Many businesses engage in activities they believe qualify for the research tax credit under Section 41 of the tax code. They conduct tests, develop products, and innovate processes, but still find their credit claims denied by the IRS. Why? Often, the answer lies in the “process of experimentation” test—a requirement that trips up even companies genuinely engaged in research and development.
The disconnect typically occurs between what businesses consider research and what the tax code defines as qualified research. Simply conducting tests or developing new products isn’t enough. The tax law requires a structured, methodical scientific approach that many businesses fail to document properly, even when they’re actually following such processes.
This distinction is particularly relevant for manufacturers who regularly conduct product development and testing. Their activities might constitute genuine innovation, but without documentation of a structured scientific method, they may fail to qualify for the valuable research credit.
The recent case of Siemer Milling Company v. Commissioner of Internal Revenue, T.C. Memo. 2019-37, provides an opportunity to consider how the process of experimentation requirement functions as a gatekeeper for research credit eligibility, and why many taxpayers struggle to meet this standard despite conducting what appears to be legitimate research.
Facts & Procedural History
Siemer Milling Company is an Illinois-based wheat flour miller that has been in business since the 1950s. During the tax years ending May 31, 2011 and 2012, Siemer operated two mills (in Illinois and Kentucky) and conducted several research projects, including a flour heat-treatment project, Pulsewave technology implementation, wheat hybrids testing, and ozone integration into the milling process.
The company employed millers, maintenance personnel, lab technicians, lab supervisors, and research and development staff. Notably, Siemer did not employ anyone with the title engineer or geneticist during the years at issue, nor did it employ anyone with degrees in computer science or chemical and mechanical engineering.
On its tax returns for the years in question, Siemer claimed research tax credits of $122,424 for 2011 and $116,246 for 2012. The company engaged its long-time accounting firm, CliftonLarsonAllen (CLA), to prepare credit studies supporting these claims. CLA had prepared Siemer’s returns for more than two decades and was familiar with the company’s business operations.
The IRS audited Siemer’s returns and disallowed the research credits, determining that Siemer had “not proven that [its] expenses qualify for research credit.” The IRS also made several other adjustments related to depreciation and repair costs. In response, Siemer filed a petition with the Tax Court challenging the IRS’s determination.
The Research Tax Credit Framework
The research tax credit under provides a signficant tax benefit for businesses that engage in research activities. This credit equals 20% of qualified research expenses that exceed a base amount, which is calculated using the taxpayer’s historical research spending.
To qualify for the credit, research activities must meet four key requirements:
- Business Component Test – The research must be intended to be useful in developing a new or improved business component of the taxpayer.
- Section 174 Test – The expenses must be eligible for treatment as research and experimental expenditures under Section 174.
- Technological Information Test – The research must be undertaken to discover technological information.
- Process of Experimentation Test – Substantially all of the research activities must constitute elements of a process of experimentation.
Each of these tests has specific requirements that must be met, and failure to satisfy any one test disqualifies the entire research project from credit eligibility.
How Does the Business Component Test Apply to Manufacturers?
The business component test requires that research be undertaken to discover information “the application of which is intended to be useful in the development of a new or improved business component of the taxpayer.”
A business component is defined broadly to include “any” product, process, computer software, technique, formula, or invention held for sale or used in the taxpayer’s business. This component is the “thing,” if you will, that the other three rules are applied to.
For manufacturers like Siemer, the business component can be either the final product sold to customers or the manufacturing process itself. This flexibility recognizes that innovation can occur in both the product and the methods used to create it.
In Siemer’s case, the court was unpersuaded by the IRS’s argument that Siemer’s descriptions of its business components were inconsistent. The court found that Mr. Tegeler’s description of the projects as “processes that we worked with to develop products” was not inconsistent with Siemer’s characterization of the projects as “process improvements, product improvements, or some combination of both.”
The Section 174 Test: Facing Uncertainty
The Section 174 test requires that research activities be eligible for treatment as research and experimental expenditures under Section 174. This provision allows taxpayers to either deduct or amortize research expenses that might otherwise need to be capitalized.
At its core, this test examines whether the activities were intended to eliminate uncertainty concerning the development or improvement of a product. Treasury Regulation 1.174-2(a)(1) defines research or experimental expenditures as “expenditures incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense.”
Uncertainty exists when “the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product.” This is an objective test based on information available to the taxpayer at the time.
In Siemer’s case, the court rejected the IRS’s argument that facing the same uncertainty across multiple years disqualified the research. The court noted that “not all uncertainties are neatly resolved within the confines of a single taxable year.”
What Makes Research “Technological” in Nature?
Under the technological information test, research must be undertaken to discover information that “fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.” This requirement distinguishes scientific research from market research, consumer surveys, or other non-technological information gathering.
The IRS argued that since Siemer didn’t employ engineers or people with specialized degrees, it couldn’t have relied on such principles. The court rejected this simplistic view, stating that “nothing requires a taxpayer to employ or contract with someone with a specialized degree to prove that research relied on the physical or biological sciences, engineering, or computer science.”
However, the court did note that Siemer generally failed to identify the specific scientific principles it relied upon in most of its projects, although it acknowledged that projects aimed at reducing bacteria in flour relied on principles of biology.
Why Do Research Credit Claims Often Fail the Process of Experimentation Test?
The process of experimentation test proved to be the most significant obstacle for Siemer, as it is for many taxpayers. This test requires that “substantially all” (80% or more) of the research activities constitute elements of a process of experimentation for a qualified purpose related to function, performance, reliability, or quality.
The regulations define a process of experimentation as a “process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain.” This requires more than just uncertainty—it demands a structured method of discovery.
The Tax Court explained that a qualifying process of experimentation must “involve a methodical plan involving a series of trials to test a hypothesis, analyze the data, refine the hypothesis, and retest the hypothesis so that it constitutes experimentation in the scientific sense.” Simply conducting tests or attempting improvements isn’t enough.
This is where many taxpayers, including Siemer, fall short. They may conduct legitimate research, but they fail to document a methodical scientific process with hypothesis formation, testing, analysis, refinement, and retesting.
How Did Siemer’s Projects Fail to Meet the Standard?
The court analyzed each of Siemer’s research projects and found that none satisfied the process of experimentation test:
What Was Missing from the Flour Heat-Treatment Project?
For the flour heat-treatment project, Siemer aimed to develop processes to produce cake flour without chlorine, low-microorganism flour without chemicals, and all-natural replacements for modified starches. While these were legitimate research goals, the court found that Siemer didn’t demonstrate a methodical scientific process. The record didn’t establish how Siemer set out to achieve these goals through systematic experimentation.
Why Was the Pulsewave Project Considered Maintenance Rather Than Research?
The court characterized Siemer’s Pulsewave activities as “more akin to mechanical maintenance than research and experimentation.” Siemer claimed uncertainty about operating speeds, but documentation showed the machine had already been tested at the speeds Siemer claimed were uncertain. Additionally, the activities focused on mechanical adjustments rather than scientific experimentation.
What Distinguishes Testing from Experimentation in the Wheat Hybrids Project?
The wheat hybrids project involved testing new varieties of wheat to determine their suitability for current or new products. The court found this project failed both the business component test and the process of experimentation test. Rather than developing new wheat varieties, Siemer was merely testing existing hybrids from breeders—similar to evaluating commercial products, which explicitly doesn’t qualify under regulations.
The Takeaway
The Siemer Milling case demonstrates that documenting research activities isn’t enough—taxpayers must prove they followed a methodical scientific process. Companies seeking research credits should implement and document a structured approach involving hypothesis formation, testing protocols, data analysis, hypothesis refinement, and retesting. Without evidence of this scientific methodology, even genuine research activities may fail to qualify for the research credit.
