Grigsby v. United States

United States v. Grigsby, Civil Action No. 19-00596-BAJ-SDJ (M.D. La. Oct. 19, 2022), affirmed sub nom. Grigsby v. United States, 85 F.4th 258 (5th Cir. 2023), is a leading modern application of the Section 41(d)(4)(H) "funded research" exclusion to the construction industry. The Government sued Leonard and Barbara Grigsby to recover a $576,756 tax refund (plus interest) that resulted from a qualified research tax credit ("QRTC") claimed by their S-corporation, Cajun Industries, LLC, a Baton Rouge civil construction company. Judge Brian A. Jackson granted the Government's motion for summary judgment, and the Fifth Circuit affirmed.

Background

In 2015, Cajun retained alliantgroup LP to review whether it was entitled to amend prior returns to claim additional Section 41 research credits for the 2011 through 2016 tax years. Based on a sample of 105 projects from Cajun's 2012 tax year, alliantgroup determined that Cajun was entitled to claim more than $1.3 million in additional research credits. Cajun, which had never before claimed the QRTC, amended its return for the tax year ending September 30, 2013 to claim a credit of $1,341,420, generating a pro rata K-1 allocation to Leonard Grigsby (a 73 percent shareholder) of $979,237. On their own amended return, the Grigsbys claimed a resulting tax credit of $954,527, producing an overpayment of $576,756 plus $73,663.38 in statutory interest -- the "Contested Refund" the IRS paid out in September 2017 and the Government later sued to recover.

The parties agreed to resolve the case by reference to four representative projects from Cajun's 2013 tax year: the Methanex Project (a capped subcontract with Jacobs Field Services for site preparation of a methanol plant relocation), the Chevron Project (a capped contract for refinery expansion work in Pascagoula, Mississippi), the Claiborne Project (a fixed-price federal contract with the U.S. Army Corps of Engineers to build a flood-control box culvert in New Orleans), and the East Bank Project (a fixed-price contract with the Sewerage and Water Board of New Orleans for flood-protection work).

Failure to Establish a Qualifying "Business Component"

Before reaching the funded research exclusion, the court rejected Defendants' claim on an independent, threshold ground. Qualified research requires that the work be intended to develop a new or improved "business component" -- a product, process, technique, formula, or invention. Defendants' verified interrogatory responses had stated that Cajun developed a new "product" on each representative project, but their summary judgment opposition pivoted, without ever supplementing discovery, to arguing that Cajun instead developed new "construction processes." The court held that this undisclosed, last-minute shift ran afoul of Federal Rule of Civil Procedure 26(e) and warranted exclusion under Rule 37(c)(1), and that in any event Defendants never identified even a single specific process that was actually new or improved, offering only the vague assertion that Cajun "performed engineering analyses that fundamentally relied on engineering principles." Vague and conclusory statements, the court held, cannot defeat summary judgment.

The Funded Research Exclusion

The court went on to hold, independently, that any qualified research Cajun did perform was "funded" within the meaning of Section 41(d)(4)(H), which excludes "any research to the extent funded by any grant, contract, or otherwise by another person." Under Treasury Regulation section 1.41-4A(d), research is unfunded only if (1) payment is contingent on the success of the research, and (2) the taxpayer retains substantial rights to use or exploit the results without paying for that right.

Substantial Rights: Methanex, Chevron, and Claiborne

The Methanex, Chevron, and Claiborne contracts each failed the substantial-rights prong on their face. The Methanex subcontract designated all of Cajun's "Work Product" -- defined expansively to include any technical manifestation of Cajun's efforts -- as "work made for hire" with all rights, title, and interest vesting in Methanex USA. The Chevron contract similarly required Cajun to use its "Technical Information" -- including "all inventions, discoveries or improvements" made in performing the work -- solely for Chevron's benefit, to disclose it promptly to Chevron, to assign any resulting patent applications to Chevron, and to consent to injunctive relief for any unauthorized use. And under the Claiborne contract, incorporated FAR provisions gave the government sole ownership of "all material and work" covered by progress payments, a term broadly defined to include construction activity generally. The court found these provisions eliminated any plausible reading under which Cajun retained the right to use its own construction methods without paying for that right, citing Dynetics, Inc. v. United States, 121 Fed. Cl. 492 (2015), and Tangel v. Commissioner, T.C. Memo. 2021-1, as directly analogous.

Payment Contingency: The East Bank Project

The East Bank contract was silent on ownership of any research results, so the court instead analyzed whether Cajun's payment was contingent on the success of its research. Fixed-price contracts are ordinarily presumed unfunded, since the contractor typically bears the risk of remedying failed work at its own expense. But the East Bank contract rebutted that presumption: its Monthly Payments clause expressly compensated Cajun for "all loss, damages or risks of every description ... connected with or resulting from the nature of the work," and separately required the client, not Cajun, to bear the cost of any additional laboratory testing. Because Cajun was contractually insulated from the financial consequences of any research failure, its work on the East Bank Project was funded research regardless of the fixed-price structure.

Disposition and Significance

The district court granted the Government's motion for summary judgment in full, and the Fifth Circuit affirmed at 85 F.4th 258 (2023). Grigsby has become a frequently cited warning to contractors -- particularly in architecture, engineering, and construction -- that standard-form intellectual property and confidentiality clauses common to commercial and government contracts can independently defeat a research credit claim, regardless of how much genuine technical uncertainty the underlying work involved. It sits alongside Dynetics, Inc. v. United States and Populous Holdings, Inc. v. Commissioner, both discussed in the opinion, in the modern line of authority applying the funded research exclusion.