Appeal of Advanced American Laboratories, Inc.

Appeal of Advanced American Laboratories, Inc., 2026-OTA-397P, decided by Administrative Law Judge Asaf Kletter, is a pending precedential Office of Tax Appeals (OTA) opinion addressing whether an environmental testing consulting firm's incorporation of newer analytical instruments into its hazardous-materials testing practice constituted qualified research. Advanced American Laboratories, a California C corporation that tested for mold, asbestos, lead, and similar contaminants, appealed the Franchise Tax Board's (FTB) denial of research credit refund claims of $11,022 for 2019 and $10,518 for 2020.

The Claimed Projects

The company's research and development study, prepared by a CPA who did not personally examine the underlying source documents, identified five projects: transmission electron microscopy dust sampling using a new comparative method; an artificial-intelligence system intended to automate microbiological sample analysis; adoption of xRapid Group's already-automated hands-free microscope platforms; forward-looking infrared (FLIR) thermal imaging to detect moisture intrusion and energy inefficiencies; and polymerase chain reaction (PCR) analysis to identify microbial contamination in dust samples. The study asserted that each project satisfied the four-part qualified research test but acknowledged that the company lacked a formal system for tracking research activity and instead estimated its research costs at 30 percent of certain direct expenses based on the CEO's own recollection.

No Contemporaneous Substantiation

OTA held that appellant's evidence -- the study itself, together with credible but general hearing testimony from the company's CEO describing the uncertainties each project addressed -- did not satisfy the section 174 test, the business component test, or the process of experimentation test. Citing its own precedential opinion in Appeal of Pino, 2020-OTA-375P, OTA reiterated that merely asserting the existence of an evaluative process does not establish that the taxpayer actually engaged in a qualified process of experimentation, and that a taxpayer claiming the credit must retain records in sufficiently usable form and detail to substantiate the expenditures, per Treasury Regulation section 1.41-4(d). The company's CEO testified that records were kept for only three years under a document retention policy and were not produced on appeal; without any contemporaneous emails, lab data, notes, or reports, OTA found the record insufficient to determine that at least 80 percent of the company's activities for any of the five projects constituted a structured process of experimentation for a qualified purpose, rather than the adaptation of existing, pre-developed instruments -- AI microscopy, hands-free platforms, FLIR cameras, and PCR analysis -- into the company's day-to-day testing practice, an outcome IRC section 41(d)(4) excludes from qualified research.

OTA also rejected appellant's argument that a federal tax refund for the same years established that the IRS had accepted the company's research credit, explaining that no evidence in the record showed the IRS had actually examined or approved the claim, and that FTB in any event is not bound to follow an IRS determination it believes to be erroneous, citing Appeal of Der Wienerschnitzel International, Inc. (79-SBE-063).

Significance

Advanced American Laboratories reaffirms that a taxpayer's good-faith belief that it improved its operations by adopting newer commercial technology is not, by itself, sufficient to establish qualified research; without contemporaneous technical documentation supporting a genuine process of experimentation, an after-the-fact study built on interview recollection and cost estimation cannot carry the taxpayer's burden of proof.