The 4 Part Test to Qualify for the R&D Tax Credit

Written by Graham Eichman

A person reviewing the four part test

If you are considering exploring the R&D tax credit advantage further, it would be important to first review this four-part test provided by the IRS. If it seems you qualify under the guidelines of this test, talk to a tax professional that specializes in the R&D tax credit. There is documentation you will need to provide and keep track of moving forward. This may sound arduous, but the benefits could lead to hundreds of thousands of dollars in savings. We can’t overstate the strategic advantage tax credits can provide. Taxation is a way to incentivize or disincentivize behavior, and in the case of R&D tax credits, the government wants your company to invest in your company. The credits eliminate or dramatically reduce the risk of innovation.

  1. Elimination of Uncertainty: You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process. In other words, something that has been changed solely for aesthetic purposes would not qualify.

  2. Process of Experimentation: You must demonstrate – through modeling, simulation, systematic trial and error or other methods — that you’ve evaluated alternatives for achieving the desired result.

  3. Technological in Nature (The Discovering Technological Information Test): The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science. Note: companies are not required to exceed, expand or refine existing scientific principles.

  4. Qualified Purpose (The Business Component Test): The purpose of the research must be to create a new or improved product or process, resulting in increased performance, function, reliability or quality.

Example: Let’s say your firm has a product run by software. Development costs for new software to make the product more reliable and more efficient might qualify for the credit. This is not predicated to an industry, so all companies that use software to improve business functions developed for the business could qualify.

Some activities do not qualify for the R&D credit, including funded research (for example, funded by a government grant), ordinary testing and inspection, research done outside the U.S., reverse engineering (unless such engineering involves an enhancement, in which case a percentage of your R&D costs may qualify for the credit), adaptation of an existing business component to a particular customer’s requirement or need (for example, adapting a computer program you sell to a particular customer’s requirement), or research with a non-functional focus such as improving or changing style, taste, or cosmetic changes.

Learn about the top five R&D tax credit Misconceptions

Written by Graham Eichman

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