, 316 (2003) (“Even under
Cohan, there must be sufficient evidence in the record to provide a basis
upon which an estimate may be made.” (citing Vanicek v. Commissioner,
85 T.C. 731, 742–43 (1985))); Coors Porcelain Co. v. Commissioner, 52
T.C. 682, 697–98 (1969), aff’d, 429 F.2d 1 (10th Cir. 1970).

If a business component as a whole fails any of the four qualified
research tests, the taxpayer must still show that a particular employee
performed qualified services with respect to a particular subset of the
component, in order to implicate Cohan. See Eustace, 81 T.C.M. (CCH)
at 1372, 1374 (rejecting taxpayers’ attempt to invoke Cohan rule when
they lacked “the substantiation necessary to tie salaries to activities at
the subcomponent level” and merely “delineated the employees and
activities” believed to qualify for research credit); Trinity Indus., Inc. v.
United States, 691 F. Supp. 2d 688, 693 (N.D. Tex. 2010) (declining to
apply shrinking-back rule because taxpayer “offered no evidence of the
costs associated with any subset” of the product), aff’d in part and
remanded, 757 F.3d 400 (5th Cir. 2014). Finally, the U.S. Court of
Appeals for the Seventh Circuit—to which an appeal in this case would
lie, absent stipulation to the contrary, see § 7482(b)(1)(A), (2)—has
 66

[*66] previously described the Cohan rule as “rarely compulsory” and
suggested it is not applicable where the expenses at issue are of a sort
where the taxpayer should have been able to produce some form of
substantiating evidence, see Lerch v. Commissioner, 877 F.2d 624, 628,
629 n.9 (7th Cir. 1989) (quoting Williams v. United States, 245 F.2d 559,
560 (5th Cir. 1957) (describing estimate without reasonable basis as
“unguided largesse”)), aff’g T.C. Memo. 1987-295; see also Buelow v.
Commissioner, 970 F.2d 412, 415 (7th Cir. 1992) (affirming this Court’s
decision not to apply Cohan rule where taxpayer failed to question
knowledgeable trial witnesses about expenses at issue), aff’g T.C. Memo.
1990-219.

More recently, the Seventh Circuit has had occasion to address
the substantiation burden that taxpayers claiming the research credit
must bear. See Little Sandy Coal Co. v. Commissioner, 62 F.4th 289,
308 (7th Cir. 2023), aff’g T.C. Memo. 2021-15. In Little Sandy Coal Co.,
the Seventh Circuit encountered a similar research credit claim by a
taxpayer that relied on trial testimony as substantiation for its
estimated QREs; the Seventh Circuit characterized the taxpayer’s
evidentiary showing as asking this Court “to take on faith” that the
allocations of its employees’ wages were only for activities constituting
qualified research. Id. In affirming this Court’s decision that the
taxpayer had failed to show entitlement to the credit, the Seventh
Circuit emphasized that “shortcut estimates of experimentation-related
activities will not suffice . . . [s]omething more, such as documentation
of time spent on such activities, is necessary.” Id.

Petitioners largely relied on the trial testimony of Messrs. Betz
and Harmsen to carry their substantiation burden. We found Messrs.
Betz and Harmsen to be credible with respect to the basic facts of CPI’s
business process and the technical background of oxidizers, with which
they are evidently highly familiar. However, we found their testimony
at times to be vague, in conflict with the record, and lacking in credibility
with respect to their self-serving characterizations of some of the work
performed by CPI on specific projects. See Conti v. Commissioner, 99
T.C. 370, 375 (1992) (“It is our task to decide the credibility of any lay or
expert witness based upon objective facts, the reasonableness of the
testimony, the consistency of the statements made by the witness, and,
in some cases, the demeanor of the witness.”), aff’d and remanded, 39
F.3d 658 (6th Cir. 1994); see also Lerch v. Commissioner, 877 F.2d at 631
(“The Tax Court may disregard uncontradicted testimony by a taxpayer
where it finds that testimony lacking in credibility.”). We will note
 67

[*67] below where our observations of the trial witnesses are
particularly relevant to our findings and conclusions.

C. Qualified Research

To constitute qualified research, research must satisfy a four-part
statutory test:

Sec. 41(d). Qualified research defined. . . .
(1) In general.—The term “qualified research”
means research—
(A) with respect to which expenditures may be
treated as expenses under section 174,
(B) which is undertaken for the purpose of
discovering information—
(i) which is technological in
nature, and
(ii) the application of which is intended
to be useful in the development of a new or
improved business component of the
taxpayer, and
(C) substantially all of the activities of which
constitute elements of a process of experimentation
for a purpose described in paragraph (3).
Such term does not include any activity described in
paragraph (4).

The four-part test is applied separately to each business
component. Id. para. (2)(A). A “business component” is defined in
relevant part as a product or process that the taxpayer either (1) holds
for sale, lease, or license or (2) uses in its trade or business. Id. subpara.
(B). Any plant process, machinery, or technique for commercial
production of a business component is itself treated as a separate
business component from the underlying product. Id. subpara. (C).
Here, the business components claimed by petitioners are the oxidizer
systems or components of oxidizer systems supplied to CPI’s customers.

As noted above, if a business component as a whole fails any of
the qualified research tests, the regulations provide a fallback position
for taxpayers in the form of the shrinking-back rule. See Treas. Reg.
§ 1.41-4(b)(2). The shrinking-back rule instructs us to re-apply the four-
part test to the business component at its “most significant subset of
elements.” Id. If that too fails, we generally drill down to a more
 68

[*68] granular subset of the business component, until either (1) a
subcomponent satisfies the tests or (2) the most basic level of the
component fails to satisfy the tests. Id.

We now turn to the four-part test. Respondent concedes that
CPI’s claimed activities in 2014 satisfied two parts: the technological
information test and the business component test. We thus largely focus
on the first requirement in section 41(d)(1) that respondent does
challenge: the section 174 test. 23

1. Section 174 Test

To be qualified, research must be research “with respect to which
expenditures may be treated as expenses under section 174.”
§ 41(d)(1)(A). We have previously interpreted section 41(d)(1)(A) as
incorporating the section 174 requirements on both the nature of the
activity and the nature of the expenditure. See Norwest Corp. & Subs.
v. Commissioner, 110 T.C. 454, 491 (1998) (interpreting section
41(d)(1)(A) as requiring “the taxpayer to satisfy all the elements for a
deduction under section 174”); Union Carbide Corp., 97 T.C.M. (CCH)
at 1255 (analyzing both whether taxpayer’s activities “constitute
research and development within the meaning of section 174” and
whether the costs of those activities “may be treated as expenses under
section 174”). To satisfy the section 174 test, the taxpayer thus must
show (1) that the claimed research expenditures would be eligible for a
deduction under section 174 and (2) that the claimed research activities
constituted research and development within the meaning of section
174. See Norwest Corp., 110 T.C. at 491; Union Carbide Corp., 97 T.C.M.
(CCH) at 1274 (“[The taxpayer] cannot avoid the restrictions of section
174 by arguing that section 174 is relevant only for determining whether
activities constitute qualified research and has no bearing on whether
the costs of those activities may be QREs.”). If we conclude that the
taxpayer has failed to satisfy the section 174 test at “the level of a
product” as a whole, the taxpayer may still satisfy the test “at the level

23 The process of experimentation test (which respondent also raises) is a

higher bar, which requires “essentially the same uncertainty as is required by the
section 174 test” but “imposes a more structured method of discovering information
than section 174 requires and may not include all actions a taxpayer takes to resolve
uncertainty.” Union Carbide Corp., 97 T.C.M. (CCH) at 1256.
 69

[*69] of the component or subcomponent of the product.” 24 Treas. Reg.
§ 1.174-2(a)(5) (providing a section 174-specific shrinking-back rule).

On its own, section 174 operates as a narrow, elective exception
to the general capitalization rules. See §§ 263(a)(1)(B), 263A(c)(2);
INDOPCO, Inc. v. Commissioner, 503 U.S. at 84 (“[D]eductions are
exceptions to the norm of capitalization . . . .”); see also Donald C.
Alexander, Research and Experimental Expenditures Under the 1954
Code, 10 Tax L. Rev. 549, 549–52 (1955) (contrasting pre-1954
treatment of research costs with section 174); David S. Hudson, The Tax
Concept of Research or Experimentation, 45 Tax Law. 85, 112–20 (1991)
(discussing the origins of section 174 as a practical solution to the
accounting difficulty of allocating and capitalizing research costs).
Section 174(a)(1) allows taxpayers to elect a current-year deduction for
“research or experimental expenditures which are paid or incurred by
[the taxpayer] during the taxable year in connection with [its] trade or
business.” 25 See Spellman v. Commissioner, 845 F.2d 148, 149 (7th Cir.
1988), aff’g T.C. Memo. 1986-403; see also Treas. Reg. § 1.174-1. The
corresponding regulations define “research or experimental
expenditures” as those that “represent research and development costs
in the experimental or laboratory sense” including costs “incident to the
development or improvement of a product.” Treas. Reg. § 1.174-2(a)(1).
The regulations further provide:

Expenditures represent research and development costs in
the experimental or laboratory sense if they are for
activities intended to discover information that would
eliminate uncertainty concerning the development or
improvement of a product. Uncertainty exists if the
information available to the taxpayer does not establish
the capability or method for developing or improving the
product or the appropriate design of the product.

24 The applicable regulatory preamble describes this rule as “intended to
ensure that section 174 eligibility is preserved in instances in which a basic design
specification of the product may be established, but there is uncertainty with respect
to certain components of the product.” T.D. 9680, 2014-32 I.R.B. 254, 256; see, e.g.,
Caltex Oil Venture v. Commissioner, 138 T.C. 18, 34 (2012) (consulting regulatory
preamble to resolve ambiguity in regulatory text).
25 Congress has since amended section 174 to eliminate the option of a current-

year deduction and provide instead for mandatory amortization of research and
development expenditures for taxable years starting after December 31, 2021. See Tax
Cuts and Jobs Act of 2017, Pub. L. No. 115-97, § 13206, 131 Stat. 2054, 2111–13.
 70

[*70] Id.

We apply a two-step test with respect to whether a taxpayer’s
activities constituted research and development within the meaning of
section 174. First, the taxpayer must show that the information
available to it did not establish (1) that the taxpayer was capable of
developing or improving the product; (2) the method by which the
taxpayer would develop or improve the product; or (3) the appropriate
design of the product. See Treas. Reg. § 1.174-2(a)(1); see also Max v.
Commissioner, T.C. Memo. 2021-37, at *29. If information was not
available to the taxpayer with respect to establishing either capability,
method, or appropriate design, then uncertainty existed. See Union
Carbide Corp., 97 T.C.M. (CCH) at 1255. In applying this first step, we
examine the information objectively available to the taxpayer, rather
than the taxpayer’s subjective understanding of that information. Id.
(“Whether an uncertainty exists is an objective test that depends on the
information available to the taxpayer.” (citing Mayrath v.
Commissioner, 41 T.C. 582, 590–91 (1964), aff’d, 357 F.2d 209 (5th Cir.
1966))); see Max, T.C. Memo. 2021-37, at *30 (finding no uncertainty
where appropriate design may have been subjectively unknown to
taxpayer but taxpayer “already ha[d] the information necessary to
address that unknown”). Second, if uncertainty existed, the taxpayer
must still show that it undertook investigative activities that were
“intended to discover information that would eliminate uncertainty.”
Treas. Reg. § 1.174-2(a)(1); see Max, T.C. Memo. 2021-37, at *30–31. In
Little Sandy Coal Co. v. Commissioner, 62 F.4th at 298, the Seventh
Circuit recently clarified the nature of the uncertainty required by
section 174:

Generic uncertainty is inherent in constructing or
manufacturing a product. That involves questions like:
Will this tire fit? What kind of screws are needed to attach
this panel? Or will this weld hold up this truss? But
“uncertainty” in Section 174 means something more. . . .
Expenses incurred merely to determine whether a product
is built to satisfy a client’s desired specifications—without
any indication that the expenses were incurred to improve
or develop the concept of the product—do not qualify.

Continuing, the Seventh Circuit looked to the ordinary meaning of
“development,” as used in Treasury Regulation § 1.174-2(a)(1), and
concluded that the term requires some “advancement in technology or
product concept” as opposed to “mere construction.” Little Sandy Coal
 71

[*71] Co. v. Commissioner, 62 F.4th at 298. The Seventh Circuit noted
the difficulty in establishing uncertainty at the level of a product as a
whole, emphasizing that “a manufacturer may not simply ‘add a few new
bells and whistles’ on a pre-existing product and claim uncertainty as to
the whole.” Id. at 299. Finally, the Seventh Circuit noted that, “[i]f
summed up in one word, expenses deductible under [s]ection 174 must
be ‘investigative.’” Id. (quoting Union Carbide Corp., 97 T.C.M. (CCH)
at 1255).

The section 174 test implicates one more relevant limitation.
Expenditures paid or incurred for “ordinary testing or inspection of
materials or products for quality control (quality control testing)” are
not deductible under section 174. Treas. Reg. § 1.174-2(a)(6)(i). Quality
control testing includes “testing or inspection to determine whether
particular units of materials or products conform to specified
parameters” but “does not include testing to determine if the design of
the product is appropriate.” Id. subpara. (7).

2. Supply QREs

We first focus on whether the claimed supply QREs for all 19
projects would be eligible for a deduction under section 174, as a
category of expenditure. The record demonstrates that the claimed
supply QREs correspond to payments made by CPI to various
subcontractors and suppliers for the costs of fabricating, assembling,
and supplying components of the oxidizers. CPI does not itself fabricate,
assemble, or manufacture any components at its own facility. The
“supply” label used by petitioners is thus partially a misnomer here, as
the claimed supply QREs appear to encompass not only payments CPI
made to its suppliers for the cost of supplies (i.e., physical components)
but also certain payments made to its subcontractors for services (e.g.,
payments labeled in CPI’s accounting system as for “assembly” of
components). 26 See § 41(b)(2)(C) (defining “supplies” as “any tangible
property” other than land, improvements to land, and depreciable
property).

26 Petitioners do not contend that the cost of the services the subcontractors

performed on the projects constituted contract research expenses incurred by CPI, nor
did the Alliantgroup study identify any contract research expenses as part of the credit
amount claimed. See § 41(b)(3)(A) (providing a limited credit for contract research
expenses for research performed by another). Given our conclusions below, we need
not speculate as to what amount of the claimed supply QREs would actually be
creditable in full.
 72

[*72] Section 174 provides a deduction only for “‘expenditures of an
investigative nature expended in developing the concept of a model or
product’, as opposed to the construction or manufacture of the product
itself.” Union Carbide Corp., 97 T.C.M. (CCH) at 1255 (alteration in
original) (quoting Mayrath, 41 T.C. at 590); see Little Sandy Coal Co. v.
Commissioner, 62 F.4th at 298 (distinguishing between generic
construction uncertainty and uncertainty as to the underlying concept
of a model or product); Kollsman Instrument Corp. v. Commissioner,
T.C. Memo. 1986-66, 51 T.C.M. (CCH) 463, 466 (distinguishing between
nondeductible production activities and deductible research activities),
aff’d, 870 F.2d 89 (2d Cir. 1989). Consequently, a deduction under
section 174 is generally not available with respect to costs of production,
and claimed QREs incurred in the actual production of a product
typically fail the section 174 test. See Max, T.C. Memo. 2021-37, at *30–
31.

The relevant exception, as set forth in the regulations, is for costs
incurred in constructing a prototype or “pilot model,” which is defined
as “any representation or model of a product that is produced to evaluate
and resolve uncertainty concerning the product.” Treas. Reg. § 1.174-
2(a)(4); see Little Sandy Coal Co., T.C. Memo. 2021-15, at *38–39. The
regulations note that “a fully-functional representation or model of the
product or . . . component of the product” can still be a pilot model if
produced to evaluate and resolve uncertainty. See Treas. Reg. § 1.174-
2(a)(4). Expenditures incurred for the actual construction of a pilot
model are generally deductible under section 174, even if the model itself
is ultimately sold to customers. See Treas. Reg. § 1.174-2(a)(1) (“The
ultimate success, failure, sale, or use of the product is not relevant to a
determination of eligibility under section 174.”); see also id. subpara.
(11) (example 7). To qualify for the pilot model exception, the taxpayer
must show that (1) uncertainty existed (i.e., an objective lack of
information) as to capability, method, or appropriate design of a product,
(2) it constructed “a representation or model” of the product, and (3) its
purpose in constructing the representation or model was to “evaluate
and resolve uncertainty” about capability, method, or appropriate
design. See Little Sandy Coal Co., T.C. Memo. 2021-15, at *41 (“[T]he
classification of a product as a pilot model turns on the taxpayer’s
purpose in producing it.”); see also Little Sandy Coal Co. v.
Commissioner, 62 F.4th at 303 (“[T]he creator’s intent matters.”). Once
objective uncertainty is eliminated with respect to the underlying
product, any further costs of production do not qualify under section 174.
See Treas. Reg. § 1.174-2(a)(1), (11) (example 3).
 73

[*73] In their pretrial memorandum, petitioners initially asserted that,
because each oxidizer was “uniquely designed for the particular
application on which it is being designed,” each oxidizer was a pilot
model, with costs of its production qualifying under section 174 until the
oxidizer was “running in a manner which meets the project
requirements.” However, petitioners failed to explicitly contend in their
posttrial briefing that the oxidizers were pilot models. Petitioners did
make on brief the broader, more general argument that the supply costs
were for materials “used in the development process, prior to the end of
uncertainty of appropriate design [sic].” Similarly, in their posttrial
briefing, petitioners referenced on one occasion that the supplies were
“utilized in the development of the prototypes.” Despite petitioners’
failure to explicitly brief the pilot model exception, we find that
petitioners’ more generalized contentions that the supply costs were
QREs necessarily raises this issue for decision. 27 See Purple Heart
Patient Ctr., Inc. v. Commissioner, T.C. Memo. 2021-38, at *35 n.10
(questioning taxpayer’s failure to explicitly brief issue but “nonetheless”
addressing issue as “entwined” with other issues properly raised by
taxpayer).

In any event, we conclude that petitioners have failed to carry
their burden of establishing that the oxidizer systems at issue were pilot
models. The record demonstrates that the supply QREs related to the
cost of producing functional systems for CPI’s customers. Accordingly,
in order to satisfy the section 174 test, petitioners are required to show
that the supply QREs related to the cost of producing pilot models.
While the regulations note that a fully functional representation or
model can qualify as a pilot model, the taxpayer must establish that its
purpose in producing that representation or model was to evaluate and
resolve uncertainty about the product (i.e., to obtain unavailable
information necessary to establish capability, method, or appropriate
design). Treas. Reg. § 1.174-2(a)(1), (4); cf. Natkunanathan v.
Commissioner, T.C. Memo. 2010-15, 99 T.C.M. (CCH) 1071, 1074
(“Expenditures made to develop and deliver functional products for use
by customers do not usually constitute ‘research and development * * *
in the experimental or laboratory sense.’”), aff’d, 479 F. App’x 775 (9th
Cir. 2012). Petitioners have failed to make such a showing.

27 We typically treat a failure to adequately argue a point on brief as a

concession. See Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989); see also Mendes,
121 T.C. 308 at 312–13 (“If an argument is not pursued on brief, we may conclude that
it has been abandoned.”).
 74

[*74] Instead, we conclude that the various projects were not
“representation[s] or model[s]” as a whole and that CPI’s purpose in
incurring their production costs was not to evaluate and resolve
uncertainty. First, any suggestion that CPI’s various subcontractors
and suppliers were constructing or supplying representations or models
is wholly unsupported by the record. A representation or a model is
generally defined as an accurate stand-in for something else.
Representation, Oxford English Dictionary (3d ed. 2009),
https://www.oed.com/view/Entry/162997 (last updated March 2023)
(“Something which stands for or denotes another symbolically . . . .”);
Model, Oxford English Dictionary (3d ed. 2002),
https://www.oed.com/view/Entry/120577 (last updated December 2022)
(“Something which accurately resembles or represents something else,
esp. on a small scale . . . .”); accord Representation, Webster’s New World
College Dictionary (5th ed. 2016) (defining in relevant part as “a
likeness, image, picture, etc.”); Model, Webster’s New World College
Dictionary (5th ed. 2016) (“[A] preliminary representation of something,
serving as the plan from which the final, usually larger, object is to be
constructed . . . .”). The subcontractors and suppliers were not
constructing representations or models that stood in for the final
product in discovering information about whether a design was
appropriate; instead, they were constructing the final product itself. See
Little Sandy Coal Co., T.C. Memo. 2021-15, at *42–43 (observing that
example in regulations “draws a distinction between a model of a
product and the product itself” (citing Treas. Reg. § 1.174-2(a)(11)
(example 3))).

CPI’s process confirms the proposition. If the oxidizers were pilot
models, one might expect CPI to have conducted early-stage “testing to
determine if the design of the product [was] appropriate” and then to
have modified the design as necessary. Treas. Reg. § 1.174-2(a)(7), (11)
(example 3). However, the record demonstrates that testing of the
oxidizers as a whole occurred either at the subcontractor’s facility before
shipping or at the customer’s facility after installation. At this late
stage, CPI’s design drawings were typically finalized, having already
incorporated revisions earlier in the project in response to feedback from
the customer and/or the subcontractors. Further, by the time testing
occurred, CPI had incurred tens (sometimes hundreds) of thousands of
dollars of costs in ordering specially sized components, in reliance upon
the design drawings. If CPI still lacked information as to the
appropriate design of each oxidizer as a whole (i.e., the oxidizer’s basic
design specification), incurring such costs would have been economically
irrational in the extreme. See Little Sandy Coal Co., T.C. Memo.
 75

[*75] 2021-15, at *35 (observing that any defects found in late-stage,
postconstruction testing would not have caused taxpayer to “scrap” the
entire project and start over); Treas. Reg. § 1.174-2(a)(11) (example 4).
We do not accept the circular argument that CPI incurred the
substantial costs of implementing its designs with the purpose of
discovering information about whether those designs as a whole were
appropriate. We conclude that the claimed supply QREs incurred in the
actual production of the oxidizers were not deductible under section 174.
Having failed the section 174 test, these costs were not “incurred for
supplies used in the conduct of qualified research” and thus are not
creditable QREs. See § 41(b)(2)(A)(ii).

This conclusion would not necessarily mean the end of the
inquiry. As noted above, the section 174 regulations provide a
shrinking-back rule, which would instruct us to next analyze whether
any particular components or subcomponents of the oxidizer systems
were pilot models, discretely constructed with the purpose of evaluating
and resolving uncertainty. See Treas. Reg. § 1.174-2(a)(5). However,
petitioners have failed to carry their burden of establishing that any
particular components or subcomponents were pilot models.
Consequently, we conclude that none of CPI’s claimed supply costs are
QREs, and we will partially sustain on this basis respondent’s
determination that petitioners are not entitled to a research credit.

3. Wage QREs

We now turn to the issue of whether the claimed wage QREs
satisfy the section 174 test. As a category of expenditure, such wages
are potentially deductible under section 174 if paid or incurred during
the taxable year. 28 However, we must still determine whether the
employee activities underlying the claimed wage QREs constituted
“research and development” within the meaning of section 174. To
recap, petitioners must show that (1) information was not available to
CPI establishing the appropriate design of the oxidizers and (2) CPI
undertook investigative activities intended to discover such information.

Respondent argues that CPI employees’ activities were not
intended to discover information that would eliminate uncertainty
regarding the development of the systems. Respondent focuses on the

28 For an accrual method taxpayer such as CPI, wages are generally incurred

and taken into account for the taxable year in which they are earned by the employee
providing services. See § 461(h)(2)(A)(i); see also Burlington N. R.R. Co. v.
Commissioner, 82 T.C. 143, 148 (1984).
 76

[*76] fact that CPI had extensive experience in supplying commercially
viable oxidizer systems to customers and had developed substantial
industry-specific knowledge before 2014. Respondent also notes that
CPI guaranteed the performance of its systems to customers and never
failed such a guarantee; respondent thus suggests that CPI did not lack
information with respect to the appropriate design of its systems. 29

Petitioners counter that CPI faced uncertainty as to the
appropriate design of each system even beyond the initial starting point
of each system’s commercial production, because the appropriate design
of each system could not be established until after that system cleared
various onsite tests. Petitioners suggest that uncertainty existed,
because “[i]n all of these projects, the prospect of revising or altering the
design of the overall system existed.” Petitioners also point to several
projects where the oxidizer supplied by CPI failed postinstallation
testing and argue that “the appropriate design was not determined until
after the design failed onsite testing.”

The parties thus dispute whether CPI was uncertain as to the
appropriate design for all 19 projects. At the outset, we must reject
petitioners’ blanket assertions that uncertainty existed with respect to
the products as a whole simply because of the mere “prospect of revising
or altering the design” before completion of onsite testing. The
applicable regulations distinguish between objective uncertainty as to
the design of a product as a whole (i.e., its basic design specification) and
objective uncertainty as to the design of a particular component or
subcomponent. See Treas. Reg. § 1.174-2(a)(5). As alluded to above,
conducting postproduction testing on a product does not establish that
its appropriate design as a whole “remained uncertain before those tests
were successfully completed.” Little Sandy Coal Co., T.C. Memo. 2021-
15, at *53. Any failure of an oxidizer system to pass testing might have
resulted in some additional information-discovering activities with
respect to a redesign of a particular component or subcomponent (with
corresponding wage QREs then being potentially creditable) but would
not have required CPI “to scrap the entire [oxidizer] and start afresh.”
See id.

Our determination of whether the activities underlying the wage
QREs satisfied the section 174 test must necessarily be more granular,
examining the activities of CPI employees. The parties did not agree to

29 The record supports respondent’s factual contention that CPI ultimately

satisfied the provided performance guarantees for all 19 projects.
 77

[*77] a sample of CPI’s projects for 2014, thus placing at issue all 19
projects for which CPI claimed the research credit. 30 See § 41(d)(2)(A);
cf. Little Sandy Coal Co., T.C. Memo. 2021-15, at *3, *20 (effecting
parties’ agreement to select only 4 of 11 projects as samples). We thus
must determine whether the wage QREs associated with each project
satisfied the section 174 test, at the level of both the projects as a whole
and particular subcomponents that petitioners identified at trial. 31

a. 3M Hutchinson (#13-07520)

This project involved CPI’s design and supply of a 30,000 SCFM
regenerative thermal oxidizer for a 3M facility that manufactured sticky
notes. Petitioners suggest that CPI was uncertain as to the appropriate
design for the 3M Hutchinson project as a whole until the oxidizer
passed onsite testing. Petitioners emphasize that this was the first
regenerative thermal oxidizer designed by CPI.

Petitioners’ argument overlooks key facts. CPI submitted its
final, revised proposal to 3M on August 30, 2013, and 3M accepted the
proposal via a purchase order issued on September 3, 2013. Acceptance
of the proposal by 3M was a key date in the development of the basic
design of the oxidizer. The proposal, which relied upon and addressed a
detailed set of specifications provided by 3M, demonstrated that CPI
already had considerable information available to it with respect to the
appropriate design. For instance, the proposal observed that the
exhaust from the Hutchinson facility “is understood to come from the 2L
Coating Line at a volume of 18,000–25,000 SCFM at 125 F to 175 F and
contains a combination of methanol, ethyl acetate, IPA, toluene, and
other common solvents at loadings of 245–1750 lb/hr.” The proposal
further provided for a 99% destruction efficiency performance

30 Absent an agreement between the parties, project sampling improperly
relieves the taxpayer of its burden of proving entitlement to the research credit
claimed. See Bayer Corp. v. United States, 850 F. Supp. 2d 522, 538, 545–46 (W.D. Pa.
2012).
31 Petitioners allocated wage QREs project by project and did not further allege

or brief the amounts of wage QREs relating to specific components or subcomponents;
given petitioners’ “all or nothing” litigation strategy on this point, we could decline to
go deeper than the level of the 19 projects as a whole. Cf. Little Sandy Coal Co. v.
Commissioner, 62 F.4th at 303 (affirming this Court’s decision not to apply shrinking-
back rule where taxpayer failed to document research activities corresponding to
project subcomponents). However, the trial testimony in this case addressed
particular components and subcomponents on some of the projects, and, for the sake
of completeness, we believe it appropriate to perform a shrinking-back rule inquiry, to
the extent the limited record allows us to do so.
 78

[*78] guarantee. As Mr. Harmsen later testified: “The majority of the
[3M Hutchinson] oxidizer design was decided upon with the 99 percent
destruction efficiency and the air flow rate and the VOCs that [we] are
talking about.” Further bearing this out, CPI prepared initial general
arrangement and P&ID drawings for the oxidizer soon after acceptance
of the proposal, in October 2013. While minor revisions were
subsequently made to those drawings in late 2013 and 2014, the basic
design specification of the oxidizer did not change as a result of those
revisions. 32 We find that information available to CPI in 2013
established the appropriate design of the oxidizer as a whole.

Consequently, corresponding wage expenditures for any
theoretical investigative activities with respect to the oxidizer as a whole
would have been incurred in 2013, rather than 2014, the taxable year at
issue. See § 174(a)(1) (requiring that expenditures be “paid or incurred
. . . during the taxable year”), § 41(b)(1). We conclude that the
appropriate design of the oxidizer as a whole had already been
established by information gathered in 2013; thus the product as a
whole fails the section 174 test. We look next to whether the shrinking-
back rule is applicable with respect to particular components or
subcomponents.

At trial, Mr. Harmsen identified a number of further “difficulties”
that CPI encountered “during the design and development” of the 3M
Hutchinson project, some of which related to particular components of
the oxidizer design. These identified difficulties included (1) 3M’s
preference for an induced draft fan; (2) 3M’s preference for a two-burner
system; and (3) 3M’s discovery of discrepancies in the electrical design.
With respect to the induced draft fan, CPI already had extensive
specifications provided by 3M that provided information about the
necessary fan design. In July 2013 Mr. Harmsen used those
specifications to initially calculate the size of the fan as 23 inches. The
final proposal then further detailed key elements of fan design,
including the horsepower, temperature rating, and arrangement of the
fan. In December 2013 CPI then provided that information to a fan
supplier, AirPro, which provided design drawings for a 300 horsepower
booster fan component. Those design drawings were then incorporated
into the final oxidizer design. The record is unclear as to (1) what

32 When prompted at trial to describe what subsequent changes were made to

the design, Mr. Harmsen described (1) the addition of a walkway to the front of the
oxidizer, (2) moving the gas trains to the back of the oxidizer, and (3) adding crane
davits in order to lift components off the oxidizer.
 79

[*79] additional, unavailable information CPI needed to determine the
appropriate fan design and (2) what investigative activities particular
CPI employees undertook in 2014.

With respect to the two-burner feature, CPI similarly already had
extensive specifications provided by 3M, specifying the brand of burner
to be used and various operational requirements. Mr. Harmsen further
testified that the particular burner size was determined by 3M’s choice
of brand (Maxon Kinemax). In February 2014 CPI purchased two four-
inch Kinemax burners to be shipped to Pre-Heat. Petitioners did not
produce further evidence establishing (1) what additional, unavailable
information CPI needed to determine the appropriate design of the
burners and (2) what investigative activities particular CPI employees
undertook with respect to the burners in 2014. Cf. Union Carbide Corp.,
97 T.C.M. (CCH) at 1261 (finding no uncertainty as to appropriate
design where manufacturer designed and supplied component and
taxpayer presented no evidence of adaptation).

Finally, with respect to the change in the electrical components,
we find that CPI employees did not perform any investigative activities
that would constitute research and development. To the contrary, Mr.
Harmsen’s testimony established that 3M’s electrical engineer simply
noticed certain discrepancies where the design drawings differed from
the specifications and requested specific changes. In response, CPI
directed Quantum Design to make those changes. At the shrunk-back
component level, we conclude that petitioners have failed to satisfy the
section 174 test.

We conclude that petitioners have failed to carry their burden of
establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the 3M Hutchinson project.

b. Akzo Nobel (#13-07645)

This project involved CPI’s design and supply of a 6,000 SCFM
regenerative thermal oxidizer for an industrial paint manufacturer.
CPI’s final proposal was accepted in December 2013. Consequently, as
with 3M Hutchinson, any theoretical investigative activities performed
by CPI before submission of the final proposal corresponded to wage
QREs that were not incurred in tax year 2014. Given that the proposal
memorialized many of the already-determined basic design
considerations and specifications (e.g., type of oxidizer, airflow volume,
VOCs at issue), we conclude that any objective uncertainty as to the
 80

[*80] design of the oxidizer as a whole was resolved before 2014, and
thus petitioners have failed to satisfy the section 174 test.

In contrast, petitioners have established that they performed
some investigative activities in 2014 at the shrunk-back component
level. Namely, Mr. Harmsen and J.O.’s meeting with Akzo Nobel
personnel in February 2014 appears to constitute research and
development within the meaning of the section 174 regulations. Mr.
Harmsen documented that meeting in contemporaneous notes, which
demonstrate that he and J.O. elicited further information and
specifications from Akzo Nobel about necessary design features for
oxidizer components, particularly the flame arrestor component.
However, allocating an estimated amount of wages to the activities of
Messrs. Harmsen and J.O., pursuant to the Cohan rule, would be futile,
because we alternatively hold that the activities performed on the Akzo
Nobel project were not part of a process of experimentation, as required
by section 41(d)(1)(C). See Union Carbide Corp., 97 T.C.M. (CCH) at
1256 (observing that process of experimentation test “requires the use
of the scientific method” and “imposes a more structured method of
discovering information than section 174”); Treas. Reg. § 1.41-4(a)(5)(i)
(setting out process of experimentation test’s requirements); see also
Eustace v. Commissioner, 312 F.3d at 907 (“Experimentation is a subset
of all steps taken to resolve uncertainty; otherwise searching for a place
to park a car would be a ‘process of experimentation’.”). We thus more
broadly conclude that CPI’s activity with respect to the flame arrestor
component did not constitute qualified services.

Further, petitioners have failed to demonstrate any additional
investigative activities that CPI personnel performed to resolve design
uncertainty with respect to the flame arrestor or any other shrunk-back
components of the oxidizer. We conclude that petitioners have failed to
carry their burden of establishing that they satisfied the section 174 test
with respect to the claimed wage QREs on the Akzo Nobel project.

c. HA International (#13-07615)

This project involved CPI’s design and supply of two 13,700 SCFM
recuperative thermal oxidizers for a manufacturer of fracking sand. At
trial Mr. Betz identified several potential uncertainties as to the
appropriate design of the oxidizers as a whole, including the potential
for phenolic resin buildup and the presence of water and sand
particulates in the process airflow.
 81

[*81] However, the record demonstrates that by November 6, 2013,
when CPI delivered to HAI a final proposal for the oxidizers, CPI had
extensive information available to it that established the appropriate
design of the oxidizer as a whole. In early 2013 CPI personnel had
visited HAI’s facility and had received emissions testing information as
to the facility’s air exhaust. That testing informed CPI of the airflow
volume at the facility and the particular VOCs at issue, both of which
dictated the basic design specification of the oxidizer. Cf. Siemer Milling
Co. v. Commissioner, T.C. Memo. 2019-37, at *33–34 (concluding that
project failed section 174 test where taxpayer already had prior year
testing information resolving uncertainty). CPI also had extensive
generalized information available to it as to the appropriate design of a
system that dealt with sand particulate. As its proposal to HAI stated,
CPI had previously designed “+30 units in the sand resin coating
industry” and was highly experienced in dealing with the sand
particulate issue. Cf. Max, T.C. Memo. 2021-37, at *33 (concluding that
section 174 test was not satisfied where taxpayer regularly encountered
the claimed uncertainty in past and had developed standardized
solutions to it). To resolve the sand issue, CPI included in the November
2013 proposal hinged access doors to allow HAI to periodically clear sand
out of the bottom of the combustion chamber. We conclude that objective
uncertainty did not exist with respect to the appropriate design of an
oxidizer as a whole that could satisfy the customer’s needs and resolve
the sand particulate issue. See Union Carbide Corp., 97 T.C.M. at 1262
(looking to taxpayer’s “significant experience” in previously using
component to resolve issue and finding no uncertainty under section
174).

The November 2013 proposal similarly addressed other
“uncertainties” as to the appropriate design identified by Mr. Betz. The
proposal stated that the oxidizer would include a “direct fired duct
heater system” that was “designed to help reduce both water and resin
build up prior to” the oxidizers. At trial Mr. Shaver credibly testified
that CPI had encountered the resin buildup issue before 2014 and had
previously developed this particular design solution. We find that
information was available to CPI establishing the appropriate design of
the oxidizer as a whole during the proposal stage, before 2014.

We next look to the shrinking-back rule. At trial Mr. Betz
discussed space constraints at the HAI facility, which required that the
high horsepower booster fan be placed close to the oxidizer. That
proximity posed problems, as the air from the fan would come out in a
high-velocity jet aimed at the center of the oxidizer’s heat exchanger,
 82

[*82] degrading the heat exchanger’s performance and running the risk
of pipe components’ burning up because of a lack of cooling airflow. Mr.
Betz testified that CPI addressed this issue by including baffles and
deflection plates in the design, both of which are components that can
dissipate and redirect airflow. Even assuming arguendo that this
implicated objective uncertainty, petitioners failed to establish that
investigative activities were performed by CPI employees in 2014 with
respect to the fan/baffle sheet components. 33

Mr. Betz also identified a pair of issues with components that
emerged during postinstallation testing. First, a quality audit
performed by L.S. on the oxidizer, as installed at HAI’s facility in 2014,
revealed that several tubes in the heat exchanger had overheated
because of inadequate airflow and broken free from the heat
exchanger. 34 CPI replaced and rewelded the tubes and then installed a
different air splitting component (a turning vane) that more evenly
dispersed air throughout the heat exchanger. The second issue that
emerged during postinstallation testing was ruptured pressure release
valves from excess vibration. CPI resolved the issue by cutting down
the length of the damper blades.

The decisions to add the turning vane and cut down the damper
blades may well have implicated objective uncertainty and investigative
activities. However, on the record before us, we are unable to bridge the
vast evidentiary gap petitioners left. Aside from Mr. Betz’s vague
testimony, petitioners’ failure to produce evidence as to what
investigative activities were performed with respect to the turning vane
and damper blades prevents us from applying the shrinking-back rule.
See Eustace, 81 T.C.M. (CCH) at 1374; Trinity Indus., Inc., 691 F. Supp.
2d at 693; see also United States v. Davenport, 897 F. Supp. 2d 496, 517–
18 (N.D. Tex. 2012) (declining to apply shrinking-back rule and
concluding that “even if the court had concluded that some of the
expenses claimed” were for qualified research, taxpayers failed to

33We note that the project proposal (finalized in 2013) stated that baffle sheets
would be included in the oxidizer, thus suggesting that information was already
available to CPI with respect to this component before 2014.
34 We note that any wage expenditures incurred in connection with conducting

the quality audit would appear to be for quality control testing and thus would fail to
satisfy the section 174 test. See Treas. Reg. § 1.174-2(a)(6)(i), (7) (providing that
section 174 deduction is not available with respect to expenditures for “testing or
inspection to determine whether particular units of materials or products conform to
specified parameters”). Petitioners fail to identify how much (if any) of L.S.’s wage
QREs correspond to this testing.
 83

[*83] provide evidence tying costs to specific subcomponents). Even if
petitioners had established that activities performed with respect to
these two components satisfied the section 174 test, they also failed to
identify the activity-performing CPI employees and thus did not provide
a reasonable basis for estimating the amount of corresponding wage
QREs. See Eustace, 81 T.C.M. (CCH) at 1374 (declining to apply the
Cohan rule where taxpayers failed to substantiate employee’s wages at
subcomponent level); see also Shami v. Commissioner, 741 F.3d at 569
(“[T]he Tax Court was entitled to decline to make an estimate if it found
that [the taxpayers] had not provided a reasonable basis on which to
make one.”). We conclude that petitioners have failed to carry their
burden of establishing that they satisfied the section 174 test with
respect to the claimed wage QREs on the HAI project.

d. 3M Hartford (#13-07611)

This project involved CPI’s design and supply of a 25,000 SCFM
recuperative thermal oxidizer for a 3M facility that manufactured tape.
The final proposal for the project was accepted by 3M in 2013. As with
the 3M Hutchinson project, the final project proposal incorporated and
addressed detailed specifications provided by 3M and thus
demonstrated that considerable information was already available to
CPI with respect to the appropriate design of the oxidizer as a whole.

In addition, with respect to the 3M Hartford project as a whole,
petitioners argued on brief that “CPI developed proprietary technology
to design this silicone oxidizer with vertical tubes and a larger heat
exchanger.” Petitioners failed to mention that this proprietary,
industry-specific technology—its Quadrant SRS Silicone series—had
been developed by CPI, in the words of Mr. Harmsen, over a period of
“close to 20 years.” Consequently, CPI had a plethora of information
available to it with respect to the basic design specification of an oxidizer
that worked well in the presence of silicone dioxide. The vertical
orientation of the oxidizer, which petitioners identified as a key design
feature addressing silicon dioxide, was well understood by CPI and had
been used by CPI in designs for many years before 2014. We find that
information was available to CPI establishing the appropriate design of
the oxidizer as a whole in 2013, before tax year 2014.

At the shrunk-back component level, Mr. Harmsen identified a
design change made to the recirculation duct component; he testified
that 3M provided CPI with more precise specifications about the process
airflow, which CPI was able to use to make the duct component smaller
 84

[*84] at 3M’s request. The record demonstrates that Mr. Harmsen
performed basic calculations to determine the duct size that were based
on the revised airflow specifications provided by 3M. The basic
calculations performed by Mr. Harmsen were not investigative activities
within the meaning of the section 174 regulations. See Max, T.C. Memo.
2021-37, at *30 (finding that information was subjectively unknown to
taxpayer with respect to appropriate sizing of component but concluding
that the taxpayer “already ha[d] the information necessary to address
that unknown”); see also Little Sandy Coal Co. v. Commissioner, 62
F.4th at 298 (characterizing a sizing question as implicating only generic
construction uncertainty). Petitioners did not produce additional
credible evidence as to what investigative activities were performed
with respect to the duct component.

With respect to the burner and gas train components, Mr.
Harmsen also identified an instance where 3M requested that CPI
determine whether the oxidizer could run the process combustion air as
fuel for the burner. CPI input the provided specifications into
standardized spreadsheets, which output the estimated fuel costs and
sizes for a burner that used either combustion air or raw gas. Mr.
Harmsen testified that CPI ultimately determined that using the
combustion air would be countereffective, as the silicone dioxide
byproduct would plug the burner. However, the record establishes that,
to the extent uncertainty may have existed with respect to this issue, it
was resolved in 2013, before the tax year at issue. The final project
proposal, which was accepted by 3M in November 2013, contained
footnotes in the sections discussing the burner and gas train
components, stating: “Burner system changed to raw gas, 11/12/13” and
“Combustion air eliminated and Gas train modified to accommodate raw
gas burner, 11/12/13.” Petitioners have thus failed to establish that
uncertainty existed in 2014 with respect to the burner and gas train
components designs.

Finally, in June 2014 3M and CPI executed a scope change to the
project proposal, replacing the proposed backward inclined blade style
fan with a radial blade style fan. Again, however, petitioners did not
produce evidence of what investigative activities were performed by CPI
employees with respect to any uncertainty. To the contrary, Mr.
Harmsen testified that 3M personnel instigated the change because of
their concerns about how the fan would handle particulates.
 85

[*85] We conclude that petitioners have failed to carry their burden of
establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the 3M Hartford project.

e. C&D Zodiac (#13-07583)

This project involved CPI’s design and supply of a 9,400 SCFM
regenerative thermal oxidizer for an aircraft composite manufacturer.
CPI’s final proposal for the project was accepted by C&D Zodiac in
October 2013. The record establishes that, as of October 2013, when
CPI tendered its final project proposal to C&D Zodiac, CPI had the
necessary information with respect to the appropriate design of the
product as a whole. In October 2013 CPI obtained detailed
measurements and calculations from the process airflow, which Mr.
Harmsen was able to use to make determinations about the oxidizer size
and the necessity of additional features. After acceptance of the final
proposal, in November 2013, C&D Zodiac provided some additional
information to CPI that necessitated minor changes to the design. We
conclude that any objective uncertainty was resolved in 2013, rather
than 2014.

At the shrunk-back component level, petitioners failed to
establish that investigative activities were performed in 2014. Mr.
Harmsen identified an instance where CPI moved the location of
thermocouples on the oxidizer from the top of the oxidizer to its back
wall. 35 The record contains only a rough handwritten drawing of the
new location, made by J.O. in February 2014. Neither the drawing nor
Mr. Harmsen’s vague testimony established what investigative
activities CPI performed with respect to the thermocouples.

We conclude that petitioners have failed to carry their burden of
establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the C&D Zodiac project.

f. Teva (#14-07808)

This project involved CPI’s design and supply of a 1,500 SCFM
regenerative thermal oxidizer for a pharmaceutical pill manufacturer.
Petitioners presented comparatively little trial testimony with respect
to CPI’s work on the Teva project. Petitioners presented some
photographic evidence and testimony about dye penetrant testing

35 A thermocouple is a device that measures temperature inside an oxidizer.
 86

[*86] conducted on the oxidizer. Mr. Betz characterized that testing as
intended to confirm that the subcontractor’s assembly was “being made
as per our drawings.” Taking that uncontroverted testimony as credible,
the purpose of the testing was thus to determine whether the oxidizer,
as fabricated and assembled, conformed to the design, not to determine
whether the design itself was appropriate. See Max, T.C. Memo. 2021-
37, at *35 (concluding that testing conducted to determine whether
components met taxpayer’s “established parameters” for product was
excluded quality control testing); Natkunanathan, 99 T.C.M. (CCH) at
1074 (observing that any testing conducted by taxpayer to “ensure
compliance with customer specifications” was excluded quality control
testing). We find that the dye testing constituted excluded quality
control testing, not research and development within the meaning of the
section 174 regulations. 36 See Treas. Reg. § 1.174-2(a)(7) (“[T]esting or
inspection to determine whether particular units of materials or
products conform to specified parameters is quality control testing.”).

We now turn to petitioners’ evidence relating to shrunk-back
components of the design. Mr. Betz identified the site-specific
requirement that the oxidizer transmit no more than a “certain amount
of vibration” to Teva’s pharmaceutical facility. Petitioners produced
photographs of vibration spring components that were installed on the
oxidizer to mitigate this concern. 37 However, petitioners did not produce
further evidence establishing what investigative activities were
performed by particular CPI employees with respect to the spring
components. Merely identifying a project difficulty and the eventual
design solution, without bridging the gap with evidence as to what
investigative activities were performed, does not satisfy petitioners’
burden.

Mr. Betz also discussed an issue where postinstallation testing
showed that the heat exchanger was preheating the airflow at too high
a level, a flaw which CPI corrected by modifying the control system to
introduce fresh diluting air. Again, however, petitioners did not
establish what investigative activities were performed by particular CPI
employees with respect to the heat exchanger. We conclude that

36Even if the testing were research and development within the meaning of
the section 174 regulations, we would still conclude that petitioners have failed to
provide a reasonable basis for the Court to apply the Cohan rule, given the absence of
evidence in the record as to which particular CPI employees conducted the testing.
37 The record is unclear as to when the vibration spring components were
installed.
 87

[*87] petitioners have failed to carry their burden of establishing that
they satisfied the section 174 test with respect to the claimed wage
QREs on the Teva project.

g. Mitsubishi (#14-07899)

This project involved CPI’s design and supply of a 35,000 SCFM
regenerative thermal oxidizer. Petitioners suggest that CPI personnel
conducted investigative activities in calculating the various component
sizes of the oxidizer. We again reject their assertion. CPI already had
the necessary information, from both the customer and CPI’s own
existing knowledge of the facility (where it had previously installed a
catalytic oxidizer), to determine the basic design specification of the
oxidizer as a whole. See Max, T.C. Memo. 2021-37, at *30–31 (finding
that taxpayer already had information necessary to determine
appropriate size of design element before performing iterative size
testing). Mr. Harmsen then used that information to perform basic
calculations for components, both by hand and by inputting it into a
computer spreadsheet. As noted above, performing simple calculations
on already-available information or data does not itself constitute an
investigative activity within the meaning of the section 174 regulations.
Cf. id. at *31. Petitioners have not established that CPI employees
undertook investigative activities with respect to the design of the
oxidizer as a whole.

We next look to the shrinking-back rule. At trial Mr. Harmsen
testified that the oxidizer’s poppet valve went out of alignment and came
unscrewed. Mr. Harmsen testified that CPI initially addressed the issue
by temporarily welding connections, before eventually replacing the
valve and shaft system completely. Such activities do not appear to be
research and development within the meaning of the section 174
regulations. See Siemer Milling Co., T.C. Memo. 2019-37, at *33
(concluding that section 174 test was not satisfied by activities “more
akin to mechanical maintenance”). Further, Mr. Harmsen did not
address in his testimony (1) when the valve issue was discovered; (2)
which CPI employees performed activities; or (3) whether any activities
were investigative. Mr. Harmsen’s testimony was the primary evidence
that petitioner produced regarding the valve issue. Even if petitioners
had established that the valve component satisfied the section 174 test,
petitioners nonetheless have not provided a reasonable basis for the
Court to estimate the amount of creditable wage QREs. See Shami v.
Commissioner, 741 F.3d at 569 (affirming this Court’s decision not to
apply Cohan where taxpayer failed to produce reasonable evidentiary
 88

[*88] basis for estimate). We conclude that petitioners have failed to
carry their burden of establishing that they satisfied the section 174 test
with respect to the claimed wage QREs on the Mitsubishi project.

h. 3M Monrovia (#14-07784)

This project involved CPI’s design and supply of a 12,000 SCFM
recuperative thermal oxidizer. Petitioners did not present credible
evidence establishing uncertainty as to the design of the oxidizer as a
whole (i.e., the basic design specification). To the contrary, Mr.
Harmsen testified to the following:

3M has a good idea of what their process can do. So they
know their VOCs, they know their ranges very well. They
know the extent of their equipment they used to buy to
make this thing. So they know what their design criteria
needs to be, that doesn’t get iterated very much.

Mr. Harmsen’s characterization of the basis of design accords
with the record, particularly with the extensive design specifications
that 3M provided to CPI at the outset of the project. We find that the
information provided by 3M established the design of the oxidizer as a
whole.

With respect to shrunk-back components, Mr. Harmsen described
the 3M Monrovia design as using a unique particulate-capturing device
that would intake airflow during the startup and shutdown phases of
the system to capture silicone dust and silicone dioxide. Mr. Harmsen
noted that the idea for the particulate-capturing device was jointly
conceived by himself and personnel from 3M. However, Mr. Harmsen
did not elaborate on what investigative activities were performed to
determine the design of the particulate-capturing device.

Mr. Harmsen further testified that, on account of California
environmental regulations with respect to nitrogen oxides and carbon
monoxides, the burner system (and its fuel emissions) was the design’s
“driving factor.” Mr. Harmsen testified that CPI personnel talked to
Maxon about the requirements for a low nitrous oxide burner, which was
then incorporated into the design. Discussions with Maxon
representatives might well have involved investigative activities within
 89

[*89] the meaning of the section 174 regulations. 38 Once again,
however, petitioners failed to elaborate as to which particular CPI
employees were involved with respect to the burner and its fuel
emissions.

Petitioners did not establish that particular CPI employees
performed investigative activities with respect to any other shrunk-back
components of the oxidizer. We conclude that petitioners have failed to
carry their burden of establishing that they satisfied the section 174 test
with respect to the claimed wage QREs on the 3M Monrovia project.

i. Celanese (#14-07852)

This project involved CPI’s design and supply of a 20,000 SCFM
regenerative thermal oxidizer. In December 2013 the engineering firm
engaged by Celanese, WorleyParsons, provided CPI with extensive
design specifications and requirements. That information in turn
dictated the basic design specification of the oxidizer. We thus conclude
that CPI did not undertake investigative activities with respect to the
oxidizer as a whole. We now turn to the question of whether the section
174 test was satisfied at the shrunk-back component level.

At trial Mr. Harmsen identified the cold temperatures at the
Edmonton facility as a design difficulty. 39 With respect to the cold
temperatures, petitioners established that objective uncertainty existed
as to how to design the gas train component. The record contains an
email from Mr. Betz to a Maxon representative asking about how to
meet Celanese’s cold temperature specifications in designing the gas
train. We further find that Mr. Betz’s email activity was an
investigative activity within the meaning of the section 174 regulations.
See Treas. Reg. § 1.174-2(a)(1). However, allocating a de minimis,
estimated amount of wages to Mr. Betz’s email activity, pursuant to the
Cohan rule, would be futile; we alternatively hold that Mr. Betz’s email

38 However, such activities would likely not satisfy the process of
experimentation test. See Siemer Milling Co., T.C. Memo. 2019-37, at *24 (citing
Treas. Reg. § 1.41-4(a)(8) (example 5) (“[E]valuation of products available from vendors
is not a process of experimentation.”)).
39 Mr. Harmsen also vaguely alluded to difficulties relating to Canadian

building code and product standards, which the record suggests may have involved
whether the control house was subject to building code standards. Petitioners did not
establish (1) what information was unavailable to CPI with respect to the Canadian
rules, nor (2) what investigative activities were undertaken by CPI employees with
respect to those rules.
 90

[*90] activity was not part of a structured process of experimentation
and thus fails to clear the higher bar of section 41(d)(1)(C). See Siemer
Milling Co., T.C. Memo. 2019-37, at *36 (describing taxpayer’s testing
of third-party product “more akin to evaluating available products on
the market . . . than a true process of experimentation”); Union Carbide
Corp., 97 T.C.M. (CCH) at 1256 (observing that process of
experimentation test “requires the use of the scientific method” and
“imposes a more structured method of discovering information than
section 174”); see also Eustace v. Commissioner, 312 F.3d at 907. We
thus more broadly conclude that petitioners did not carry their burden
of establishing that CPI’s activity with respect to the gas train
component constituted qualified services.

Petitioners have failed to demonstrate any additional
investigative activities that CPI personnel performed with respect to the
gas train or other shrunk-back components of the oxidizer. We conclude
that petitioners have failed to carry their burden of establishing that
they satisfied the section 174 test with respect to the claimed wage
QREs on the Celanese project.

j. Smalley (#14-07658)

This project involved CPI’s design and supply of an 800 SCFM
direct thermal oxidizer for an aircraft engine fastener manufacturer.
The Smalley project involved the customer’s concern about preventing
visible smoke emissions, rather than eliminating particular VOCs.
Because this objective was unusual for CPI, CPI did not have
information available as to what temperatures would cause emissions
to be visible in the process airflow. To gather that information, CPI
conducted simulation testing at the Smalley facility in 2014, using steel
samples coated with the facility’s condensation byproduct, which were
then placed in a furnace at the Smalley facility. By setting the furnace
to particular temperatures, CPI personnel were able to observe when
smoke emissions from the condensation were present. Using the testing
results, CPI personnel then programmed the oxidizer’s control system
to automatically turn the burner on and off according to whether the
facility’s furnaces were operating at the observed temperatures that had
created visible smoke. We find that this testing constituted research
and development within the meaning of the section 174 regulations. 40
See Treas. Reg. § 1.174-2(a)(1) (“[A]ctivities [must be] intended to

40 We note that programming of the control system itself was not an

investigative activity within the meaning of the section 174 regulations.
 91

[*91] discover information that would eliminate uncertainty concerning
the development or improvement of a product.”)

However, assuming arguendo that the testing would satisfy the
process of experimentation test, petitioners did not produce evidence
sufficient to provide the Court with a reasonable basis to approximate
the wage QREs corresponding to these activities, pursuant to the Cohan
rule. Petitioners did not produce any evidence as to which employees
performed the testing, leaving a potential Cohan rule estimate as little
more than a stab in the dark. See Shami v. Commissioner, 741 F.3d at
568 (observing that applying Cohan rule to an employee’s wage QREs
requires a threshold showing by taxpayer that “its employee performed
some qualified services”); Moore, T.C. Memo. 2023-20, at *10–11; CRA
Holdings US, Inc. v. United States, No. 15-CV-239, 2018 WL 4001675,
at *8 (W.D.N.Y. Aug. 22, 2018) (concluding that Cohan rule was
inapplicable in discovery where taxpayer failed to provide “specific
information to document the actual time [the taxpayer’s employees]
spent in performing qualified services”); see also Coors Porcelain Co., 52
T.C. at 698 (observing that taxpayer’s failure to produce evidence
rendered it “impossible” to differentiate section 174 research
expenditures from nondeductible costs). We see no reason petitioners
could not have elicited testimony from their trial witnesses on this point.
See Buelow v. Commissioner, 970 F.2d at 415; Kollsman Instrument
Corp., 51 T.C.M (CCH) at 467 (declining to apply Cohan rule where
taxpayer was unable to present trial witnesses knowledgeable about the
expenses at issue). We thus decline to excuse petitioners’ failure to do
the necessary evidentiary spadework before trial.

In addition, Mr. Betz identified a design difficulty due to the
oxidizer’s proposed location in the middle of the Smalley facility
building; because of that location, a fan could not be used to blow process
airflow into the oxidizer. Accordingly, CPI determined to use a vertical
combustion chamber that would allow hot air to naturally rise through
the oxidizer. However, the record establishes that CPI had determined
the basic design specification of the vertical oxidizer before submitting
a project proposal to Smalley in late 2013. That project proposal
described the vertical combustor process at length and provided sizes for
its components. We conclude that any investigative activities were
performed in 2013 and thus do not satisfy the section 174 test in 2014.

At the shrunk-back component level, petitioners did not establish
that investigative activities were performed in 2014 by CPI employees.
We conclude that petitioners have failed to carry their burden of
 92

[*92] establishing that they satisfied the section 174 test with respect
to the claimed wage QREs on the Smalley project. 41

k. Isola I (#14-07607)

This project involved CPI’s design and supply of several
replacement parts for an existing 7,000 SCFCM recuperative thermal
oxidizer. Petitioners also spent relatively little trial testimony
discussing this project. The record demonstrates that CPI had extensive
information available to it as to the appropriate design of those parts by
the time the final revised proposal was accepted by Isola on November
12, 2013. Most significantly, CPI had previously supplied the existing
oxidizer at the Isola facility and thus had extensive information
available with respect to its design. Petitioners failed to establish that
particular CPI employees performed investigative activities with
respect to the design of the replacement parts. We conclude that
petitioners have failed to carry their burden of establishing that they
satisfied the section 174 test with respect to the claimed wage QREs on
the Isola I project.

l. Isola II (#14-07890)

This project involved CPI’s design and supply of a 6,000 SCFM
recuperative thermal oxidizer. As with Isola I, CPI already possessed
extensive information about the Isola facility and its process airflow.
Also as with Isola I, petitioners spent relatively little trial testimony
addressing this project. Petitioners did not establish (1) that objective
uncertainty existed as to the oxidizer as a whole or (2) what
investigative activities particular CPI employees undertook to resolve
any theoretical uncertainty.

We thus move on to the shrunk-back component level. At trial
Mr. Betz identified a postinstallation issue with the control system
component, where testing revealed that the system was pushing some
hot air out of the ovens. However, the record bears out that this was
ordinary testing for quality control and thus not research and
development. See Treas. Reg. § 1.174-2(a)(7). While CPI did modify the

41 Alternatively, we hold that petitioners failed to carry their burden of

establishing that the testing was part of a methodical plan that constituted a process
of experimentation. Cf. Siemer Milling Co., T.C. Memo. 2019-37, at *9–10, *38
(concluding that taxpayer’s heat treating of grain samples at “varying times and
temperatures” to determine functionality lacked a hypothesis and “methodical plan”
and thus was not part of a process of experimentation).
 93

[*93] control system after discovering the air pressure issue, petitioners
have failed to establish that testing itself was intended to gather
information about the appropriate design of the oxidizer, rather than to
simply test whether the system conformed to the design and met quality
standards. See id. para. (a). Similarly, petitioners have failed to
demonstrate what investigative activities CPI employees performed
after the testing to determine the necessary modifications to the control
system’s sequence of operations.

In addition, Mr. Betz’s trial testimony did not establish that
further investigative activities were performed with respect to any other
shrunk-back component of the oxidizer. We conclude that petitioners
have failed to carry their burden of establishing that they satisfied the
section 174 test with respect to the claimed wage QREs on the Isola II
project.

m. Goodyear Lawton (#14-07925)

This project involved CPI’s design and supply of a 50,000 SCFM
regenerative thermal oxidizer. Petitioners did not establish (1) that
objective design uncertainty existed as to the oxidizer as a whole or
(2) what investigative activities particular CPI employees undertook to
resolve that uncertainty.

That leaves the shrinking-back rule. Petitioners suggest that CPI
encountered “technical challenges with effectively distributing the
temperature with only a single burner, creating proper seals on the
poppet valves and strict shipping constraints.” At trial, Mr. Harmsen
similarly testified that CPI was “worried about distribution of
temperature with a single burner inside of a combustion chamber”
because of the large size of the oxidizer. We found Mr. Harmsen to lack
credibility with respect to this contention at trial. 42 Mr. Harmsen did
not testify as to (1) when that concern arose; (2) what information was
unavailable with respect to the appropriate design of the burner
component; or (3) what actions were taken by CPI employees to gather
additional information for the design. The record is similarly silent on
this point.

42 We note that, in contrast to Mr. Harmsen’s characterization, the final project

proposal stated that CPI’s burner design “provides the high velocity which creates a
tremendous amount of turbulence and leads to the excellent temperature uniformity
for which TRITON RTO’s are known,” suggesting that information was already
available to CPI with respect to a design that achieved temperature uniformity.
 94

[*94] Next, Mr. Harmsen testified that CPI was concerned about
getting the poppet valves to seal, because of their large size. Again,
neither Mr. Harmsen’s testimony nor the record establishes (1) when
the concern arose; (2) what information was unavailable; and (3) what
actions were taken by CPI employees to gather additional information.

Finally, Mr. Harmsen testified that the possibility of oversizing
the oxidizer was a design challenge, as freight trucks might not be able
to carry a too-wide oxidizer. We fail to see how this issue establishes
that CPI lacked information as to the appropriate design of the oxidizer.
To the contrary, Mr. Harmsen’s testimony suggests that information
was readily available to CPI with respect to the typical capacity of
freight trucks, and CPI personnel simply kept this information in mind
when determining the oxidizer’s size.

We conclude that petitioners have failed to carry their burden of
establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the Goodyear Lawton project.

n. Wenner (#14-0800)

This project involved CPI’s design and supply of a 3,000 SCFM
catalytic oxidizer for an artisanal bread manufacturer. After contacting
CPI, Wenner provided CPI with specifications about the airflow and
ethanol quantities at its facility. CPI personnel then entered those
specifications into a spreadsheet that provided heat release and LEL
levels. Those outputs in turn dictated CPI’s design choice to use a
catalytic oxidizer, rather than a thermal one.

We thus agree with petitioners’ suggestion that information was
not initially available to CPI to establish the appropriate design of the
oxidizer as a whole. However, we disagree that CPI undertook activities
intended to discover such information. Wenner provided CPI with the
key information and specifications, which were then entered into
spreadsheets in a rote fashion. The output of the spreadsheets then
dictated CPI’s ensuing design choices. We conclude that petitioners
have failed to carry their burden of establishing that the product as a
whole satisfied the section 174 test. We look next to whether the
shrinking-back rule is applicable.

At trial, Mr. Betz identified several design challenges that relate
to components, including (1) the need to control high temperatures and
(2) the concern that baking oils and fats would degrade the catalyst.
With respect to the temperatures, CPI included an internal hot gas
 95

[*95] bypass in the design, which avoided overheating the heat
exchanger by outputting hot air directly from the catalyst bed to the
stack. However, petitioners failed to establish (1) what information was
unavailable to CPI with respect to the hot gas bypass or (2) what
investigative activities were undertaken by CPI employees.

With respect to the baking oils and fats, CPI similarly included a
catalyst guard in the design, which reacted to and vaporized the oils and
fats before they encountered the catalyst itself. Again, however,
petitioners failed to establish (1) what information was unavailable to
CPI with respect to the hot gas bypass or (2) what investigative activities
were undertaken by CPI employees.

We conclude that petitioners have failed to carry their burden of
establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the Wenner project.

o. East Balt (#14-07950)

This project involved CPI’s design and supply of a 5,000 SCFM
catalytic oxidizer for a hamburger bun manufacturer. Before submitting
a project proposal, CPI personnel initially visited the East Balt facility
to measure the airflows from the baking ovens. Absent the
measurements concerning the airflows, information was not available to
CPI establishing the appropriate design as a whole. As we have found,
airflow volume and VOC concentrations were some of the considerations
that dictated a project’s basic design specification. In addition, we find
that measuring these airflows was an investigative activity within the
meaning of the section 174 regulations. However, even assuming that
this activity also satisfied the process of experimentation test,
petitioners’ evidentiary imprecision would prevent us from applying the
Cohan rule to estimate the amount of wages that corresponded to this
activity; accordingly, petitioners have failed to establish which CPI
employees performed the measuring activities. 43 See Shami v.
Commissioner, 741 F.3d at 568.

43 The closest petitioners came to providing a reasonable basis for applying the

Cohan rule was Mr. Betz’s testimony, where he repeatedly used the collective pronoun
“we” with respect to the taking of the measurements. But as the Court had ample
opportunity to observe at trial, Mr. Betz’s frequent uses of “we” referred to CPI, rather
than to himself and any other identifiable individuals. The record is entirely silent as
to which employees performed the measurements at the East Balt facility.
 96

[*96] Next, we look to the shrinking-back rule. At trial, Mr. Betz
identified an issue that occurred during the fabrication process, where
CPI needed to increase the height of the exhaust stack in response to
concerns from the EPA. To account for the increased size, CPI added a
platform around the exhaust stack to the design in order to stabilize the
stack during high wind periods. However, once again, petitioners failed
to establish what information was unavailable with respect to the
structural support and wind speed and (2) what activities particular CPI
employees undertook to gather that information. To the contrary, Mr.
Betz testified that CPI had already accounted for a potential high wind
speed of 90 miles per hour when determining structural support for an
oxidizer in the Chicago area; it is unclear what other information CPI
needed to design the exhaust stack platform.

Petitioners did not credibly establish (1) that information was
unavailable and (2) that particular CPI employees undertook
investigative activities with respect to any other shrunk-back
components of the oxidizer. We conclude that petitioners have failed to
carry their burden of establishing that they satisfied the section 174 test
with respect to the claimed wage QREs on the East Balt project.

p. M&W Ireland (#14-07718)

This project involved CPI’s supply of a wastewater treatment
system to an Intel Corp. facility in Ireland. The proposal accepted by
M&W (Intel’s general contractor) stated that CPI would “copy exactly”
a previous wastewater treatment system supplied by CPI to Intel. The
proposal further included several minor, site-specific design changes,
some of which were necessitated by the need for the system components
to meet European product standards (known as CE). CPI thus modified
the design to include components from European suppliers. Petitioners
suggest that these site-specific requirements required CPI to engage in
an iterative process to determine a design that included components
that were in compliance with European standards. At trial Mr.
Harmsen testified that, on account of the European standards, CPI “had
to go out and figure out and find parts and pieces that were CE
approved” and then redesign the system to fit those approved
components. An objective lack of information as to how to meet the
European product standards could theoretically constitute an
uncertainty within the meaning of the section 174 regulations.
However, petitioners have not established (1) that information about the
European product standards was unavailable to CPI or (2) that CPI
employees conducted any relevant investigative activities. We find that
 97

[*97] the information previously available to CPI (i.e., the information
from its previous project with Intel) established the basic design
specification of the project. See Little Sandy Coal Co. v. Commissioner,
62 F.4th at 299 (“[A] manufacturer may not simply ‘add a few new bells
and whistles’ on a pre-existing product and claim uncertainty as to the
whole.”).

In addition, at the shrunk-back component level, petitioners have
not established that CPI employees performed any investigative
activities. We conclude that petitioners have failed to carry their burden
of establishing that they satisfied the section 174 test with respect to the
claimed wage QREs on the M&W Ireland project. 44

q. Enterprise (#14-07851)

This project involved CPI’s design and supply of two hot air
recirculation systems and two internally insulated VOC hot gas
bypasses. The record firmly establishes that, as of 2014, CPI had
information available to it establishing the basic design specification of
both products, each of which was a commonly used component in CPI’s
systems. Before 2014 CPI was particularly experienced in resolving the
outdoor low temperature issues that Enterprise was facing, to the extent
that CPI personnel had published an industry-facing article discussing
its standard hot air recirculation solution. Cf. Union Carbide Corp., 97
T.C.M. (CCH) at 1261 (concluding that information was available to
taxpayer under section 174 in part because of taxpayer’s experience in
using particular component to solve design issue). CPI’s generalized
experience with the low temperature issue was bolstered by the site-
specific information that Messrs. Betz and Harmsen obtained from their
inspection of the Rifle facility’s existing oxidizers in 2013. From that
inspection, CPI determined that the oxidizer was experiencing issues

44 In the alternative we also conclude that the expenditures incurred in

connection with the M&W Ireland project are independently excluded from the
definition of qualified research by way of the section 41(d)(4)(B) adaptation exclusion.
Cf. Trinity Indus., Inc., 691 F. Supp. at 697 & n.11 (holding in the alternative that
adaptation exclusion applied to taxpayer’s “refinement of a preliminary design”
provided by customer). Whatever the scope of the adaptation exclusion, we find it
evident that an exact copy of a previous product with some minor site-specific
modifications falls squarely within its plain meaning. See § 41(d)(4)(B) (excluding
“[a]ny research related to the adaptation of an existing business component to a
particular customer’s requirement or need”); Adaptation, Oxford English Dictionary
(3d ed. 2011), https://www.oed.com/view/Entry/2115 (last updated March 2023)
(defining adaptation as “[t]he action or process of adapting one thing to . . . suit
specified conditions, esp. a new or changed environment, etc.”).
 98

[*98] with (1) recirculation of cold air at the inlet; (2) pinhole leaks;
(3) uninsulated components; and (4) a possibly dangerous natural gas
injector. On January 2, 2014, Mr. Harmsen submitted a report to
Enterprise, detailing the inspection findings and the recommendation
that Enterprise engage CPI to design and supply CPI’s hot air
recirculation solution and make other necessary fixes. That report
included the necessary basic information and specifications for
designing the components, including the particular VOCs at issue and
the cold temperatures at the facility. We thus conclude that CPI had
resolved any objective uncertainty about the basic design specification
of the two components before 2014. Cf. Siemer Milling Co., T.C. Memo.
2019-37, at *33 (concluding that project failed section 174 test where
taxpayer already had prior-year testing information resolving
uncertainty).

At trial, petitioners’ counsel and Mr. Harmsen sought to
characterize the ultimate design of the components as “significantly
different” from the initial design projections in the report. This
characterization appeared to rely on the fact that the final general
arrangement drawing changed the location of the hot air recirculation
duct system and added a new fan to one of the existing oxidizers.
However, petitioners failed to further explain how the design of the hot
air recirculation component itself (as opposed to its location) changed.
Nor did petitioners produce evidence showing what activities particular
CPI employees performed to gather information about the appropriate
placement of the air recirculation duct system or the addition of the fan.
We find Mr. Harmsen to lack credibility with respect to his testimony
suggesting that the final design as a whole was “significantly different”
from his initial recommendations.

We conclude that petitioners have not produced credible evidence
establishing (1) what information was otherwise unavailable to CPI
with respect to the design of the two components; and (2) what
investigative activities CPI personnel undertook to obtain such
information in 2014. To the extent that investigative activities were
performed with respect to the Enterprise project, we find that they
correspond to wages that were incurred in tax year 2013. We conclude
that petitioners have failed to carry their burden of establishing that
they satisfied the section 174 test with respect to the claimed wage
QREs on the Enterprise project.
 99

[*99] r. DuPont La Porte (#14-07831)

This project involved CPI’s design and supply of a 1,067 SCFM
direct thermal oxidizer for a chemical manufacturing facility.
Petitioners identified the large size of the exhaust stack as a design
uncertainty. However, petitioners failed to establish that CPI itself
conducted any investigative activities intended to resolve this
uncertainty. Indeed, we find that, in contrast to its typical process, CPI
simply engaged IVI North to design the exhaust stack itself to DuPont’s
provided specifications, because CPI lacked the capability to do so. 45
Petitioners have offered no evidence establishing what (if any)
investigative activities IVI North or CPI may have conducted with
respect to the stack’s design. Cf. Union Carbide Corp., 97 T.C.M. (CCH)
at 1261 (holding that uncertainty did not exist where third party
designed product and taxpayer provided no evidence that it modified the
design). Even if petitioners had been able to make such a showing with
respect to IVI North, they have not contended at any point in this
litigation that they incurred contract research expenses with respect to
amounts paid to their subcontractors, and we would thus deem that
issue conceded. 46 See Petzoldt, 92 T.C. at 683.

At trial Mr. Harmsen also identified the design of a custom burner
for the project as a design difficulty. However, Mr. Harmsen testified
that this entailed “going out and finding a supplier that could design a
custom-made burner for this application.” Even assuming arguendo
that contacting suppliers for bids constitutes research and development
within the meaning of the section 174 regulations, it is assuredly not
part of a process of experimentation. See Siemer Milling Co., T.C.
Memo. 2019-37, at *36.

We conclude that petitioners have failed to carry their burden of
establishing that CPI employees performed qualified services with
respect to the DuPont La Porte project.

45 On this point, we find Mr. Harmsen’s trial testimony—that IVI North did
not do any design work—to lack credibility, in part because it directly conflicted with
Mr. Betz’s testimony, as well as with the IVI North quote and the purchase order CPI
issued to IVI North, which described the agreed-upon services as “[d]esign and
fabricate exhaust stack.”
46 As noted above, section 41(b)(3)(A) allows a limited amount of the credit for

contract research expenses, defined as amounts paid or incurred “by the taxpayer to
any person (other than an employee of the taxpayer) for qualified research.”
 100

[*100] s. Reclaimed Energy (#14-07981)

This project involved CPI’s design and supply of a 15,000 SCFM
regenerative thermal oxidizer. Because of CPI’s longtime customer
relationship with Reclaimed Energy, CPI personnel already had
significant information about the facility’s airflow from work on previous
projects, much of which they re-incorporated into a P&ID drawing for
the new oxidizer. Trial testimony by Mr. Harmsen further addressed
the basis of this design:

Petitioners’ counsel: “What information were you provided
at the beginning of the project?”

Mr. Harmsen: “We had history with Ron [Snyder, a
Reclaimed Energy representative] in his process, so we
knew a little bit about it. What we wanted from him and
what we received were what he could perceive as a
maximum. So if he was adding a new distillation column,
what was that going to do to his existing, how many rows
are you going to add, and what would they produce. And
we use that to try to reconcile against what the oxidizer
maximums would be.”

We understand Mr. Harmsen’s testimony as stating that Reclaimed
Energy provided CPI with information about the potential airflow
volume and VOC concentrations at the Connersville facility, taking into
account potential future expansion of the facility. Mr. Harmsen further
testified that he input the VOC solvent toluene into a Bessy spreadsheet,
because that was “the solvent [Ron] likes to say he has a lot of.” 47 Using
the provided information and the output of the spreadsheet, Mr.
Harmsen and other CPI personnel were able to determine the
appropriate size of the various components and reduce them to design
drawings. Petitioners point to no evidence suggesting that CPI
employees conducted investigative activities with respect to the basic
design specification of the oxidizer. We thus find that the information
provided to CPI by Reclaimed Energy established the appropriate
design of the oxidizer as a whole, and CPI personnel thus did not
perform activities intended to discover such information within the
meaning of the section 174 regulations.

47 Mr. Harmsen also input methane into a separate Bessy spreadsheet to

account for a possible worst-case scenario, because of methane’s high BTU rating.
 101

[*101] In addition, Mr. Harmsen’s trial testimony did not establish that
further investigative activities were performed with respect to any
shrunk-back component of the oxidizer. We conclude that petitioners
have failed to carry their burden of establishing that they satisfied the
section 174 test with respect to the claimed wage QREs on the
Reclaimed Energy project.

t. Conclusion

We conclude that petitioners have failed to carry their burden of
establishing that the activities corresponding to their claimed wage
QREs constituted qualified research or direct supervision or support of
qualified research, within the meaning of section 41(b)(2)(B).
Accordingly, we will sustain respondent’s determination that petitioners
are not entitled to a research credit.

D. Funded Research Exclusion

We now address the parties’ arguments with respect to the funded
research exclusion, as a discrete alternative holding. Section 41(d)(4)(H)
excludes from the definition of qualified research “[a]ny research to the
extent funded by any grant, contract, or otherwise by another person.”
Section 41 does not define the term “funded.” The regulations provide
two factors that are relevant in determining whether research is
funded. 48 First, “[a]mounts payable under any agreement that are
contingent on the success of the research and thus considered to be paid
for the product or result of the research” are not treated as funding. See
Treas. Reg. § 1.41-4A(d)(1); see also Fairchild Indus., Inc. v. United
States, 71 F.3d 868, 870 (Fed. Cir. 1995) (describing exclusion as
allocating the credit “to the person that bears the financial risk of failure
of the research”). Second, “[i]f a taxpayer performing research for
another person retains substantial rights in the research under the
agreement providing for the research,” that research is likewise not
treated as funded. See Treas. Reg. § 1.41-4A(d)(3); see also Treas. Reg.
§ 1.41-2(a)(3). Respondent challenges petitioners’ claim that CPI
retained substantial rights in its research under the contracts for eight
of the projects at issue.

48 Treasury Regulation § 1.41-4A is captioned “Qualified research for taxable

years beginning before January 1, 1986” but remains applicable in relevant part for
tax year 2014, by way of a separate regulatory provision. See Treas. Reg. § 1.41-4(c)(9)
(“To determine the extent to which research is so funded, § 1.41-4A(d) applies.”); see
also Tangel v. Commissioner, T.C. Memo. 2021-1, at *9 n.4.
 102

[*102] We determine whether a taxpayer has substantial rights in
research by looking to the terms of the parties’ contract for each project
at issue. See Tangel, T.C. Memo. 2021-1, at *11; Treas. Reg. § 1.41-
4A(d)(1); see also Lockheed Martin Corp. v. United States, 210 F.3d 1366,
1376 (Fed. Cir. 2000) (stating that application of the exclusion “must be
determined by reference to the research agreements”). A taxpayer
retains no substantial rights in research performed “under an
agreement that confers on another person the exclusive right to exploit
the results of the research.” Treas. Reg. § 1.41-4A(d)(2). Similarly, a
taxpayer retains no substantial rights in research “if the taxpayer must
pay for the right to use the results of the research.” Id. subpara. (3)(i);
cf. Lockheed Martin Corp., 210 F.3d at 1375 (“The right to use the
research results, even without the exclusive right, is a substantial
right.”). Finally, “[i]ncidental benefits” to the taxpayer from performing
research, such as “increased experience in a field of research,” are not
substantial rights. Treas. Reg. § 1.41-4A(d)(2). As with other elements
of the research credit, petitioners bear the burden of showing that CPI
retained substantial rights in the results of any research performed
under the contracts. See Dynetics, Inc. & Subs. v. United States, 121
Fed. Cl. 492, 523 (2015).

We start by looking to the relevant caselaw and its treatment of
contractual provisions similar to those at issue here. In Tangel, T.C.
Memo. 2021-1, at *4-5, we reviewed a contract that stated in relevant
part:

A. With respect to Articles for which any technical
information, written, oral or otherwise, (i) has been
supplied to Seller by or on behalf of Buyer; or (ii) Seller has
designed at Buyer’s expense; or (iii) Seller has designed
specifically to meet Buyer-furnished technical
requirements (hereinafter designated “Information”),
Seller, in consideration of Buyer’s furnishing of such
Information and/or design funding, agrees that it will not
use, or assist others in using, such Information, design
funding or tooling to develop or sell such Articles (or
similar interchangeable or substitute Articles, or parts
thereof) to anyone other than Buyer, either as production,
spare or repaired Articles, without Buyer’s prior written
consent. Seller shall not use or disclose such Information
except in the performance of Orders for Buyer, and, upon
Buyer’s request, such Information and all copies thereof
shall be returned to Buyer.
 103

[*103] B. Information prepared by Seller specifically in
connection with performance of this Order, including
original works of authorship created by Seller, are
considered “works made for hire” within the meaning of the
U.S. Copyright Laws. Buyer shall be deemed the author of
such works. If any such work is determined by a court of
competent jurisdiction not to be a work made for hire, this
Order shall operate as an irrevocable assignment to Buyer
of all right, title and interest in and to such work.

We concluded that paragraph A prevented the taxpayers from
using the results of the research under the contract for any other
purpose, unless the customer gave prior written consent. Id. at *12–13.
We further concluded that paragraph B vested the customer with the
right to any copyrightable materials created in performing the contract.
Id. at *13–14. The taxpayers argued in part that the institutional
knowledge gained from research was a substantial right; we squarely
rejected this contention, characterizing institutional knowledge as a
mere incidental benefit from performing research within the meaning of
Treasury Regulation § 1.41-4A(d)(2). Tangel, T.C. Memo. 2021-1, at *16.
Accordingly, we concluded that the taxpayers had failed to retain
substantial rights in research under the contract.

In Dynetics, Inc., 121 Fed. Cl. at 518–23, the Court of Federal
Claims (CFC) analyzed two separate contracts under the substantial
rights doctrine. The first contract, between the taxpayer and the
University of Alabama, Huntsville (University), stated in relevant part:

All rights, title, and interest in and to inventions or other
intellectual property rights conceived or reduced to
practice in the course of performance of the work called for
by this Contract are hereby vested in the University. The
contractor agrees to promptly disclose to the University, in
a format acceptable to the University, any potentially
patentable idea or concept conceived or reduced to practice
in the course of performance of the work called for by this
Contract.

Id. at 518.

The taxpayer argued that its work under the contract, which
involved solving equations and developing simulations, was not
patentable and was thus outside the scope of the terms. Id. Focusing
 104

[*104] on the phrase “other intellectual property rights,” the CFC
determined otherwise and found that the contract vested a “broad
category of rights” in the University, including both patentable and
nonpatentable technology “conceived or reduced to practice in the course
of performance.” Id. at 519. Accordingly, the CFC concluded that the
taxpayer had failed to retain substantial rights in the research with
respect to the contract. Id.

The second contract, between the taxpayer and the United States
Department of Defense (DOD), was subject to a number of standard
national security requirements with respect to the taxpayer’s use of
classified intelligence information. Id. at 519–20. Those requirements
prohibited the taxpayer from reproducing intelligence materials or
releasing intelligence materials to others without authorization and
required the return or destruction of all materials generated by the
taxpayer as directed upon completion of the contract. Id. at 521. The
taxpayer made a three-pronged argument, asserting that (1) it retained
the right to use generalized “skills and advancements” that it developed
in performing the contract; (2) it could use the particular research
results for other contracts following authorization from the relevant
component of DOD; and (3) a regulation incorporated into the contract
provided that it would retain the rights to any patentable invention or
discovery conceived or reduced to practice in performing the contract.
Id. at 521–23.

With respect to the taxpayer’s initial argument, the CFC
characterized any skill or advancement gained as an “incidental benefit”
from performing research and thus not a substantial right under
Treasury Regulation § 1.41-4A(d)(2). Dynetics, Inc., 121 Fed. Cl. at 521.
With respect to the second argument, the CFC observed that the
taxpayer had not answered “the obvious question of how it could have
substantial rights in the results of the research, if it needed the
government’s ‘authorization’ to use those results.” Id. Finally, while the
CFC acknowledged that the taxpayer would retain patent rights under
the contract, the CFC concluded that such a right would be irrelevant to
whether the taxpayer retained substantial rights in the nonpatentable
results of its research at issue. Id. at 523. The CFC thus concluded that
the taxpayer retained no substantial rights in the research performed
under this contract. Id.

Here, respondent points to the fact that CPI’s standard terms and
conditions are silent with respect to CPI’s rights in its research.
Respondent thus argues that the terms and conditions in the purchase
 105

[*105] orders issued by CPI’s customers control whether CPI retained
substantial rights in research performed. Respondent identifies eight
projects—3M Hutchinson, 3M Monrovia, 3M Hartford, Celanese,
Smalley, Enterprise, Teva, and HAI—where the governing terms
purportedly conferred on the customer all substantial rights in
research. 49 Relying on Lockheed Martin Corp., 210 F.3d at 1374,
petitioners respond that the express transfer of usage rights in these
contracts was not exclusive and thus CPI still retained substantial
rights in the research. We now turn to the eight projects at issue.

1. 3M (#13-05720, 13-07611, 14-07784)

The master agreement between CPI and 3M governed all three
3M projects for which CPI claimed the research credit for 2014. Clause
10.2 of the master agreement provided in relevant part that 3M owned
all intellectual and tangible property rights in “any goods, equipment
. . ., apparatus, documents, drawings, computer software and artwork
which . . . [CPI] creates at 3M’s expense or [CPI] creates using 3M
Confidential Information (‘3M Rights’).” Clause 10.2 further provided
that CPI assigned to 3M “all of [CPI’s] rights, including, without
limitation, all intellectual and tangible property rights” with respect to
“any property subject to 3M Rights.” Finally, clause 8.3 provided that
“if [CPI] retains ownership” of any “drawing, illustrations, instructions,
maintenance information, and other materials that relate to the
Equipment,” CPI “grants 3M the perpetual, unrestricted right to use,
copy, and distribute those materials for 3M’s internal use.”

We find the contract terms to be unambiguous. Via clause 10.2,
CPI assigned to 3M “without limitation, all intellectual and tangible
property rights” in the work product resulting from research performed
under the contract. In turn, clause 8.3 vested nonexclusive usage rights
in 3M for materials that “relate to the Equipment,” but only “if [CPI]
retains ownership” of those materials. Reading the two clauses
together, we understand clause 8.3 as inapplicable to work product that
CPI did not retain ownership over, pursuant to the assignment in clause
10.2 (i.e., work product “create[d] at 3M’s expense” or “create[d] using
3M Confidential Information”). Clause 8.3 thus appears to be a fallback
provision, applying primarily to pre-existing, project-related materials

49 We thus deem respondent to have conceded that, under the remaining 11

projects’ contracts, CPI retained substantial rights and thus did not perform funded
research. See, e.g., Petzoldt, 92 T.C. at 683 (treating party’s failure to argue point on
brief as concession).
 106

[*106] that (1) were not created in performing the project and (2) are
owned by CPI.

We conclude that CPI no longer retained a right to use any of the
work product and thus no longer retained a substantial right in the
results of its research. See Treas. Reg. § 1.41-4A(d)(2); see also United
States v. Grigsby, No. 19-00596, 2022 WL 11269773, at *4, *14–15 (M.D.
La. Oct. 19, 2022) (finding no substantial rights where “all rights, title
and interest” to similar work product was vested in customer). Absent
a right to use such work product, CPI retained only incidental benefits
from the project, namely any increased institutional knowledge. See
Treas. Reg. § 1.41-4A(d)(2). Consequently, any research activities
performed by CPI on the three 3M projects were funded research and
thus excluded from the definition of qualified research.

2. Celanese (#14-07852)

The governing terms and conditions between CPI and Celanese
provided that “any deliverables or other work product arising from”
CPI’s services would be confidential property of Celanese and thus could
not be used by CPI “for any purpose other than as expressly
contemplated by the Purchase Order.” The terms also stated that CPI
assigned to Celanese “all other copyright and derivatives, trade secret
and other proprietary rights that arise out of the performance of the
Services or that are applicable to any deliverables under the Purchase
Order.” Finally, the terms vested in Celanese the rights to all works
eligible for copyright protection arising out of CPI’s performance as
“work[s] made for hire.” 50 The terms provided that if “any such work is
deemed for any reason not to be a work made for hire,” CPI “hereby
assigns all rights, title and interest in the copyright to such work” to
Celanese.

Again, we find the contract terms to be unambiguous. We
conclude that the applicable terms prohibited CPI from using the results
of its research other than for the purpose of performing under the

50 In copyright law, a work made for hire is “a work prepared by an employee

within the scope of his or her employment” or “a work specially ordered or
commissioned” within nine enumerated categories. 17 U.S.C. § 101; see Cmty. for
Creative Non-Violence v. Reid, 490 U.S. 730, 750–52 (1989) (applying common law
agency principles to determine whether person was employee within the meaning of
copyright law); Billy-Bob Teeth, Inc. v. Novelty, Inc., 329 F.3d 586, 591 (7th Cir. 2003).
If the work was determined to be a work made for hire, the person “for whom the work
was prepared is considered the author” for copyright purposes. 17 U.S.C. § 201(b).
 107

[*107] contract. See Tangel, T.C. Memo. 2021-1, at *13 (finding no
substantial rights in contract that prevented seller “from using the
results of its research for any purpose outside” of performing under the
contract). The terms also expressly vested in Celanese the rights to all
copyrightable material arising out of CPI’s work under the contract as
either works made for hire or, in the alternative, as an outright
assignment. See id. at *5, *16 (analyzing similar provision); Grigsby,
2022 WL 11269773, at *15 (“Together, the . . . [c]ontract’s ‘work for hire’
and transfer of title provisions eliminate any plausible reading under
which [the taxpayer] retains the right to use.”). CPI conferred on its
customer the exclusive right to use the results of its research and the
intellectual property rights to any copyrightable material, reserving to
itself only the institutional knowledge—an incidental benefit—that it
gained in designing the oxidizer system. Consequently, any research
activities performed by CPI on the Celanese project were funded
research and thus excluded from the definition of qualified research.

3. Smalley (#14-07658)

Clause 6 of governing terms and conditions between CPI and
Smalley provided that CPI would keep confidential “all information,
drawings, specifications or data furnished by Buyer” and would “not
divulge or use such information, drawings, specifications or data” except
in performing its contractual obligations to Smalley. Clause 6 also
provided that, upon completion of the order, CPI would “make no further
use, either directly or indirectly, of any such data or of any information
derived therefrom without obtaining Buyer’s prior written consent.”

We find these contract terms to be ambiguous with respect to
whether CPI retained substantial rights. Clause 6 could be read as
divesting CPI of a right to use “all information, drawings, [and]
specifications,” as well as all “data furnished by” Smalley. The
ambiguity derives from the placement of the phrase “furnished by
Buyer.” One method of resolving that ambiguity would be to apply the
last antecedent rule. 51 Under that rule, a limiting phrase (here,
“furnished by Buyer”) should presumptively be read as modifying only
the noun that immediately precedes it (here, “data”). Barnhart v.
Thomas, 540 U.S. 20, 26 (2003). However, the rule “is not an

51 Neither CPI nor Smalley appears to have included a choice-of-law provision

in the contract documents, and both CPI and Smalley are based in Illinois. Illinois
courts apply the last antecedent rule in construing ambiguous contract terms. See,
e.g., State Farm Mut. Auto. Ins. Co. v. Murphy, 136 N.E.3d 595, 602–03 (Ill. App. Ct.
2019).
 108

[*108] absolute and can assuredly be overcome by other indicia of
meaning.” Id.

We conclude that the last antecedent rule is inapposite here, for
several contextual reasons. Clause 6 goes on to require that CPI “return
such information, drawings, specifications and data” (emphasis added)
to Smalley upon completion of the contract, thus suggesting that CPI
was required only to give back materials furnished to it by Smalley, not
deliver newly generated materials to Smalley. Further, the preceding
clause 5 states in relevant part: “If drawings and specifications are
furnished by Buyer, this Order shall be based upon such drawings and
specifications.” That prior context, which connects “drawings and
specifications” with being “furnished by” Smalley, is relevant to reading
“all information, drawings, specifications or data” in clause 6. See
Martindell v. Lake Shore Nat’l Bank, 154 N.E.2d 683, 689 (Ill. 1958)
(“The intention of the parties is not to be gathered from detached
portions of a contract or from any clause or provision standing by itself,
but each part of the instrument should be viewed in the light of the other
parts.”). Given that context and the simplicity of the categories
“information, drawings, specifications or data,” a reader can intuitively
apply “furnished by” as a modifier to each category. See Lockhart v.
United States, 577 U.S. 347, 352 (2016) (observing that the last
antecedent rule is less applicable where “the listed items are simple and
parallel without unexpected internal modifiers or structure”). To
narrowly construe only one category as modified by the limiting phrase,
despite the categories’ similarities, is thus not the most natural reading
of the provision. See Paroline v. United States, 572 U.S. 434, 447 (2014)
(“When several words are followed by a clause which is applicable as
much to the first and other words as to the last, the natural construction
of the language demands that the clause be read as applicable to all.”
(quoting Porto Rico Ry., Light & Power Co. v. Mor, 253 U.S. 345, 348
(1920))); see also Facebook, Inc. v. Duguid, 141 S. Ct. 1163, 1169 (2021).
We read the provision as prohibiting only CPI’s use of work product
“furnished by” Smalley to CPI. Consequently, we conclude that clause 6
does not necessarily preclude CPI from retaining substantial rights in
the results of any research it performed itself under the Smalley
contract.

We turn now to clause 10 of the terms, which defined “Buyer-
Owned Property” as “any tools, tooling, patterns, equipment, materials,
or other property used in the manufacture of the Goods . . . that are
either supplied to [CPI] by [Smalley] or have been acquired by [CPI] and
specifically paid for by [Smalley].” The terms stated that CPI “shall not
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[*109] use Buyer-Owned Property in the performance of any other work
without prior written approval of [Smalley]” and that “[t]itle to all
Buyer-Owned Property shall at all times remain with [Smalley].” We
find these terms to be unambiguous in vesting ownership in Smalley of
certain property provided by Smalley to CPI or acquired and specifically
paid for by Smalley and then used by CPI in performing the contract.
However, clause 10 on its face does not apply to property that CPI
developed itself (rather than acquired) in the course of performing the
contract (i.e., the results of research). Reading clauses 5, 6, and 10
together, we conclude that CPI’s retained right to use the work product
results of research it performed was substantial. Accordingly, we hold
that any research that CPI performed on the Smalley project was not
excluded from the definition of qualified research.

4. Enterprise (#14-07851)

The governing terms and conditions between CPI and Enterprise
provided that Enterprise would be the owner of “all information and
materials resulting from [CPI’s] services, including sketches, layouts,
negatives, photographs, designs, blueprints, and specifications relating
thereto, and of the work product of all services furnished or performed
. . . including all creative ideas included therein.” The terms also stated
that “[n]o copies or reproductions” of the information and materials
would “be made or retained by [CPI] except as authorized in writing by
[Enterprise].”

We construe the terms as requiring CPI to seek permission from
Enterprise to retain and use any information, materials, and work
product generated in performing the contract. Cf. Dynetics, Inc., 121
Fed. Cl. at 521 (construing similarly provisions for taxpayer to seek
permission from customer for use or reproduction of material). No
provision otherwise limited Enterprise’s ability to withhold consent
from CPI as to the retention of such materials. See Tangel, T.C. Memo.
2021-1, at *17 (“Having to secure permission to use the research, with
no conditions limiting the other party’s ability to withhold consent,
prevents [the taxpayer] from possessing substantial rights.”). If CPI
was unable to retain and use such information, material, and work
product without permission, then we fail to see what rights CPI retained
under the contract to any research performed, aside from the incidental
benefit of increased knowledge and experience. See Treas. Reg. § 1.41-
4A(d)(2); see also Dynetics, Inc., 121 Fed. Cl. at 521 (“[The taxpayer] does
not address the obvious question of how it could have substantial rights
in the results of the research, if it needed the [customer’s] ‘authorization’
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[*110] to use those results.”). We thus conclude that any research that
CPI performed on the Enterprise project was funded and thus excluded
from the definition of qualified research.

5. Teva (#14-07808)

The governing terms and conditions between CPI and Teva
provided that CPI would “not use, sell, loan or publicize any of the tools,
specifications, blueprints, designs or artwork supplied or paid for by
Buyer for the fulfillment of this order without Buyer’s written consent.”
We conclude that this provision presents the same issue as clause 10 of
the Smalley terms discussed above. While the terms divested CPI of the
unconditional right to use certain “tools, specifications, blueprints,
designs or artwork,” the scope is limited to such materials as are
“supplied or paid for by [Teva] for the fulfillment of this order.”
Accordingly, CPI retained the unconditional right to use work product
results that it itself generated in performing any research on the project.
We thus conclude that any research that CPI performed on the Teva
project was not funded and thus is not excluded from the definition of
qualified research.

6. HA International (#13-07615)

The governing terms and conditions between CPI and HAI
provided that HAI would be “entitled to all documents, drawings,
specifications, calculations and other information carriers” with respect
to CPI’s activities for HAI. The terms went on to state that HAI would
be “solely entitled to all intellectual property rights (including patents)
created during the performance of the obligations” under the contract.
Finally, the terms provided that HAI would have a “full license to use”
any intellectual property, in a case where “the intellectual property
rights are with both” CPI and HAI.

We find the HAI terms to be unambiguous as to CPI’s rights in
the research. In interpreting the contract between CPI and HAI, we
apply Ohio law, pursuant to the choice-of-law provision in the HAI
terms. This includes the familiar maxim that we must construe a
contract “so as to give effect to all of its provisions.” R.L.R. Invs., LLC
v. Wilmington Horsemens Grp., LLC, 22 N.E.3d 233, 240 (Ohio Ct. App.
2014). In doing so, we “presume that the intent of the parties is reflected
in the plain language of the contract” and thus “enforce the terms as
written.” Beverage Holdings, LLC v. 5701 Lombardo, LLC, 150 N.E.3d
28, 31 (Ohio 2019); see also Stewart v. Hartford Life & Accident Ins. Co.,
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[*111] 43 F.4th 1251, 1255 (11th Cir. 2022) (“When interpreting a
written text—a contract no less than a statute—we generally
understand ‘a material variation in terms [to] suggest[ ] a variation in
meaning.’” (quoting Antonin Scalia and Bryan A. Garner, Reading Law:
The Interpretation of Legal Texts 51, 170 (2012))).

The text of the provision at issue is clear as to what rights in
research were vested in HAI. While HAI was “solely entitled” to
intellectual property rights created during the contract, HAI was
“entitled” only to the various work products used by CPI in performing
the contract. Giving effect to both clauses and their material difference
(i.e., the presence or absence of “solely”), we construe the terms as
providing HAI with only a nonexclusive right to use the work product,
as contrasted with its exclusive right to intellectual property. CPI thus
necessarily retained its own right to use any work product generated
under the contract. This right to use was substantial. See Lockheed
Martin Corp., 210 F.3d at 1378 (concluding that the “right to use is not
a zero-sum game” and that the taxpayer still retained substantial rights
in research despite its customer’s “unlimited right to use, duplicate, and
disclose” research). We thus conclude that any research that CPI
performed on the HAI project was not excluded from the definition of
qualified research as funded.

7. Conclusion

For five of the eight projects at issue—3M Hutchinson, 3M
Hartford, 3M Monrovia, Celanese, and Enterprise—we conclude that
any research performed by CPI was funded and thus independently
excluded from the definition of qualified research. As an alternative
holding, we will thus partially sustain respondent’s determination to
disallow CPI’s claimed research credit on this basis with respect to these
projects.

E. Accuracy-Related Penalties

Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related
penalty on, as relevant here, any underpayment of federal income tax
which is attributable to negligence, disregard of rules or regulations, or
a substantial understatement of income tax. Negligence includes “any
failure to make a reasonable attempt to comply” with the Code, see
§ 6662(c), or a failure “to keep adequate books and records or to
substantiate items properly,” see Treas. Reg. § 1.6662-3(b)(1). An
understatement of income tax is “substantial” if it exceeds the greater
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[*112] of 10% of the tax required to be shown on the return or $5,000.
§ 6662(d)(1)(A).

Respondent argues that petitioners are liable for a penalty under
section 6662(a) on the basis of both negligence and a substantial
understatement of income tax. Generally, the Commissioner bears the
initial burden of production to establish via sufficient evidence that a
taxpayer is liable for penalties and additions to tax; once this burden is
met, the taxpayer must carry the burden of proof, including with regard
to defenses such as reasonable cause. § 7491(c); see Higbee v.
Commissioner, 116 T.C. 438, 446–47 (2001). As part of that burden, the
Commissioner must satisfy section 6751(b), by producing evidence of
written approval of the penalty by an immediate supervisor, made
before formal communication of the penalty to the taxpayer. See Graev
v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and
overruling in part 147 T.C. 460 (2016); see also Clay v. Commissioner,
152 T.C. 223, 246 (2019), aff’d, 990 F.3d 1296 (11th Cir. 2021).

Petitioners have conceded that respondent secured timely written
supervisory approval for the accuracy-related penalties pursuant to
section 6751(b)(1), thus satisfying part of respondent’s initial burden.
See, e.g., Sestak v. Commissioner, T.C. Memo. 2022-41, at *8 (accepting
stipulation that agent obtained approval from immediate supervisor
before formal communication as satisfying section 6751(b)(1)). We also
conclude that respondent carried his burden of establishing that
petitioners were negligent with respect to their underpayments of tax,
failing to maintain adequate records substantiating their entitlement to
the research credits. See Treas. Reg. § 1.41-4(d) (“A taxpayer claiming
a credit under section 41 must retain records in sufficiently usable form
and detail to substantiate that the expenditures claimed are eligible for
the credit.”); see also § 6001; Treas. Reg. § 1.6001-1(a). Alternatively,
petitioners are liable for section 6662 penalties on the basis of
substantial understatements of income tax to the extent that the
understatements meet the applicable definition. See § 6662(d)(1)(A).

Section 6664(c)(1) provides that a section 6662 penalty will not be
imposed for any portion of an underpayment if the taxpayer shows
reasonable cause and good faith with respect to that underpayment. A
taxpayer may establish reasonable cause by showing actual, good-faith
reliance on the advice of a competent tax professional. See Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221
(3d Cir. 2002); Treas. Reg. § 1.6664-4(b)(1), (c)(1). In posttrial briefing,
petitioners made the single statement, as a proposed finding of fact, that
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[*113] they “are not liable for penalties under section 6662(a),” with a
supporting citation of the “Entire Record.” Petitioners made no other
statement or argument in their posttrial briefing with respect to their
liability for accuracy-related penalties; nor did petitioners argue on brief
that they had reasonable cause and acted in good faith with respect to
any underpayment. 52 See Rule 151(e)(5) (requiring that parties’
arguments in posttrial briefing “set[] forth and discuss[] the points of
law involved and any disputed questions of fact”); cf. United States v.
Dunkel, 927 F.2d 955, 956 (7th Cir. 1991) (“A skeletal ‘argument’, really
nothing more than an assertion, does not preserve a claim.”). As noted
above, reasonable cause is an affirmative defense, for which the
taxpayer bears the burden of proof. See ATL & Sons Holdings, Inc. v.
Commissioner, 152 T.C. 138, 154 (2019). Petitioners’ failure to raise
reasonable cause in posttrial briefing thus constitutes an abandonment
of the issue. See Mendes, 121 T.C. at 312–13; Efron v. Commissioner,
T.C. Memo. 2012-338, at *23 (concluding that taxpayer conceded
reasonable cause when he failed to argue it on brief); see also Sanchez v.
Miller, 792 F.2d 694, 703 (7th Cir. 1986) (“It is not the obligation of this
court to research and construct the legal arguments open to parties,
especially when they are represented by counsel.”). We will to the extent
stated herein sustain respondent’s determination that petitioners are
liable for accuracy-related penalties for tax years 2014, 2015, and
2016. 53

III. Conclusion

For the foregoing reasons, we hold (1) that petitioners are not
entitled to a section 41 research credit and (2) that petitioners are liable
for section 6662(a) penalties. We have considered all of the arguments
made by the parties and, to the extent they are not addressed herein, we
find them to be moot, irrelevant, or without merit.

52 Indeed, before posttrial briefing petitioners expressly conceded in a
stipulation of settled issues that they did not rely upon Mr. Smiejek of Porte Brown
nor any other representative of Porte Brown in claiming the research credit on CPI’s
2014 Form 1120S.
53 Alternatively, even if reasonable cause had been properly raised, we would

still conclude that any apparent reliance by petitioners on Alliantgroup with respect
to claiming the research credits was inconsistent with ordinary business care and
prudence and thus that petitioners failed to establish reasonable cause for their
underpayments of tax. See § 6664(c).
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[*114] To reflect the foregoing,

Appropriate decisions will be entered.