It's not often that fashion and baseball make it into one space, let alone a Tax Court case. This one was worth the read - fun, full of subtle burns, and insightful as to qualifying for the research credit.
Well-known fashion designer Leon Max, who had engaged a tax consulting firm to perform an R&D study, was denied over $800,000 in §41 research credits because the activities were found to not constitute qualified research. Both parties presented fashion industry experts to prove or disprove the company had used science and technology to experiment and eliminate uncertainties in its pre-production process.
Mr. Max laid out a detailed account of the clothing design and production process, and pointed out that the development team occasionally did not know how to execute certain design elements in the beginning, necessitating a trial and error process. Apparently twisted shoulder straps caused quite the ordeal on one occasion. Additionally, significant testing was done on garments to ensure proper fit. Mr. Max’s fashion industry expert testified that the company had “utilized and relied on principles of material science, textile engineering and chemistry.”
The IRS and its fashion industry expert disagreed that such activities qualified for the research credit as developing or improving a product or process, and instead fell under the disqualified nontechnical categories of style and taste. Furthermore, Max’s company was not conducting processes out of the norm for creating garments – there was no discovery of information or uncertainty that relied upon the sciences. How to “drape a particular fabric to achieve the desired aesthetic may be unknown, but the [company’s] garment makers already have the information necessary to address that unknown.” Moreover, the fit testing described at length by Mr. Max was deemed ordinary testing or inspection of materials for quality control – which does not meet requirements for the credit.
It then gets desperate – Mr. Max insisted that because a coefficient exists to express how a fabric drapes (even though the company did not use it!), that suggests a reliance on scientific principles. The Tax Court countered with the fact that a formula exists on the physics of baseball "does not make a centerfielder a mathematician." Burn? Having played softball competitively for over a decade, I'm offended and also flattered people think our natural reflexes alone make us good at a sport. I’m sure pool sharks would disagree with the Court's assumption, also. Either way, the Court said no, sir, it is not a function of “high technology activities” for the purposes of the research credit.
And as far as experimentation goes, the Court noted most clothing design is style driven with a predefined purpose. “The function of all pants is essentially the same: to stay up and cover the wearer from the waist to somewhere below the knee. Every other consideration when buying pants is one of cosmetics.”
Strike 1, 2, 3…Mr. Max’s credit is outta here.
The Tax Court will not hesitate to burn a taxpayer when provoked and wears pants in the blandest way possible, while acknowledging that beauty is pain.
There must be an element of uncertainty and scientific experimentation to claim the research credit. Quality control and processes with a known outcome generally won’t work.
Leon Max v. Commissioner, TC Memo. 2021-37