# United States Tax Court

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URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A2e9ea9ca749d4d1f

## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

United States Tax Court
T.C. Memo. 2024-113
PHOENIX DESIGN GROUP, INC.,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
__________
Docket No. 4759-22.

Filed December 23, 2024.
__________

Matthew S. Reddington, Russell G. Garza, Janine M. Campanaro, and
Jefferson H. Read, for petitioner.
Jonathan E. Behrens, Hannah Kate Comfort, and Randall B. Childs, for
respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION
GREAVES, Judge: This case involves the section 41 “Credit for
Increasing Research Activities” (research credit) claimed by Phoenix
Design Group (PDG or petitioner), a multidisciplinary engineering
consulting firm. 1 The Internal Revenue Service (IRS or respondent)
disallowed research credits claimed for 2013 through 2016 (research
years) and imposed accuracy-related penalties.
The disallowed research credits relate to over 200 projects;
however, the parties agreed to try a nonbinding three-project sample.
The issues for decision are (1) whether any of the three trial projects
entailed qualified research and (2) whether petitioner is liable for
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.

Served 12/23/24

2
[*2] accuracy-related penalties under the parties’ stipulations. We hold
that none of the three projects entailed qualified research and that
petitioner is liable for accuracy-related penalties as stipulated by the
parties.
FINDINGS OF FACT
Some of the facts are stipulated and are so found. The parties’
stipulations of facts and the attached exhibits are incorporated herein
by this reference. Between 2015 and 2019 (credit years), PDG was
treated as a C corporation for federal tax purposes and had a principal
place of business in Tennessee.
I.

PDG History

To understand PDG and the projects at issue, one must first
appreciate the journey the company’s principals took to become
professional engineers. The path to becoming a professional engineer is
a long and rigorous one. It begins with a four-year course of study
through an accredited engineering program, focusing on principles of
science and math. During this time, the student chooses a specific
discipline such as civil, mechanical, electrical, or biomedical
engineering. Following completion of his undergraduate studies, the
student must take a two-day fundamentals of engineering exam within
the chosen discipline. After passing this exam, the graduate is an
“engineer” but not a “professional.” Training continues with the
aspiring professional engineer serving in an apprentice-like role for four
years under a professional engineer. Thereafter, he may sit for the
professional engineering exam over the course of two days, which again
focuses on his discipline of choice. If successful, he can finally add the
word “professional” to his resume.
So why does someone put in all the work to become a professional
engineer? A professional engineer leads teams that design and maintain
infrastructure that is vital for life and commerce. A professional
engineer is the ultimate authority on building projects with the power
to stamp and approve design documents. This approval signifies that
all requested revisions have been made and the final design satisfies all
requirements of applicable law.
At the beginning of his career, the professional engineer is greatly
involved in the day-to-day activities of design work, using his years of
training. However, as he climbs the corporate ladder, the professional
engineer, who has spent countless years steeped in the intricacies of

3
[*3] engineering, assumes an unfamiliar business and marketing role.
He will go from designing complex fire suppression systems that are
vital for the safety of high-rise building occupants to putting out
mundane human resources fires between employees. He will go from
calculating the appropriate pitch of sewer pipelines to proofreading
marketing pitches. This career path results in the most experienced
professional engineers’ having little to no involvement in the design
process.
Discouraged by this rat race, professional engineer Ross T.
Malloy, along with professional engineers Thomas Fisher and Clyde
Searcy, sought to create an alternative engineering firm, focused on
keeping those with the most experience involved in the design process.
In 1997 they formed PDG, a professional engineering firm that focuses
on designing mechanical, electrical, plumbing, and fire protection
(MEPF) systems in laboratories and hospitals. These MEPF systems
are often not visible to an occupant and are forgotten during the day-today use of a building. However, if one stops working, such as the boiler
system heating the courtroom during the trial for this case, their
importance is clear.
During the research years, PDG’s principals were Ross T. Malloy,
Thomas Fisher, John Wade, Jerry Young, and Brian Moore. They never
sought to be the largest engineering firm; instead, they strived to
distinguish PDG from the field by using senior employees’ experience.
This business strategy succeeded, with PDG developing a reputation
that attracts clients around the country. As a result, PDG does not
dedicate a lot of time to marketing. Instead, it relies on word-of-mouth
endorsements from satisfied customers and architecture firms. PDG is
recognized in the industry as a firm on the forefront of technology with
its engineers frequently speaking at industry-wide conferences to
discuss the revolutionary MEPF systems PDG engineers design.
II.

PDG Disciplines and Organization Structure

It is said that engineers solve problems you did not know you had
in ways you cannot understand. This saying is readily apparent in the
highly complex and technical projects undertaken by PDG. PDG
engineers work within three disciplines: mechanical, electrical, and
plumbing. 2
2 Plumbing engineers are typically engineers with formal training in
mechanical engineering that subsequently specialize in plumbing systems.

4
[*4] We start with a basic discussion of the systems designed by PDG
mechanical engineers that we were able to stitch together from the
discrete presentation of the various components. The mechanical
discipline focuses on customizing heating, ventilation, and air
conditioning (HVAC) systems to meet a client’s specific needs. There
are various customizable components that PDG mechanical engineers
consider in designing an HVAC system, including the air volume, the
components of the air handler, and the distribution of the air around the
building.
One of the first decisions PDG mechanical engineers must make
is whether the HVAC system will be a constant air volume system or a
variable air volume system. In a constant air volume system, a constant
stream of air flows through the system. The airflow in each room cannot
be changed. Instead, to adjust the temperature in each room, a
mechanism located near the room heats the air to raise the temperature
to desired levels. In contrast, a variable air volume system adjusts the
amount of airflow entering each space to control temperature. This
means when an occupant wants a warmer temperature, the HVAC
system will reduce the airflow to that zone.
After determining the type of system, PDG mechanical engineers
begin designing the air handling unit. The air handling unit is the
component of the HVAC system that heats or cools the air by blowing
air across a hot or cold coil with a fan. The air handling unit also
contains filters to purify the air and a mechanism to control the
humidity of the air. There are multiple options for each of these
components. First, PDG mechanical engineers must determine the
source of energy for the coils. For cooling, the coils may be cooled with
chilled water or refrigerant. As air blows over the coil, the liquid inside
the coil heats up and that heat must be removed from the system. This
may be done with a chiller, a cooling tower, or a condensing unit. For
heating, the coils may be heated with steam, hot water, or electricity.
Fan size varies with the pressure required to distribute air
around the building. To determine the appropriate fan size, PDG
mechanical engineers calculate the resistance in the duct system, which
is the measure of the decrease in pressure between the air handling unit
and the room. This calculation is based on the characteristics of the
ducts, including the size and the fittings. The result of this calculation
is the required pressure to move air through the system and determines
the appropriate fan size.

5
[*5] Depending on the needs of the client, PDG mechanical engineers
may add components to the HVAC system. For example, the system
may use a dedicated outside air system to circulate additional fresh air
in the building. There are also various energy-saving components that
may be added to the system.
After the air passes through the air handling unit, the ductwork
designed by PDG mechanical engineers distribute the air around the
building. PDG mechanical engineers focus on the ventilation in the
room and any pressure differential created by the HVAC system. Air is
fed into a room via ducts and discharged from the room via return ducts
or other exhaust points such as fume hoods.
PDG mechanical engineers also design fire prevention systems
that are integrated into the HVAC system. Buildings with high
occupancy are generally required to have fire rated walls that will
prevent fire and smoke from spreading across the building. When
running duct work for an HVAC system, a hole is created in the wall to
allow the ductwork to pass, which compromises the fire rated wall. To
prevent fire and smoke from spreading through the duct work, fire and
smoke dampers are installed, which seals the duct in the event of a fire.
These dampers are required by building code.
We move now to the systems designed by PDG electrical
engineers. The electrical discipline focuses on lighting and electricity,
emergency electricity, and communication systems. PDG electrical
engineers design all electrical systems for the projects from the point at
which the electricity is fed into the building to the outlet used to power
lifesaving or research equipment. PDG electrical engineers work with
utility companies to bring electricity to a project, if required. Once the
electricity is connected to the building, PDG electrical engineers design
switchboards that distribute the electricity to smaller electrical panels
around the building. From the smaller electrical panels, PDG electrical
engineers route wires of varying sizes to access points.
Finally, we conclude with the systems designed by PDG plumbing
engineers. The plumbing discipline focuses on waste piping, fluid
piping, reverse osmosis and distilled water systems, and effluent
disinfecting systems for laboratories. PDG plumbing engineers also
design water-based fire protection systems such as sprinklers.
Each discipline works on the building systems within its
expertise. PDG engineers and support staff are assigned to a specific

6
[*6] discipline and for the most part work exclusively in that discipline.
Within each discipline, there are four types of employees: 3 principals,
senior engineers, engineers, and computer aided design (CAD)
designers. A principal is a professional engineer with a minimum of five
years of experience that is responsible for project management and has
stock ownership. A senior engineer is a professional engineer that does
not have stock ownership. Principals and senior engineers have
supervisory authority and are ultimately responsible for final review
and approval of projects. An engineer is an employee that has an
engineering degree but is ineligible to sit for the professional
engineering exam. Finally, a CAD designer is an employee that has
some technical education but did not complete an accredited engineering
program. The CAD designers create construction drawings and
sketches on computer design software. CAD designers do not design
projects independently but rather do “some legwork” for engineers by
entering marked-up drawings into the computer design software. In
addition to the employees within each discipline, PDG has limited
administrative staff. Ross T. Malloy’s wife, Melanie Malloy, acts as the
bookkeeper, janitor, and receptionist, among other roles within PDG.
Throughout trial, petitioner did not clearly distinguish the work
performed by the various types of engineers. Therefore, we use the term
“engineers” in this Opinion to refer collectively to professional engineers,
senior engineers, and engineers. Petitioner likewise failed to clearly set
forth the work done by the CAD designers. We use the term “PDG
employees” to refer collectively to the engineers and the CAD designers.
III.

PDG Design Process

Generally, an architect engages PDG to design MEPF systems for
a hospital or a laboratory. PDG engineers design these systems against
the backdrop of local building codes. Building codes set forth specific
minimum requirements for how structures and building systems are
constructed to provide a minimum standard to ensure public health,
safety, and welfare. 13 Am. Jur. 2d Buildings § 2 (2024). Building codes
provide standards for structural materials, design and construction
materials, fire protection, health, sanitation, and safety that may vary
with the use of a building. Id. For example, building codes may require
6 air changes per hour in a laboratory and 20 air changes per hour in an

3 This Opinion will use the term “employee” in the colloquial sense and not as
defined in section 3401(c).

7
[*7] operating room. PDG engineers must adhere to the relevant
building codes from initial planning through final inspection.
Petitioner describes PDG engineers’ approach to designing MEPF
systems as a six-stage design process: basis of design, schematic design,
design development, construction documents, bidding, and construction
administration. Petitioner indicated that the design process is not
linear but instead PDG engineers may loop back to previous stages if an
issue is encountered in a later stage.
The first stage is the basis of design. The basis of design phase is
an information gathering stage where the engineers attempt to
determine the design requirements of each project, including the scope
and unique characteristics of the project. The goal of this stage is to
define the client’s objectives and any restrictions that may affect the
design.
The second stage is the schematic design phase. The architect
begins determining the footprint of the building and creates gross block
diagrams. PDG engineers analyze this initial information to estimate
the appropriate MEPF systems and establish contact with utilities to
determine how to connect the building to existing infrastructure. PDG
engineers also provide the architect preliminary locations for the MEPF
systems.
The third stage of the design process is the design development
stage. The design development stage begins with the architect’s
providing PDG with plans that incorporate PDG’s preliminary locations
for the MEPF systems. PDG engineers use this information to
determine the best route for the HVAC system and adjust the MEPF
systems to accommodate any changes to the size of the building. PDG
engineers also work with local zoning authorities to ensure compliance
with any legal requirements. PDG engineers develop alternative
systems and run calculations to ensure feasibility. PDG engineers
convey the alternative systems and suggestions to the architect to
incorporate in the design. The architect or owner determines which
system to incorporate.
The fourth stage is the construction document phase. The owner
determines final equipment selection, such as imaging systems, and
PDG engineers ensure that the MEPF systems can support the
equipment. To make these determinations, PDG engineers rely on cut
sheets provided by the manufacturers, which explain the requirements

8
[*8] of the new equipment. PDG mechanical engineers run final load
calculations to ensure the HVAC system can properly serve the building.
PDG electrical engineers design the lighting systems in the building. At
the conclusion of this phase, PDG produces the construction documents
that contractors will use in construction and code officials will review for
compliance. PDG professional engineers stamp these documents as a
final product.
Next is the bidding stage. The owner or architect solicits bids
from construction contractors to complete the work. The building owner
may request that PDG revise the design plan to minimize costs.
The final stage is construction administration, in which the actual
construction of the building begins. At the beginning of this stage, PDG
engineers review shop drawings from contractors, which set forth the
equipment they plan to use. PDG engineers review the shop drawings
to ensure that the contractor complied with the construction documents
and that PDG engineers made no mistakes in the construction
documents. PDG engineers sometimes recorded this work as a separate
stage from construction administration.
PDG engineers also make site visits to determine compliance with
the construction documents. PDG engineers prepare a report on any
errors they encounter. Throughout this process, contractors will send
PDG requests for information. These requests for information flag
conflicts in the construction documents and request PDG engineers’
input on alternatives. The owner may also request changes to the design
based on shifting business needs.
During the research years, PDG employees generally recorded
their time by discipline and stage of the design process. PDG employees
recorded their time spent in hourly increments on projects through
Azero (hour sheets). The hour sheets were not used to bill clients but
were instead an internal metric to measure employee performance.
Each project had a unique project number assigned, and employees
recorded time to the specific project number. Each time that the scope
of the project expanded, PDG created a derivative project number from
the main project. Employees were instructed to record time separately
to the main project number and the derivative numbers. 4 Once a
particular design phase was completed, an employee could not go back
4 It appears that employees generally followed this instruction. However, the
hour sheets that petitioner provided for the main project numbers contain some entries
associated with the derivative project numbers.

9
[*9] and add time to that phase. For each increment of time, an
employee included a short narrative description of his work.
IV.

alliantgroup Study

On February 1, 2017, Melanie Malloy executed an engagement
letter on petitioner’s behalf with alliantgroup, a tax consulting and
lobbying firm, to conduct a section 41 research credit study. Petitioner
provided documentation on all projects undertaken between 2012 and
2016, and alliantgroup identified 419 possible projects that qualified for
research credits. From this group, alliantgroup removed all projects
known not to contain qualifying activities and de minimis projects,
which reduced the total possible projects to 238. alliantgroup conducted
an analysis of a sample of these projects and issued a report to
petitioner.
V.

Amended Returns and Audit

On the basis of the alliantgroup reports, petitioner amended its
2014 through 2016 tax returns to claim the research credits. Petitioner
did not amend its 2013 tax return. Rather on its amended 2014 tax
return, petitioner included the credits allocable to 2013 on line 4 of Form
3800, General Business Credit, as a carryforward of a general business
credit to 2014. 5 Petitioner claimed the following research credits per
year: 6

5 It appears petitioner did not properly claim the credit for the 2013 tax year
on its 2014 tax return. However, petitioner raised this issue in its petition, and we
have jurisdiction over this claimed credit because it relates to the determination of the
correct tax liability for the credit years. See § 6214(b) (allowing us to “consider such
facts with relation to the taxes for other years or calendar quarters as may be necessary
correctly to redetermine the amount of such deficiency”); Brock v. Commissioner, T.C.
Memo. 1982-335, 1982 WL 10645 (holding that the Court had jurisdiction to consider
facts related to prior years to determine the proper amount of credit carryforward); see
also Noell v. Commissioner, 66 T.C. 718, 727 (1976) (considering a tax credit raised for
the first time at trial); Norwest Corp. & Affiliated Cos. v. Commissioner, T.C. Memo.
1992-282 (considering a tax credit first raised in a petition), aff’d, 69 F.3d 1404 (8th
Cir. 1995).
6 All numbers are rounded to the nearest whole number.

10
[*10]

Tax Year

Research Credit Claimed

2013

$138,205

2014

158,031

2015

138,334

2016

128,228

The research credits are attributable solely to wages paid to
PDG’s employees. Petitioner used the research credits during the credit
years as follows:
Tax Year

Research Credit Claimed

2015

$110,576

2016

74,488

2017

211,142

2018

68,147

2019

71,102

Respondent selected petitioner’s tax returns for 2015 through
2019 for examination. On December 14, 2021, respondent issued a
notice of deficiency to petitioner, disallowing the research credits and
determining the following deficiencies and accuracy-related penalties:
Tax Year

Deficiency

Accuracy-Related
Penalty

2015

$55,504

$11,101

2016

47,811

9,021

2017

219,177

43,835

2018

68,147

13,629

2019

71,102

14,220

Petitioner timely petitioned this Court for redetermination of the
deficiencies and penalties.
VI.

Research Projects

Given the number of projects for which petitioner claimed
research credits, the parties agreed to try a sample of three research
projects (trial projects). Our conclusions with respect to these trial
projects are not binding as to the remaining research projects. Rather,

11
[*11] it is the Court’s expectation that this decision will enable the
parties to mutually resolve the credits for the remaining research
projects. See Little Sandy Coal Co. v. Commissioner, T.C. Memo. 202115, at *20, aff’d, 62 F.4th 287 (7th Cir. 2023). The parties selected the
following three projects for trial: (1) Gerald Champion Military
Psychiatric Unit (Gerald Champion), project No. 13008.00; (2) Baptist
Memorial Health North Mississippi Oxford (BHNM Oxford), project No.
13003.00; and (3) Vanderbilt University Engineering and Science
Building (VU ESB), project No. 12010.01. 7
The parties further narrowed the scope of trial to the
determination of whether these projects entailed qualified research and
not the amounts of qualified research expenses. Additionally, the
parties stipulated that if we determine that none of the trial projects
involved qualified research, petitioner will be liable for an accuracyrelated penalty for each of the credit years in which there is a deficiency
determined by the Court or by agreement of the parties. However, if we
determine that one or more of the trial projects involved qualified
research, respondent concedes that petitioner is not liable for accuracyrelated penalties for any of the credit years.
A.

Gerald Champion, Project No. 13008.00

Gerald Champion Regional Medical Center contracted
architecture firm Ascension Group Architects, LLP, for two projects:
(1) a geropsychiatric and military psychiatric renovation and new
construction and (2) a catheterization laboratory infill. 8 As to the first

7 Petitioner contends in its posttrial brief that the Court should expand the

scope of the stipulation to all projects at a given location. For example, Gerald
Champion is project No. 13008.00. The related catheterization laboratory is assigned
project No. 13008.01. Petitioner contends both of those projects should be considered
part of the trial; whereas respondent argues the parties tried only project No. 13008.00.
Because the parties agreed to the specific project numbers in both stipulations related
to the scope of trial, we will limit our review to the project numbers specified in the
stipulations as listed above. Petitioner’s argument to expand the scope of trial directly
conflicts with the representation that employees billed times to the appropriate project
number. Petitioner did not provide hour sheets related to the derivative project
numbers.
Petitioner did not provide a project description for each project number and
derivative project number. Therefore, we have used the titles of the projects and the
hour sheets related to the primary project number to discern the scope of the projects
at issue.
8 The catheterization laboratory is beyond the scope of this trial.

12
[*12] project, the renovations occurred in two existing wings in the
hospital and included a small addition.
On July 23, 2013, PDG and Ascension Group Architects, LLP,
entered a service contract related to these projects. Specifically, PDG
was engaged to design and update the MEPF systems within the
renovation and addition area. Gerald Champion Regional Medical
Center sought to retain as much of the existing systems as possible to
reduce costs. PDG agreed to a fixed compensation of $90,000, which
would be paid at the completion of specified milestones in the design and
construction process.
Gerald Champion initially provided PDG
engineers with existing schematic design documents from previous
engineering firms, a gross block diagram, and historic data that would
allow sizing of equipment.
Petitioner did not identify the final construction documents it
provided to Ascension Group Architects, LLP. The record contains a
series of design drawings dated September 26, 2013, that appear to set
forth a nearly complete plan for the MEPF systems. On the same day,
PDG engineers also delivered a project manual for the renovation. PDG
engineers periodically revised the designs and issued new design
drawings. However, petitioner did not explain why or how the revisions
were made.
PDG’s employees recorded time to the Gerald Champion project
under at least three distinct project numbers, including separate project
numbers for the catheterization laboratory and military behavioral
health wing. 9 As established above, the scope of the trial is confined to
project No. 13008.00, which is described as “Gerald Champion Military
Psychiatry Unit.” To act as engineers of record on the final project, PDG
engineers had to ensure that any retained MEPF systems complied with
relevant building codes.
1.

Mechanical Systems

Gerald Champion Regional Medical Center wanted to use its
existing HVAC system to support the renovations and the addition. To
determine the feasibility of this request, PDG mechanical engineers
reviewed the existing drawings and systems during the design
9 The projects include Gerald Champion Military Psychiatry Unit, project No.
13008.00; Gerald Champion Cath Lab, project No. 13008.01; and Gerald Champion
Cath Lab Revisions, project No. 13008.02. We have disregarded all evidence to the
extent it does not relate to Gerald Champion Military Psychiatry Unit.

13
[*13] development phase. PDG mechanical engineers determined that
the existing HVAC system was installed in accordance with the original
plan documents but found major flaws in the design. The original
engineers failed to account for the elevation of the hospital in designing
the existing HVAC system, which affects the required airflow to reach a
desired temperature. After calculating the heating and cooling loads of
the spaces, PDG mechanical engineers “analyzed” the existing HVAC
system and determined that it could support the renovation but not the
small addition. Therefore, PDG mechanical engineers designed a new
air handling system to serve the addition.
PDG mechanical engineers considered whether the system should
be a constant air volume system or a variable air volume system. PDG
mechanical engineers selected the variable air volume system because
of the need for individual temperature control in the rooms.
As for the energy source to cool the coils, PDG mechanical
engineers considered whether to use chilled water supplied from the
hospital’s central plant or to design a standalone refrigeration system
for the unit. PDG mechanical engineers performed some calculations
that determined that the existing plumbing was insufficient to serve the
new air handling system, and thus they selected a local system.
Relatedly, PDG mechanical engineers designed a method to reject the
excess heat from the cooling system. PDG mechanical engineers
determined that it was not cost efficient to connect to the hospital-wide
refrigerant system that was located on the opposite side of the building.
Therefore, PDG mechanical engineers selected a local condensing unit
that would sit outside and reject the excess heat into the environment.
As for the energy source to heat the coils, PDG mechanical engineers
determined that the existing piping distribution was sufficient to serve
the new air handling unit. To make this determination, PDG
mechanical engineers calculated the amount by which the water
pressure dropped between the central plant and the addition. PDG
mechanical engineers performed static pressure calculations during the
construction document phase to determine the appropriate fan size for
the HVAC system.
After making these determinations, PDG mechanical engineers
identified the addition’s heating and cooling requirements, the range of
possible temperatures, and the filtration requirements of the new
system. Using this information, PDG mechanical engineers selected an
appropriate air handling unit from a commercial producer. At this
point, PDG mechanical engineers provided the architect with an

14
[*14] estimated size of the HVAC system. It was uncertain to this point
whether the equipment would be housed in a mechanical room or on the
roof. PDG mechanical engineers indicated their preference for a rooftop
system, but the architect rejected this option because of aesthetic
concerns. The architect approved placing the unit indoors but requested
that the mechanical room be as small as possible. PDG mechanical
engineers collaborated with the manufacturer to reduce the footprint of
the unit by splitting the equipment over two levels.
In addition to the technical HVAC design, PDG mechanical
engineers also had to ensure that the HVAC system complied with
precautions taken for psychiatric patients.
Specifically for the
mechanical engineers, this included using tamper resistant fasteners
that could not be unscrewed with a coin and restricting access to
thermostats. These precautions also limited the choice of equipment for
the system. For example, PDG considered adding a dedicated outside
air system to circulate fresh air into the building that would require a
portion of the system to be housed in patient rooms. This posed an
additional risk to the patients, and consequently, PDG mechanical
engineers rejected this idea.
During the construction administration phase, PDG mechanical
engineers also discovered new information. For example, during a site
visit, PDG mechanical engineers determined that the windows became
incredibly warm during the day. PDG mechanical engineers reran
heating and cooling load calculations to ensure the HVAC system could
compensate for this new variable and found that it could.
2.

Electrical Systems

As with the mechanical engineers, PDG electrical engineers
began work on the project by evaluating the systems currently in place.
PDG electrical engineers determined that the electrical panels were full
and could not support the renovation. They designed new electrical
panels that allowed the project to be completed in phases while patients
were on site. They also had to add another electrical panel to supply a
new information technology room.
3.

Plumbing Systems

Petitioner presented little evidence to show the work PDG
plumbing engineers performed for Gerald Champion. The sole issue
mentioned at trial was the need to design the patient-facing systems in
a way that was safe for psychiatric patients, such as slanting piping. In

15
[*15] other parts of the record, we see design drawings that appear to
show revisions to the plumbing systems, equipment selection
information and emails, and requests for information. Petitioner did not
provide any further information regarding the design decisions or the
revisions.
4.

Employee Time

PDG employees recorded a total time of 487 hours on the Gerald
Champion project. The mechanical discipline recorded 170 hours, the
electrical discipline recorded 180 hours, and the plumbing discipline
recorded 137 hours. CAD designers recorded 143 hours, broken down
by discipline as follows: 60 hours for mechanical, 52 hours for electrical,
and 31 hours for plumbing.
B.

BHNM Oxford, Project No. 13003.00

Baptist Memorial Health Care Corp. (Baptist Memorial)
contracted architecture firm Earl Swensson Associates, Inc. (Earl
Swensson), to design a new hospital to replace its current hospital. On
June 2, 2011, PDG and Earl Swensson entered into a service contract
related to this project. Specifically, Earl Swensson engaged PDG to
design the MEPF systems.
PDG agreed to a fee of 1.3% of the building’s construction cost.
This fee was payable at the completion of specific milestones in the
design and construction process. PDG’s employees recorded time to this
project solely under project No. 13003.00. Having operated several
hospitals, Baptist Memorial was familiar with the MEPF systems
required for hospitals and had strong equipment preferences.
At the start of the project, Earl Swensson provided petitioner with
floor diagrams and a preliminary master plan. Petitioner did not
identify the final construction documents it provided to Earl Swensson.
The record contains a series of design drawings dated December 15,
2014, that appear to set forth a nearly completed plan for the MEPF
systems. PDG engineers periodically revised the designs and issued
new design drawings. However, petitioner did not explain why or how
the revisions were made.
1.

Mechanical Systems

The BHNM Oxford project called for the design of a large hospital
with varying climate needs for each department. For example, the

16
[*16] surgical unit had to be cooled to 62 degrees. Because of the
varying needs of the hospital, the mechanical engineers determined that
the HVAC system should have multiple air handling units. PDG
mechanical engineers collaborated with a manufacturer that Baptist
Memorial designated to design custom air handling units for critical
areas: surgery, emergency, intensive care, imaging, and roof. For the
remaining air handling units, PDG mechanical engineers selected
conventional units designed by the manufacturer. The air handling unit
for the surgical area contained a secondary coil to ensure temperature
requirements could be met.
With several air handling units set to service the hospital, PDG
mechanical engineers had to determine the appropriate location of each
unit. PDG mechanical engineers first considered placing a mechanical
room at the end of each wing to house the air handling units. However,
Baptist Memorial rejected this option because it would take revenuegenerating space from the hospital. PDG mechanical engineers
redesigned the system to place the air handling units on the end of the
roof of each wing.
As for the source to cool the coils, Baptist Memorial indicated that
it wanted to use chilled water. To chill the water, Baptist Memorial
selected a centrifugal chiller compressor to provide refrigerant to the air
conditioning system. Baptist Memorial also set forth their preference
for a specific manufacturer, required levels of redundancies, and how
the chillers should be piped. PDG mechanical engineers designed the
piping configuration between the centrifugal chiller compressor and the
air handling units.
As for the source to heat the coils, PDG mechanical engineers
selected steam because it could serve multiple purposes. In addition to
heating the coils, the selected steam system could be used to sterilize
surgical instruments. Next, PDG mechanical engineers considered
whether the steam should be provided by local generators or at a central
steam plant. They selected a central steam plant that could service both
the heating and sterilization systems. They used heat exchangers on
the steam plant to heat water that would be used to heat the building.
They designed a complex three-boiler system to distribute heat
throughout the building and provide steam for sterilization.
Baptist Memorial indicated that it wanted a backup fuel system
to provide emergency power to the boiler system. PDG mechanical
engineers designed tanks to hold the backup fuel after Baptist Memorial

17
[*17] specified that the tanks should be above ground. PDG mechanical
engineers had to ensure the tanks could withstand earthquakes and
that the fuel stored inside would not become contaminated over time.
PDG mechanical engineers also had to comply with the local
building code regarding airflow requirements. Airflow was particularly
relevant for the hybrid operating room, which would include both
imaging equipment and operating room capabilities within a sterile
environment. Operating rooms, whether traditional or hybrid, require
very slow air to flow that does not spiral where the table is positioned.
Typically, an operating room table is in a fixed location in the room. In
contrast, the hybrid operating room was designed to allow the operating
staff to move the bed to several configurations, which affected the design
of the diffusers needed to create the required airflow. PDG mechanical
engineers designed the layout with various diffusers positioned
throughout the room to create a sterile field regardless of the orientation
of the bed.
2.

Electrical Systems

PDG electrical engineers began work on the BHNM Oxford
project by estimating the electrical needs for the various zones of the
hospital. The PDG electrical engineers then met with the utility
company, North East Mississippi Electric Power Co. (North Power), to
determine how to supply electricity to the new building. Baptist
Memorial requested that the hospital be connected to two substations in
case one substation was taken offline.
PDG electrical engineers worked with North Power to run
electricity from two substations to the hospital in a configuration that
allowed for subsequent development.
North Power provided
recommendations and alternatives on how to run the electricity lines to
the campus and the switch that would allow the hospital to be fed by the
two substations.
PDG electrical engineers communicated this
information to Baptist Memorial, and Baptist Memorial made the
ultimate decision.
Once North Power determined the route for the electric, PDG
electrical engineers had to determine how to distribute it across the
building. PDG electrical engineers estimated a large electric load would
be required for the building. To accommodate this load, PDG electrical
engineers informed the architect that they would require multiple
switchboards to distribute the electricity and the estimated size of the

18
[*18] electrical rooms needed to store this equipment. PDG electrical
engineers initially designed multiple electrical rooms to serve the
building but reduced the number at the request of Baptist Memorial.
PDG calculated the number of electrical panels required for distribution
on the basis of estimated demands of the system. As the project
progressed, the electrical demands often changed. For example, the
hospital purchased a different piece of imaging equipment and PDG
electrical engineers had to review the information provided by the
manufacturer to determine whether the current design could support
the new equipment.
The operating rooms provided an additional challenge in that the
building code required isolated power. This required an isolated power
pad, which alerts medical staff if there is a surplus of voltage that could
harm the patient. PDG electrical engineers included this in the design.
Baptist Memorial also requested that PDG electrical engineers
use a Powerwave Bus System to power the information technology
center. PDG electrical engineers met with the vender to understand
how this system worked. PDG electrical engineers then consulted with
Baptist Memorial to determine the equipment that would be housed in
the information technology room. Along with the mechanical engineers
that were responsible for cooling the room, the electrical engineers
determined the configuration of the equipment. The manufacturer then
built systems to meet the expected demand.
3.

Plumbing Systems

Petitioner presented little evidence to show the work PDG
plumbing engineers performed for BHNM Oxford. In the record we see
design drawings that appear to show revisions in the plumbing systems
and equipment selection information. Petitioner did not provide any
further information regarding the design decisions or the revisions.
4.

Employee Time

PDG employees recorded a total time of 16,650 hours on the
BHNM Oxford project. The mechanical discipline recorded 5,941 hours,
the electrical discipline recorded 5,876 hours, and the plumbing
discipline recorded 4,333 hours. The remaining 501 hours were recorded
to specific phases of the project without a specified discipline. CAD
designers recorded 2,118 hours, broken down by discipline as follows:
261 hours for mechanical, 947 hours for electrical, 909 hours for

19
[*19] plumbing, and 1 hour to construction administration without a
specified discipline.
C.

VU ESB, Project No. 12010.01

Vanderbilt University contracted architecture firm Wilson
Architects, Inc. (Wilson Architects), to design an engineering and
science building (TEAM building). Vanderbilt University intended the
new building to be an interdisciplinary research building for the school
of engineering and medical center that would house research
laboratories, faculty offices, conference facilities, a cleanroom, imaging
facilities, and a vivarium. On July 17, 2013, PDG and Wilson Architects
entered a service contract for PDG to design the MEPF systems and
telecommunication systems for the TEAM building. Specifically, PDG’s
services included (1) designing MEPF systems that meet the
requirements for LEED Silver certification and (2) consulting with the
cleanroom contractor to determine which utilities are needed for the
cleanroom.
PDG engineers completed their work through the design
development phase when the medical center pulled out of the joint
venture. Vanderbilt University stopped all work on the project until it
could determine how the project would continue. The university decided
to continue the design and construction of the building but modified the
plans to fit only its needs. Vanderbilt University decided to remove the
biomedical portions of the design plan, including reducing the number
of laboratories and deleting the vivarium. It also reduced the size of the
building. Vanderbilt University retained the cleanroom and imaging
facility.
On January 1, 2014, Vanderbilt University and Wilson Architects
entered into a new contract related to the shifting scope. Under this
new contract, Wilson Architects was to design and construct an
engineering and science building. The new building would have five
above-ground floors that would house research labs and community
spaces. The building would also house a 10,000-square-foot clean room
on the ground floor. Two floors below the ground level would house
classrooms and imaging areas containing nanoscale and atomic-level
microscopes.
PDG executed a new contract with Wilson Architects on
September 29, 2015, to design the MEPF and telecommunication
systems for the new project. Specifically, PDG’s services included

20
[*20] (1) revising the systems for the reconfigured building and
(2) reselecting the required equipment. In addition to PDG, Wilson
Architects contracted a specific engineering firm that specialized in
cleanroom mechanical, electrical, and plumbing systems. Because
previous work had been done for the combined engineering and medical
building, PDG was contracted to start at the design development phase
of the project. PDG agreed to a fixed fee of $1,758,500 for this project to
be paid at specific milestones in the project.
PDG engineers submitted the stamped final construction
documents to Wilson Architects. These construction documents set forth
the MEPF systems designs by floor, including the exhaust systems,
electricity distribution, and mechanical equipment. These documents
were subsequently revised, but petitioner did not explain the revisions
and we are unable to derive meaning from the design drawings.
PDG’s employees recorded time to this project under at least 18
distinct project numbers, including separate project numbers for
laboratory revisions, the chilled water tie-in, and the steam line
relocation. 10 As established above, the scope of the trial is confined to
project No. 12010.01, which is described as “VU ESB (Olin Hall).” PDG’s
employees recorded time to this project in years 2013 through 2017.
PDG represents that the work completed on the TEAM building with
the medical center was not recorded to project No. 12010.01.
1.

Mechanical Systems

PDG mechanical engineers were tasked with designing an HVAC
system that could accommodate the varying uses of the building and
achieve at least an LEED Silver certification. PDG mechanical
10 The projects include: VU ESB (Olin Hall), project No. 12010.01; VU ESB –

Central Plant Chilled Water, project No. 12010.02; VU ESB 3rd & 4th Floor Redesign,
project No. 12010.03; VU ESB – Olin Steam Line – Relocation, project No. 12010.04;
VU ESB – LEED Forms Additional Service, project No. 12010.05; VU – ESB – RFP
#25 Innov Ct Changes, project No. 12010.06; VU ESB – Add Third Chiller & Olin Hall,
project No. 12010.07; VU ESB – AV Revisions, project No. 12010.09; VU ESB – Roof
Terrace Revision, project No. 12010.10; VU ESB Campus Chilled Water Tie-ins, project
No. 12010.11; VU ESB 2nd Fl Server Room/IT RFP 53, project No. 12010.12; VU ESB
– CNC Laser Cutter Fitout, project No. 12010.13; VU ESB – Animal Holding, project
No. 12010.14; VU ESB – 4th Floor Revisions 2016, project No. 12010.15; VU ESB Bus
Stop Duct Bank/Light Pole, project No. 12010.16; VU ESB Bardham Lab Olin Hall,
project No. 12010.17; VU ESB – Lab 343 Buildout for Pint, project No. 12010.18; and
VU ESB – Art Work Additional Lighting, project No. 12010.19. We have disregarded
all evidence to the extent it does not relate to project No. 12010.01.

21
[*21] engineers ran heating and cooling loads throughout the design
process to account for changes in the design plans, such as changing
window sizes. In addition to calculating the heating and cooling loads,
PDG mechanical engineers made recommendations to limit the demand
on the heating and cooling systems, such as glazing the windows to
prevent heat transfer.
In considering how to achieve the LEED Silver certification, PDG
mechanical engineers contemplated whether to use water or air systems
to cool and heat the building. PDG mechanical engineers selected a
hybrid system, which would increase efficiency to help meet LEED
Silver certification. As for the source of cooling for the coils and water
system, PDG mechanical engineers selected a building chiller. 11 The
building chiller system is a large draw on electricity that could affect the
building’s qualification for LEED certification. To determine the design
of the building chiller system, PDG mechanical engineers modeled units
from three different manufacturers to determine which unit had the
lowest operating cost in peak and part load performance. PDG
mechanical engineers determined that it would use two chillers with one
on standby to service the building. 12 PDG mechanical engineers created
a control system to ensure the chillers functioned as one unit. PDG
mechanical engineers worked on the chiller system from the design
development phase to the construction document phase.
As for the source of heating for the coils and water system,
Vanderbilt University has a campus-wide steam distribution system.
The distribution system is contained in a “mole hole” 100 feet below
ground. Inside the mole hole is a pipe that carries high pressure steam
around campus. PDG mechanical engineers designed a piping system
to connect the science building to the steam distribution system. 13 In
making this design, PDG mechanical engineers had to account for the
11 In its posttrial brief petitioner categorizes this design as falling under the

plumbing discipline. However, the referenced exhibit is a mechanical engineering
diagram, and time spent on this project was billed to the mechanical discipline.
Therefore, we will treat this design challenge as falling under the mechanical
discipline.
12 PDG engineers also designed a backup system using the campus chilled
water system, but that is beyond the scope of the current trial.

13 In its posttrial brief petitioner categorizes this design as falling under the
plumbing discipline. However, the referenced exhibit is a mechanical engineering
diagram, and time spent on this project was billed to the mechanical discipline.
Therefore, we will treat this design challenge as falling under the mechanical
discipline.

22
[*22] effect of the steam on the piping. The steam from the steam
distribution system is over 400 degrees. In contrast, the ground
temperature in the area that would house the pipes connecting the
steam distribution system to the VU ESB project would be
approximately 50 degrees. When the hot steam entered the pipe, it
would cause the pipes to expand and contract because of the change in
temperature. If PDG mechanical engineers did not account for this
expansion, the pipe would rupture.
To determine the rate of expansion or stress on the system, PDG
mechanical engineers initially hand drafted a design for the pipe and
created computer models. They then calculated the force that would be
on the pipe between the point of connection to the steam distribution
system and the VU ESB project. After coming up with an initial design,
PDG mechanical engineers entered the information into pipe stress
analysis software. This analysis flagged the points on the pipe where
the stress had to be mitigated to prevent rupture. PDG mechanical
engineers then introduced elbows, expansion bellows, and different
configurations to reduce stress on certain points of the pipe. After
making these edits, PDG mechanical engineers ran the program again
and continued this process until there were no ruptures. PDG
mechanical engineers reran the program during the construction
administration phase because the contractor could not build the pipe in
the exact location specified in the construction documents. 14
PDG mechanical engineers designed a two-story penthouse to
house the air handlers, chillers, pumps, and exhaust ducts. They
determined the layout of the penthouse but did not specify how the
components would be hung in the penthouse. The contractor came up
with a solution to provide intermediate supports rather than hanging
the piping from the ceiling.
As discussed above, once the air is chilled or heated, it is
distributed around the building via duct work and return air is
circulated out of the space. Because of the research performed in the
laboratories, the VU ESB project had additional exhaust sources from
each room. The third and fourth floors of the science building were
designed as research laboratories. Laboratories are either dry or wet.
A wet laboratory is one that contains biological or hazardous materials
14 PDG mechanical engineers also designed a mechanism to connect the old
engineering building to the VU ESB with a valve that allowed steam to travel in two
directions. This project is beyond the scope of this trial.

23
[*23] that require a fume hood. At the start of the design, Vanderbilt
University was not certain as to which researchers would be assigned to
each laboratory.
Because of this uncertainty, PDG mechanical
engineers designed each laboratory with one fume hood that would allow
each room to operate as either a wet or a dry laboratory. This was an
additional exhaust point that had to be accounted for in the design of
the HVAC system and would make the system less energy efficient. 15
PDG mechanical engineers designed a system that captured energy
from exhaust air when most of the fume hoods were not in use.
PDG mechanical engineers routed the exhausts from the
laboratories to the roof of the science building. The VU ESB project was
located among other university buildings, so there was concern about
the fallout of particles discharged from the fume hoods on adjacent
buildings. PDG mechanical engineers had to determine the proper
height of the plume exhaust system that was located on the roof and the
required fan strength to minimize fallout on adjacent buildings. They
considered two options for the plume system: one with two stacked fans
and one with a single stronger fan. They determined that the single-fan
option would not propel the air high enough to get the required
distribution, so the engineers selected the two-fan system.
PDG mechanical engineers were also particularly concerned with
airflow and pressure relationships. The work occurring in several of the
rooms was particularly sensitive to slight air disturbances. For
example, the imaging facility contained a Krios microscope that could be
used to examine atoms. This process was extremely sensitive to slight
disturbances, which would distort the images. PDG mechanical
engineers considered this sensitivity in designing the HVAC system for
this area because any airflow in the room could result in distortion.
They determined that the vent locations for the HVAC system should be
placed at the periphery of the space and the researchers would need the
ability to turn off the system during research.
In addition to airflow concerns, the pressure relationship between
the various rooms affected the design of the HVAC system. Both the
imaging room and the cleanroom required particular attention to
pressure differentials. To prevent disruption of the work in the imaging
facility, PDG mechanical engineers designed the HVAC system such
that the pressure in the imaging facility was greater than in the
15 The laboratories were then further customized as the university assigned
researchers to each space, but the redesign exceeds the scope of the trial project.

24
[*24] surrounding areas. This would ensure that when the doors were
open, air would blow out of the imaging facility and prevent dust from
entering the room. Likewise, the HVAC system for the cleanroom had
to be designed to achieve a particular pressure relationship on the
account of the biohazardous materials and hazardous chemicals studied
there.
In addition to designing the HVAC system, PDG mechanical
engineers designed smoke and fire dampers to work with the HVAC
system. One area that presented a particular challenge was the clean
room. PDG determined that traditional smoke and fire dampers would
be dangerous because the exhausts expelled air at a high rate to counter
the harsh chemicals used in the room and could not be turned off. If a
fire or smoke damper was triggered, it would cut off the makeup air
supply that compensates for the high exhaust rate, which would suck
the oxygen from the room. The imbalance in pressure would also result
in occupants’ being unable to open any outward opening doors. After
determining that their initial design led to these safety concerns, PDG
mechanical engineers considered alternative designs but did not find a
solution. PDG mechanical engineers obtained an exception from the
local authorities to not install the smoke and fire dampers in the
cleanroom.
In relation to fire prevention for the HVAC system, Vanderbilt
University requested that PDG design the system so that it could be
tested without disturbing research.
PDG mechanical engineers
discovered a vendor they had not used before that offered dampers that
could be tested from a centralized control panel without visual
inspection. They integrated this damper system into the existing design
for the fire alarm system.
2.

Electrical Systems

As with the other projects, PDG electrical engineers began the
project by determining the building’s estimated load using software that
based energy demand on square footage. Instead of using generic
laboratory estimates, Vanderbilt University and PDG electrical
engineers determined the average energy consumption of other
laboratory buildings on campus. PDG electrical engineers then worked
with Vanderbilt University to determine how to convey the electricity
from the campus distribution system to the VU ESB project. PDG
electrical engineers routed the electricity around the building, ensuring
that the requirements of each laboratory were met. This included

25
[*25] ensuring that the system could satisfy the high electrical demand
of the cleanroom.
Vanderbilt University also requested emergency electricity in the
building. Because of the large electrical demands of the building and
limited space, PDG electrical engineers determined that the backup
generators should be located on the VU ESB’s roof. Additionally, PDG
electrical engineers accounted for electromagnetic interference from all
of the electrical wires providing electricity to the cleanroom that would
disrupt the sensitive research equipment. To prevent this interference,
PDG electrical engineers insulated the wires.
3.

Plumbing Systems

Petitioner presented little evidence to show the work PDG
plumbing engineers performed for the VU ESB project. In the record we
see design drawings that appear to show revisions to the plumbing
systems and unexplained calculations. Petitioner did not provide any
further information regarding the design decisions or the revisions.
4.

Employee Time

PDG employees recorded a total time of 12,671 hours on the VU
ESB project between 2013 and 2017. 16 The mechanical discipline
recorded 3,862 hours, the electrical discipline recorded 4,086 hours, and
the plumbing discipline recorded 1,801 hours. The remaining 2,924
hours were recorded to specific phases of the project without a specified
discipline. CAD designers recorded 3,515 hours, broken down by
discipline as follows: 1,574 hours for mechanical, 1,466 hours for
electrical, 473 hours for plumbing, and 2 hours to project management
without a specified discipline.
OPINION
I.

Burden of Proof

The Commissioner’s determinations set forth in a notice of
deficiency are generally presumed correct, and the taxpayer bears the
burden of proving the determinations are in error. See Rule 142(a)(1);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Credits are a matter of
legislative grace, and taxpayers must demonstrate their entitlement to
16 The hour sheets contained entries from 2017; however, petitioner claimed
research credits only between 2013 and 2016.

26
[*26] credits claimed. See Feigh v. Commissioner, 152 T.C. 267, 270
(2019) (citing INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)).
Petitioner does not contend, and the evidence does not establish, that
the burden of proof shifts to respondent under section 7491(a) as to any
issue of fact.
II.

Section 41 Research Credit
A.

Basic Structure

Section 38(a) permits a taxpayer to claim on its return a credit
against tax equal to the sum of (1) business credits carried forward to
the tax year, (2) current year business credits, and (3) business credits
carried back to the tax year. Current year business credits include the
credit under section 41 for increasing research activities. § 38(b)(4).
Section 41(a)(1) provides that the research credit is equal to 20%
of the excess of the taxpayer’s qualified research expenses (QREs) over
the base amount. 17 QREs are limited to the amounts “paid or incurred
by the taxpayer during the taxable year in carrying on any trade or
business.” 18 §§ 41(b)(1), 7701(a)(25). QREs comprise in-house research
expenses and contract research expenses. § 41(b)(1). In-house research
expenses are (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.”
§ 41(b)(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 qualified research. § 41(b)(2)(B). Direct
support of qualified research includes direct support of either the person
engaging in qualified research or the person directly supervising the
qualified research. Treas. Reg. § 1.41-2(c)(3). Generally, wages are
considered in-house research expenses to the extent that the wages were
paid for qualified services. § 41(b)(2)(A)(i). If at least 80% of the services
an employee performs are qualified services, a taxpayer may include
100% of the wages paid to the employee as in-house research expenses.
Treas. Reg. § 1.41-2(d)(2).

17 Respondent conceded the issue of petitioner’s base amount; therefore, we
need not address it further.
18 Petitioner is a cash method taxpayer. A cash method taxpayer takes liability
into account when the expenditure is actually paid. § 446; Treas. Reg. § 1.446-1(c)(1)(i).

27
[*27] B.

Qualified Research

To constitute qualified research, the research must satisfy a fourpart 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).
The four-part statutory test is applied separately to each business
component. § 41(d)(2)(A). A business component is defined in relevant
part as a product that the taxpayer either (1) holds for sale, lease, or
license or (2) uses in its trade or business. § 41(d)(2)(B). For each trial
project, petitioner claims that the mechanical, electrical, and plumbing
systems together—the MEPF systems as a whole—represent the
business component.
Respondent concedes the technological
information test and the business component test. We now examine the
remaining portions of the four-part statutory test: the section 174 test
and the process of experimentation test. 19
1.

The Section 174 Test

The first requirement is that the research must be research “with
respect to which expenditures may be treated as expenses under

19 In addition to the four-part statutory test, section 41(d)(4) excludes certain
activities from the definition of qualified research. We need not consider these
excluded activities for purposes of deciding this case.

28
[*28] section 174.” § 41(d)(1)(A). 20 We refer to this as the “section 174
test,” whereby the taxpayer 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. &
Subs., 110 T.C. at 491. For tax years ending after July 21, 2014, if we
conclude that the taxpayer fails the section 174 test at “the level of a
product” as a whole, the taxpayer may still satisfy the test “at the level
of the component or subcomponent.” Treas. Reg. § 1.174-2(a)(5). 21
For background, section 174 operates as a narrow, elective
exception to the general capitalization rules. §§ 174(a), 263(a)(1),
263A(c)(2). Section 174(a) allows a taxpayer to elect a current deduction
for research and expenditures which are paid by the taxpayer during the
taxable year in connection with the taxpayer’s trade or business. 22 See
also Treas. Reg. § 1.174-1. Research and experimental expenditures are
research and development costs in the experimental or laboratory sense
and generally include all costs incident to the development or
improvement of a product. Treas. Reg. § 1.174-2(a)(1).
We apply a two-step test to determine whether a taxpayer’s
activities constituted research and development within the meaning of
section 174. In the first step the taxpayer must show that the
information objectively available to it did not establish 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 such information was not
available to the taxpayer with respect to establishing either the
capability, method, or appropriate design, then uncertainty existed. See
Union Carbide Corp. & Subs., T.C. Memo. 2009-50, slip op. at 195;
20 We have previously interpreted this requirement as incorporating section

174 requirements on both the nature of the activities and the nature of the
expenditures. See Norwest Corp. & Subs. v. Commissioner, 110 T.C. 454, 491 (1998)
(requiring “the taxpayer to satisfy all the elements for a deduction under section 174”);
Union Carbide Corp. & Subs. v. Commissioner, T.C. Memo. 2009-50, slip op. at 197
(analyzing whether a taxpayer’s activities constituted research and development
within the meaning of section 174 and whether the costs associated with these
activities may be treated as expenses under section 174), aff’d, 697 F.3d 104 (2d Cir.
2012).

21 For tax year 2013, Treasury Regulation § 1.41-4(b)(2) provided an identical
shrinking-back rule.

22 Section 174 was later amended to eliminate the current deduction and
instead requires amortization of research and development expenditures for tax years
starting after December 31, 2021. See Tax Cuts and Jobs Act of 2017, Pub. L. No. 11597, § 13206, 131 Stat. 2054, 2111–13.

29
[*29] Treas. Reg. § 1.174-2(a)(1). In determining whether uncertainty
existed, we examine the information objectively available to the
taxpayer, rather than the taxpayer’s subjective understanding of that
information. Union Carbide Corp. & Subs., T.C. Memo. 2009-50, slip op.
at 195–96 (“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 also Max, T.C. Memo. 2021-37, at *30 (finding no
uncertainty where appropriate design may have been subjectively
unknown to the taxpayer but the taxpayer “already ha[d] the
information necessary to address that unknown”). Expenditures that
are paid after the elimination of uncertainty are not research and
development expenditures. Treas. Reg. § 1.174-2(a)(2). Furthermore, it
bears emphasis that uncertainty related to a subcomponent does not
necessarily render the appropriate design of the product as a whole
uncertain.
Betz v. Commissioner, T.C. Memo. 2023-84, at *76
(determining that a taxpayer failed to show objective uncertainty as to
the design of the product as a whole because the taxpayer would not
have to scrap the entire product if it did not work); Little Sandy Coal
Co., T.C. Memo. 2021-15, at *53.
In the second step, if uncertainty existed, the taxpayer must show
that it undertook investigative activities that were “intended to discover
information that would eliminate uncertainty.” Treas. Reg. § 1.1742(a)(1); see Max, T.C. Memo. 2021-37, at *30–31 (citing Mayrath, 41 T.C.
at 590) (requiring the taxpayer to show it undertook investigative
activities because the purpose of section 174 was to limit deductions to
expenditures of an investigative nature). The resolution of this
uncertainty does not necessarily require experimentation. See Little
Sandy Coal Co., T.C. Memo. 2021-15, at *36. We have previously held
that a meeting or email soliciting further information and specifications
is an investigative activity within the meaning of section 174. See Betz,
T.C. Memo. 2023-84, at *80, *89.
However, performing basic
calculations on available data is not an investigative activity because
the taxpayer already has all the information necessary to address that
unknown. Id. at *84, *87 (finding that performing calculations to
determine duct size based on airflow was not an investigative activity);
Max, T.C. Memo. 2021-37, at *30 (finding that while information was
subjectively unknown to the taxpayer with respect to the appropriate
design of a component, the taxpayer “already ha[d] the information
necessary to address that unknown”). A taxpayer may not carry its
burden to show it engaged in investigative activities merely by
presenting an issue and eventual solution. See Betz, T.C. Memo.

30
[*30] 2023-84, at *86. Instead, the taxpayer must show it actually
conducted investigatory activities. See id.
Petitioner argues that the second step of the section 174
analysis—whether PDG engineers undertook investigative activities—
is not before the Court. Petitioner argues that respondent’s stipulation
that he would not contest the technological information prong of the
four-part statutory test binds respondent as a concession that PDG
engineers undertook investigative activities.
Petitioner cites no
authority for extending this concession, and we will not do so in this
case. See Betz, T.C. Memo. 2023-84, at *68, *86 (considering whether a
taxpayer satisfied the investigative activities portion of the section 174
test even when the IRS conceded the technological information test).
2.

The Process of Experimentation Test

Finally, section 41 requires that (1) substantially all the research
activities (2) constitute elements of a process of experimentation (3) for
a qualified purpose. § 41(d)(1)(C). We refer to this as the process of
experimentation test. A process of experimentation is a “process
designed to evaluate one or more alternatives to achieve a result where
. . . the appropriate design of that result, is uncertain as of the beginning
of the taxpayer’s research activities.” Treas. Reg. § 1.41-4(a)(5)(i). The
requisite uncertainty under this test is essentially identical to the
uncertainty required by the section 174 test. Union Carbide Corp. &
Subs., T.C. Memo. 2009-50, slip op. at 199. Unlike the section 174 test,
however, this evaluative process must follow the scientific method. Id.
at 201.
The substantially all requirement is satisfied if “80 percent or
more of a taxpayer’s research activities, measured on a cost or other
consistently applied reasonable basis . . . , constitute elements of a
process of experimentation for a [qualified purpose].” Treas. Reg. § 1.414(a)(6). The substantially all requirement is satisfied even “if the
remaining 20 percent (or less) of a taxpayer’s research activities with
respect to the business component do not constitute elements of a
process of experimentation for a [qualified purpose], so long as these
remaining research activities satisfy the [section 174 test] and are not
otherwise excluded under section 41(d)(4).” Id. Therefore, the
numerator of the relevant fraction is all research activities that
constitute an element of a process of experimentation for a qualified
purpose. Little Sandy Coal Co., T.C. Memo. 2021-15, at *40; Treas. Reg.
§ 1.41-4(a)(6). The denominator is all research activities that meet the

31
[*31] section 174 test that are not covered by one of the statutory
exclusions. Little Sandy Coal Co., T.C. Memo. 2021-15, at *40; Treas.
Reg. § 1.41-4(a)(6). Petitioner bears the burden of providing sufficient
information to demonstrate that the substantially all fraction equals or
exceeds 80%. Little Sandy Coal Co., T.C. Memo. 2021-15, at *43–44.
Petitioner indicated only the number of hours worked by each employee
on each project; therefore, we will apply the substantially all test on this
basis.
The final part of the process of experimentation test requires that
the activities be for a qualified purpose as defined in section 41(d)(3).
Qualified research includes research that is related to (1) a new or
improved function, (2) performance, or (3) reliability or quality.
§ 41(d)(3). Research related to style, taste, cosmetic, or seasonal factors
is not for a qualified purpose. Id.
C.

Shrinking-Back Rule

If a business component fails any part of the four-part statutory
test, we may apply the test to a subset of the product (shrinking-back
rule). Treas. Reg. § 1.41-4(b)(2). The shrinking-back rule instructs us
to reapply the four-part statutory test to the business component at its
most significant subset of elements. Id. If that subset of elements again
fails, we generally drill down to a more granular subset of the business
component until either (1) a subcomponent satisfies the test or (2) the
most basic level of the component fails to satisfy the test. Id. When a
component fails, we have previously applied this rule to an issue that a
taxpayer encounters in the design process when the issue relates to an
identifiable subcomponent. See, e.g., Betz, T.C. Memo. 2023-84, at *81.
As noted above, an identical test applies if a business component fails
the section 174 test. See Treas. Reg. § 1.174-2(a)(5).
If we determine that the MEPF systems for any trial project fails,
petitioner contends that we can apply the shrinking-back rule by relying
on the hour tracking information. Petitioner presents several options to
shrink back including by (1) discipline, (2) particular design phase, or
(3) individual employee. Petitioner’s first suggestion to apply the
shrinking-back rule by discipline aligns with the regulatory text. That
is, if the MEPF systems as a whole fail to qualify, we will narrow the
scope of our review separately to the mechanical systems, electrical
systems, and plumbing systems. If this secondary level fails, the
shrinking-back rule directs us to determine the next most significant
subset of the business component.

32
[*32] We reject petitioner’s other shrinking-back methods. We must
apply the shrinking-back rule to the next most significant subset of
elements of the business component. Looking at the design stages, we
cannot identify subsets of the MEPF systems. Instead, PDG engineers
worked on various subsets of the MEPF systems in each design stage
and subsets of the systems were not neatly resolved in one design stage.
For example, during the project design stage of the BHNM Oxford
project, PDG engineers worked on the roof units and the fire alarm
system. Additionally, work on the lighting systems extended over
several design stages.
As for applying the shrinking-back rule to focus on the activities
of one employee, we likewise run into the issue of ignoring the most
significant subset rule. No one employee exclusively focused on one
subset, nor was any one subset worked on by only one employee. For
example, in the VU ESB project mechanical engineer Thomas Fisher
worked on the chiller issue and the steam distribution issue.
Mechanical engineer Ross T. Malloy also worked on the steam
distribution issue. Therefore, applying the shrinking-back rule by
employee would not identify the most significant subset of the MEPF
systems. Thus, we will apply the shrinking-back rule, if required, to
examine the mechanical system, electrical system, and plumbing
system. If these systems also fail, we then will have to determine
whether there is sufficient information to apply the shrinking-back rule
to a further subset of the systems.
III.

The Qualification of the Trial Projects as Qualified Research

Now we turn to the issue of whether any trial project entailed
qualified research within the meaning of section 41. Petitioner contends
that it faced uncertainty as to the appropriate design of each of the
MEPF systems even beyond the delivery of stamped construction
documents because the appropriate design of the MEPF systems could
not be established until construction was complete. Petitioner claims
this uncertainty continued because PDG engineers would have to revise
and alter the design through construction. For how PDG engineers
resolved this uncertainty, petitioner directs the Court to its six-stage
design process. Petitioner alleges that when faced with an issue in a
later design stage, its engineers would revert to earlier stages to resolve
the issue, creating an iterative process that mirrors the scientific
method.

33
[*33] At the outset, we reject petitioner’s theory that uncertainty
existed because of the possibility of revising the design of the MEPF
systems before construction was complete. The regulations and our
caselaw recognize a distinction between objective uncertainty as to the
design of the whole system (its basic design specifications) and objective
uncertainty as to the design of a particular component. Treas. Reg.
§ 1.174-2(a)(5); see also Betz, T.C. Memo. 2023-84, at *76. The mere
possibility of altering the design in later stages does not itself establish
that the appropriate design remained uncertain. See Betz, T.C. Memo.
2023-84, at *76; Little Sandy Coal Co., T.C. Memo. 2021-15, at *53.
These subsequent revisions may introduce some uncertainty, but the
scope of the uncertainty is a question based on the particular facts and
does not necessarily translate to the entire system. See Betz, T.C. Memo.
2023-84, at *76; Little Sandy Coal Co., T.C. Memo. 2021-15, at *53.
We similarly reject petitioner’s argument that it satisfied the
process of experimentation test simply by directing the Court to the sixstage design process. Merely connecting an activity to a larger plan that
may resemble the scientific method does not satisfy the process of
experimentation test. While the design process as framed by petitioner
may appear similar to the scientific method, the assertion alone is not
sufficient for us to find that PDG employees engaged in the process of
experimentation. Instead, we focus on the activities of PDG employees.
See Union Carbide Corp. & Subs., T.C. Memo. 2009-50, slip op.
at 200–01.
We are also skeptical of whether PDG employees followed
petitioner’s description of the six-stage design process because of the
way the hour sheets are filled out. PDG employees did not categorize
any of their hours on the basis of design phase. Additionally, the
descriptions do not appear to line up with the work completed in each
stage. For example, petitioner described the construction document
stage as ending with the delivery of stamped construction documents.
However, for the VU ESB project, mechanical engineer Ross T. Malloy
labeled time in the design development stage as “finishing up
construction documents.” Related to the BHNM Oxford project,
mechanical engineer John Wade labeled time in the design development
stage “schematic design,” which according to petitioner’s description of
the six-stage design process is an independent stage. Given these
inconsistencies between the description of the six-stage design process
and the narrative descriptions on the hour sheets, we cannot determine
that petitioner followed a process of experimentation by merely relying
on the description. Instead, we must apply a more granular approach

34
[*34] to determine whether the activities of these employees were part
of a process of experimentation for the trial projects. We must focus on
the uncertainty and the steps taken to resolve that uncertainty. See id.
Below, we will address only the relevant portions of the four-step
statutory test.
A.

Gerald Champion
1.

MEPF Systems as a Whole

The MEPF systems designed for Gerald Champion fail the section
174 test. Petitioner alleges uncertainty as to the appropriate design of
the MEPF systems because PDG engineers had to integrate new MEPF
systems within the existing systems. Petitioner argues that the
uncertainty continued until all mechanical and appliance components of
the systems were selected.
Petitioner failed to identify the specific information that was not
available to PDG engineers at the start of the project. Instead,
petitioner points to the limited information provided to it at the start of
the project, including a simple gross-block diagram that only generally
showed the location of the buildings. PDG engineers also received
historic data from the hospital that could be used to determine the
necessary size of the equipment. Testimony at trial also revealed that
PDG engineers were provided existing schematic design diagrams
although petitioner did not identify these documents to the Court. 23
Therefore, we do not know what information was shown on this diagram
or whether it provided sufficient evidence to determine the appropriate
design. Petitioner failed to show that the information set forth on the
gross-block diagram and the schematic design diagram did not establish
the appropriate basic design of the systems. Therefore, petitioner has
failed to establish that there was objective uncertainty as to the
appropriate design of the MEPF systems.
Petitioner further failed to demonstrate how uncertainty in one
element of the MEPF systems created uncertainty throughout the entire
MEPF systems. As we reiterated recently in Betz, T.C. Memo. 2023-84,
at *76, uncertainty regarding a subset of the business component does
not make the design of the entire business component uncertain. PDG
engineers provided sparse, conclusory testimony that a change in one
subcomponent affected the basic design of the entire MEPF systems.
23 Instead, petitioner identified internal communications that discuss the
existing schematic design drawing.

35
[*35] However, petitioner failed to develop this interconnection to any
meaningful extent. Instead, petitioner presented evidence at trial and
on brief focused around discrete issues. 24 Petitioner fails to satisfy the
section 174 test as to the entirety of the MEPF systems designed for
Gerald Champion.
2.

Shrinking-Back Rule

We look next to the shrinking-back rule to determine whether any
of the activities related to a component or a subcomponent were
qualified research. The next most significant components of the MEPF
systems are the mechanical, electrical, and plumbing systems. This
level of review likewise does not involve qualified research. Petitioner
makes the same general argument about uncertainty as discussed above
and highlights a few additional uncertainties for specific systems. We
reject the general argument for the same reasons as above.
As it relates to the mechanical system, petitioner’s claimed
uncertainty relates to where the HVAC system would be located in the
hospital. Petitioner argues that this uncertainty was not resolved until
its engineers determine the required size for the system. Regardless of
whether this uncertainty existed, petitioner failed the process of
experimentation test related to the design of the mechanical systems.
PDG mechanical engineers calculated the approximate size of the
systems by referencing the historic data they were provided by Gerald
Champion at the start of the project and reported the required size of
the system to the architect. The architect ultimately decided that the
system would be placed in a mechanical room. Performing calculations
and communicating the results to the architect is not an evaluative
process that mirrors the scientific method. Instead, PDG mechanical
engineers provided the architect with the information that the architect
used to base the decision on aesthetics.
PDG mechanical engineers’ other decisions regarding the
mechanical systems likewise fail the process of experimentation test.
PDG mechanical engineers encountered several decision points in the
design, and rather than engage in experimentation, they selected an
option. This decision-making process was presented as decisions PDG
24 Even if petitioner satisfied the section 174 test, petitioner failed to provide
sufficient information to allow us to determine whether substantially all activities of
the PDG employees were part of a process of experimentation. See Little Sandy Coal
Co., T.C. Memo. 2021-15, at *40.

36
[*36] mechanical engineers made using their expertise rather than a
course of study as demanded by the scientific method.
As for the electrical systems and plumbing systems, petitioner did
not allege any additional uncertainty other than that it was “uncertain
as to the appropriate design” of each system. We reject this argument
for the same reason we rejected it with regard to the MEPF systems:
petitioner failed to set forth (1) what information was unavailable to
PDG electrical and plumbing engineers and (2) what investigative
activities PDG electrical and plumbing engineers undertook with
respect to the uncertainty. See Betz, T.C. Memo. 2023-84, at *76.
Having determined that the activities related to the mechanical,
electrical, and plumbing systems individually are not qualified research,
we shrink back to the next most significant subset of each of the systems.
While we have information to identify discrete issues faced by PDG
engineers, it would be futile. To demonstrate that its engineers
conducted qualified research, petitioner relies heavily on the hour
sheets. While these hour sheets are broken down by discipline, they are
not consistently broken down by subset or issue confronted by PDG
engineers. For example, mechanical engineer John Wade recorded time
to “HVAC,” electrical engineer Joseph Barnes recorded time to “ltg, pwr,
sys design,” and plumbing engineer Richard Miller recorded time to
“work on plumbing fixtures.” We cannot connect these time entries to
the discrete issues identified in testimony. Therefore, we are unable to
verify whether these activities were (1) investigative activities, (2) part
of a process of experimentation, or (3) for a permitted purpose.
Finally, to the extent we have the capability to apply the
shrinking-back rule, petitioner fails to carry its burden. Petitioner
failed to present any evidence that its engineers engaged in a process of
experimentation with respect to any subcomponent. Instead, petitioner
presented issues its engineers encountered and the decisions they made.
On occasion, petitioner indicated that its engineers did some
preliminary calculations or considered some factors. However, these
activities fall short of the process of experimentation test that must
mirror the scientific method.
Instead, PDG engineers made
determinations as to the design using their expertise. Likewise the
numerous design drawings in evidence do not demonstrate the activities
performed to get the solutions. As aptly summarized by petitioner’s
counsel, the unexplained design drawings “tell[] me nothing.”

37
[*37] B.

BHNM Oxford
1.

MEPF Systems as a Whole

The MEPF systems designed for BHNM Oxford fail the section
174 test. Petitioner alleges that it was uncertain as to the design for the
MEPF systems because it was new construction and the PDG engineers
did not know the footprint of the hospital. Petitioner also argues that
the hybrid operating room, the lack of knowledge regarding the final
equipment, and the building code created uncertainty regarding the
entire system.
At the start of the project, the architect provided PDG engineers
a schematic block diagram and a preliminary master plan. The
schematic block diagram showed a preliminary layout of each floor of
the hospital and identified the location of each department. The
preliminary master plan appears to lay out the configuration of the
hospital and outbuildings, which would indicate where the MEPF
systems would be needed. PDG engineers were experts in their field
that had years of experience designing MEPF systems for hospitals.
Because petitioner claimed the general uncertainty was the lack of
information regarding the construction, these documents appear to
resolve such uncertainty and serve as a basis for the basic design of the
MEPF systems. Therefore, petitioner failed to establish that there was
objective uncertainty as to the appropriate design of the MEPF systems.
Even if there was uncertainty stemming from the hybrid
operating room, equipment selection, and building codes, petitioner
failed to show how this uncertainty would lead to uncertainty regarding
the whole MEPF systems. Uncertainty as to a component of the system
does not mean there is uncertainty related to the entire business
component. See Betz, T.C. Memo. 2023-84, at *76. Other than some
conclusory statements at trial about the interconnected nature of the
various pieces of the MEPF systems, petitioner failed to explain why the
inclusion of the hybrid operating room would render the entirety of the
MEPF systems uncertain. Drilling down further, the bulk of the
uncertainty regarding the hybrid operating room appears to stem from
the placement of the vents in the room to ensure a sterile field regardless
of the position of the table. Petitioner failed to introduce evidence that
this uncertainty would affect the basic design of the MEPF systems. For
example, how the ventilation would affect the electrical switch directing
electricity into the hospital is not clear. See Betz, T.C. Memo. 2023-84,
at *76; Treas. Reg. § 1.174-2(a)(5) (distinguishing between objective

38
[*38] 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 subcomponent).
As for the equipment selection uncertainty, there may have been
objective uncertainty as even Baptist Memorial did not know the
ultimate selection of equipment. However, PDG engineers did not
engage in the process of experimentation to resolve this uncertainty.
Instead, they waited for the final selection to come from Baptist
Memorial. After receiving this information PDG electrical engineers
verified that their design could support the equipment. There is no
evidence these engineers relied on the scientific method to make this
determination. Instead, they reran load calculations, which gave them
an answer one way or another. This is not a process of experimentation.
As for the building code, petitioner did not develop this argument
to any significant extent. We note, however, that all systems designed
by PDG engineers are subject to a building code, with the majority being
the stricter hospital building codes encountered here.
To the extent any uncertainty existed before the architect
provided PDG engineers with the schematic block diagram and the
preliminary master plan, petitioner failed to show that PDG engineers
engaged in investigative activities to resolve the uncertainty. Petitioner
did not provide any information as to the activities that its engineers
conducted to determine the scope of the project before receipt of the
documents. The hour sheets do not disclose the precise activities PDG
engineers undertook to resolve the uncertainty. Instead, it appears as
though the uncertainty was resolved by the actions of Baptist Memorial
and the other contractors on the project. Again, the unexplained design
drawings tell us nothing. Petitioner failed to carry its burden that the
design of the entirety of the BHNM Oxford MEPF systems constituted
qualified research.
2.

Shrinking-Back Rule

We look next to the shrinking-back rule to determine whether any
of the activities related to a component or a subcomponent were
qualified research. The next most significant components of the MEPF
systems are the mechanical, electrical, and plumbing systems. The
activities related to these systems likewise were not qualified research.
Petitioner makes the same general argument about uncertainty as
explored above and points to additional elements that introduced

39
[*39] uncertainty as to the design of each system. We reject the general
arguments for the same reasons as above.
As it relates to the mechanical systems, petitioner claimed
uncertainty stemming from the chiller plant, the unknown size of the
hospital, the boiler plant, and the air handling systems. Petitioner
failed to demonstrate how uncertainty related to one of these
subcomponents would cause uncertainty as to the entire design of the
systems.
Rather, petitioner presented these issues as discrete
challenges its engineers encountered and did not connect the issues. See
Betz, T.C. Memo. 2023-84, at *76; Treas. Reg. § 1.174-2(a)(5).
Petitioner failed to show that its engineers conducted
investigative activities to resolve the uncertainties. Instead, the record
shows that the bulk of the claimed uncertainties, such as the chiller
system, were resolved by Baptist Memorial. As for decisions left to PDG
mechanical engineers, petitioner failed to show any investigative
activities. See Betz, T.C. Memo. 2023-84, at *86 (“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.”).
As for the electrical system, petitioner claimed an additional
uncertainty related to how to route the electricity from the substations
to the vacant lot. At a minimum, the record establishes that PDG
electrical engineers did not engage in a process of experimentation to
resolve this uncertainty. Instead, they met with the electricity company
and Baptist Memorial to resolve the uncertainties. While this could be
an investigative activity, there is no evidence that PDG electrical
engineers used a process of experimentation to determine how to route
the electric. See id. at *80, *89. PDG electrical engineers merely passed
the recommendation and options from North Power to Baptist
Memorial. Baptist Memorial then selected its preferred option. Meeting
with North Power and presenting the options to Baptist Memorial is a
far cry from the evaluative process mirroring the scientific method
demanded by the process of experimentation test. As for the other
decisions encountered by PDG electrical engineers, petitioner failed to
show any investigative activities. See id. at *86.
As for the plumbing system, petitioner spent no time at trial
explaining the uncertainties encountered by PDG plumbing engineers.
The hour sheets likewise do not disclose this information in any
meaningful manner. Petitioner failed to set forth (1) what information

40
[*40] was unavailable to PDG plumbing engineers and (2) what
investigative activities they undertook with respect to the uncertainty.
See id. at *76.
Having determined that the mechanical, electrical, and plumbing
systems individually did not involve qualified research, we shrink back
to the next most significant subset of each system. Again, petitioner
identified issues its engineers confronted in the design of the systems
and offered testimony at trial regarding the solutions to the issues and
appears to rely on the hour sheets to fill in the gaps.
However, like the hour sheets from the Gerald Champion project,
the hour sheets for the BHNM Oxford project lack sufficient detail to
allow us to make the necessary determinations.
For example,
mechanical engineers John Wade and John Beard recorded significant
time to “design,” electrical engineer Brian Moore recorded time to
“mark-ups,” and plumbing engineer James Hobbs recorded significant
time to “SD.” Petitioner provided us with no metric to allocate this
generic time to each issue encountered by its engineers. We cannot
determine, nor did petitioner explain, what subset of the systems these
engineers worked on. Therefore, we are unable to determine whether
these activities were (1) investigative activities, (2) part of a process of
experimentation, or (3) for a permitted purpose. Therefore, shrinking
back would be futile.
Even if we could apply the shrinking-back rule to the issues
petitioner confronted using solely the general descriptions provided, the
activities were not qualified research. Petitioner often identified an
issue and the solution without bridging the evidentiary gap as to the
activities its engineers conducted. Therefore, petitioner failed to carry
its burden to show its engineers conducted investigative activities. See
id. at *86. Additionally, for the vast majority of the uncertainties
petitioner claims with respect to the issues, PDG engineers did not
perform activities related to a process of experimentation. For example,
Baptist Memorial, not PDG engineers, selected the chiller that would be
used for the building. The activities and ultimate solutions were
attributable primarily to third parties.
C.

VU ESB
1.

MEPF Systems as a Whole

The MEPF systems for the VU ESB project fail the section 174
test. Petitioner alleges general uncertainty as to the appropriate design

41
[*41] of the MEPF systems because the building was new construction
and the specific use of each portion of the building was not determined.
Petitioner also alleges uncertainty related to the strict requirements of
each room.
Petitioner failed to identify specific information that was not
available to the PDG engineers at the start of the project that caused
the uncertainty. We are unable to determine this information from the
record because petitioner failed to identify the initial information
provided by the architect, the design documents completed for the
TEAM building project before the hospital pulled out of the project, and
the date it ended work on the TEAM building project. While the building
size was reduced and some portions of the building were designated for
different purposes, other portions of the building were retained, such as
the cleanroom and imaging suite. Additionally, PDG engineers recorded
considerable time before PDG was formally engaged on the VU ESB
project. While petitioner alleges none of the hours overlapped, we
hesitate to accept this as fact when there are other errors on the hour
sheets 25 and petitioner failed to provide even the most basic timeline of
the projects. Without presenting the information objectively available
to them at the start of the project, petitioner failed to show objective
uncertainty as to the design of the entire MEPF systems.
Petitioner further failed to set forth the interrelated nature of the
various components of the MEPF systems such that uncertainty as to
one portion renders the entire design of the MEPF systems uncertain.
Uncertainty as to one subcomponent does not necessarily render the
entire business component uncertain. See id. at *76. Petitioner argues
that the strict requirements of each room caused uncertainty as to the
appropriate design of the whole MEPF systems. Other than conclusory
statements that all the systems affected LEED Silver certification,
petitioner provided no evidence of the interdependence of the systems.
For example, petitioner did not explain how strict airflow requirements
in the imaging suite affected the electrical design of the building.
Therefore, even if there was uncertainty as to specific subcomponents,
petitioner failed to carry its burden to show that there was uncertainty
as to the whole design. See id.; Treas. Reg. § 1.174-2(a)(5).

25 For example, time that petitioner admits should have been recorded to the
VU ESB – Olin Steam Line – Relocation, project No. 12010.04, was recorded to the
project number at issue.

42
[*42] To the extent there was uncertainty because the specific use of
each portion of the building was not known, PDG engineers did not
engage in investigatory activities to resolve this uncertainty. There is
no evidence PDG engineers had any involvement in this decision
making. Instead, the evidence shows Vanderbilt University resolved
this uncertainty by indicating to PDG engineers the specific use of each
portion of the building. There is no evidence that PDG engineers were
involved in this decision-making process. Instead, PDG engineers began
designing the MEPF systems with the knowledge that the information
would come from Vanderbilt University. Again, the numerous versions
of the design drawings in evidence tell us nothing. 26 Petitioner has
failed to carry its burden to show that the design of the entirety of the
MEPF systems meets the section 174 test.
2.

Shrinking-Back Rule

We look next to the shrinking-back rule to determine whether the
activities related to any particular component or subcomponent were
qualified research. The next most significant component of the MEPF
systems are the mechanical, electrical, and plumbing systems. The
activities related to these systems likewise were not qualified research.
Petitioner makes the same general argument about uncertainty as
advanced for the whole MEPF systems. Again, petitioner failed to
identify the specific information unavailable to the PDG engineers at
the start of the project that resulted in the design uncertainty.
Therefore, we reject this argument.
As for the mechanical system, petitioner alleges that the
appropriate design of the entire system was uncertain because
Vanderbilt University had not assigned researchers to each laboratory
and thus PDG mechanical engineers did not know the ventilation
requirements of each laboratory. Because the ventilation in each
laboratory would require adjustments to the airflow to compensate for
the extracted air, petitioner contends that this caused system-wide
uncertainty as to the basic design of the mechanical system. This is the
first time in this case that petitioner coherently tied uncertainty in one
subcomponent to another. However, there are several other components
of the mechanical system that do not appear dependent on the
ventilation. Petitioner did not provide information on how the
26 Even if petitioner satisfied the section 174 test, it again failed to provide
sufficient information to allow us to determine whether substantially all activities of
the PDG employees were part of a process of experimentation. See Little Sandy Coal
Co., T.C. Memo. 2021-15, at *40.

43
[*43] ventilation would, for example, affect the steam pipe connection.
Therefore, petitioner failed to demonstrate that even if there was
uncertainty regarding ventilation, the basic design specifications were
uncertain. See Betz, T.C. Memo. 2023-84, at *76; Treas. Reg. § 1.1742(a)(5).
Additionally, petitioner failed to show its employees engaged in
investigative activities related to this uncertainty. Instead, Vanderbilt
University resolved the uncertainty by selecting researchers as
discussed above, which would dictate the proper configuration for the
laboratory. As for the other decisions PDG electrical engineers
encountered, petitioner failed to show any investigative activities. See
Betz, T.C. Memo. 2023-84, at *86.
As for the electrical systems, petitioner alleges there was
uncertainty regarding the appropriate design of the electrical systems
due to the unknown demand from each laboratory. Even if the activities
of PDG electrical engineers met the section 174 test, petitioner failed to
show PDG electrical engineers undertook a process of experimentation.
Electric engineer Brian Moore testified at trial that PDG electrical
engineers entered the estimated square footage of the building into
software that estimated the load of the building. PDG electrical
engineers then increased this figure to account for the higher demands
of the laboratories in the building. This increase was based on a “study
with Vanderbilt University” of the other laboratories on campus.
Petitioner provided no additional information on the study or the
division of work between PDG engineers and Vanderbilt University.
Entering previously available information into software does not
show that PDG electrical engineers engaged in a process of
experimentation. Although the study with Vanderbilt University may
have mirrored the scientific method, petitioner did not provide sufficient
information for us to make this determination. Instead, petitioner
asserts simply that a “study” was conducted. Without knowing the
activities involved in the study and PDG electrical engineers’
involvement, we cannot find that petitioner engaged in a process of
experimentation.
As for the plumbing system, petitioner did not mention any
additional uncertainty.
Petitioner failed to set forth (1) what
information was unavailable to PDG plumbing engineers and (2) what
investigative activities were undertaken by PDG plumbing engineers
with respect to the uncertainty. See Betz, T.C. Memo. 2023-84, at *76.

44
[*44] Having determined that the mechanical, electrical, and plumbing
systems individually are not qualified research, we apply the shrinkingback rule to the next most significant subset of each system. We
confront the exact difficulties in shrinking back as discussed above. As
an initial note, we are particularly skeptical of the hour sheets related
to the VU ESB project. To start, PDG engineers recorded significant
time before the execution of the new contract with the architect in 2013
and 2014. Petitioner did not provide the exact date that the TEAM
building was put on hold. Petitioner represents that all the time
recorded to this project was for the VU ESB project and not the TEAM
building project, but we are unable to verify this. Additionally,
petitioner’s other representations regarding the hour sheets, namely
that no subproject was recorded to the project number at issue, are
directly contradicted by entries on the hour sheets. Finally, the hour
sheets contain entries for 2017, which is beyond the scope of the credits
claimed in this case.
The hour sheets also fail to provide sufficient information to
conduct the qualified research analysis. As with the other projects, the
narrative descriptions do not consistently relate to the issues petitioner
identifies. Mechanical engineer John Beard recorded significant time to
“design,” electrical engineer Brian Moore recorded time to “project
coordination,” and plumbing engineer Raymond Parham recorded time
to “ABP.” Petitioner provided us with no metric to allocate this generic
time to each issue discussed in testimony. We cannot determine, nor did
petitioner explain, what subset of the systems these engineers worked
on. Therefore, we are unable to determine whether these activities were
(1) investigative activities, (2) part of a process of experimentation, or
(3) for a permitted purpose. Therefore, shrinking back would be futile.
One particular issue petitioner encountered deserves a closer
look: connecting to the steam distribution system. At trial, Ross T.
Malloy testified that he, Thomas Fisher, and Ryan Malloy were the only
employees involved in this process. The three men indicated when they
worked on the steam line project in their time sheets, but the hours
sheets tell a different story. The hour sheets show CAD designer Barry
Septer recorded time with a description referencing the steam line. This
directly refutes the testimony, and we cannot accurately determine
whether other employees worked on the steam line and recorded time
under the generic terms noted above.
Even if we could apply the shrinking-back rule to the issues
petitioner confronted solely on the basis of the general descriptions

45
[*45] provided, they would not qualify as qualified research. Petitioner
often identified an issue and the solution without bridging the
evidentiary gap as to the activities conducted by its engineers. Again,
the unexplained design drawings tell us nothing. Therefore, petitioner
failed to carry its burden to show its engineers conducted investigative
activities. See id. at *86.
IV.

Accuracy-Related Penalties

The parties stipulated that if we determine that none of the trial
projects entails qualified research, petitioner is liable for the accuracyrelated penalties for the credit years in which there are deficiencies, as
determined by the Court or agreement of the parties. Because we
determined that none of the trial projects involved qualified research,
petitioner is liable for accuracy-related penalties as specified by the
parties. 27
CONCLUSION
As said before, engineers solve problems you did not know you
had in ways you cannot understand. Without an explanation of the work
or process of the engineers, we cannot understand how PDG engineers
came to the ultimate solutions and determine whether the activities
qualify as research within the meaning of section 41. None of the trial
projects as a whole or at the shrinking-back level involved qualified
research. Petitioner is liable for the accuracy-related penalties as
stipulated by the parties.
To reflect the foregoing,
An appropriate order will be issued.

27 Nothing in this Opinion should be construed as determining the amounts of
the deficiencies in petitioner’s federal income tax for the credit years. Instead, this
Opinion solely determined that the three trial projects do not constitute qualified
research.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A2e9ea9ca749d4d1f. Public record. Not legal advice.