Expanding Small Business R&D Tax Credit Utilization and Avoiding Obstacles Using the Four Part Test

Expanding Small Business R&D Tax Credit Utilization and Avoiding Obstacles Using the Four Part Test

Posted by on 12.06.19

Many new and small businesses have limited access to the R&D tax credit. In July 2019, Senator Tom Tillis and Senator Maggie Hassan proposed a bill - The R&D Tax Credit Expansion Act, to expand the research and development (R&D) tax credits that can be taken against federal payroll taxes for startups and small businesses. Unfortunately in the past, many small businesses and new start-ups weren’t able  to utilize the R&D tax credits to their advantage; however, this bill has the potential to change that. The proposed bill would double the research credit that could be utilized against payroll taxes for start-up companies. An eligible start-up small business is currently defined as a corporation, partnership, or sole proprietorship with gross receipts averaging less than $5 million for the tax year and five years or fewer of  gross receipts. The new bill (The R&D Tax Credit Expansion Act) would now double the research credit applicable for eligible start-up companies by increasing the cap from $250,000 to $500,000 and then indexing the cap for inflation. The new bill would also expand the research credit to include all payroll taxes, as well as extend the credit to more small businesses by increasing the size of eligible companies from $5 million in average gross receipts to $10 million a year.

The R&D Tax Credit Expansion Act will modernize the payroll tax offset for start-up companies by the  R&D credit by: 

  • Doubling the credit cap from $250,000 to $500,000 
  • Expanding it to cover all payroll taxes paid by startups, which add up to 8.25% of payroll 
  • Increasing the business eligibility cap from $5 million to $10 million in receipts 
  • This bill is the first stage of the legislative process. Once introduced to Congress it will typically be considered by committee next before being sent on to the House and Senate for final decision.

Meeting the Four-Part Test

The R&D tax credit encourages certain research activities by reducing a company’s liabilities for spending money on that research. The credit is equal to a certain percentage of a business’ qualified research expenditures (QRE) in excess of a base amount. Expenditures that qualify are more comprehensive than you may think. QREs can include the salaries of employees and supervisors who are conducting research, supply costs and even the costs  of the research that is contracted out. R&D tax credit eligibility largely depends on whether the work you are conducting meets the criteria established by the IRS in its four-part test:

  1. Qualified Purpose - The purpose of the research must be to create a new or improved product, process, or formulation, resulting in increased performance, function, reliability or quality. 
  2. Technological in Nature – The research must rely on principles of the hard sciences, such as engineering, physics, chemistry, biology or computer science. 
  3. Elimination of Uncertainty – Activities must overcome some unknowns, such as uncertainty as to capability, optimal design, or optimal methodology. 
  4. Process of Experimentation – Experimentation can be demonstrated through test batches, simulations, systematic trial and error, or other methods of evaluating alternatives to achieve a desired result. 

Find Out if Your Activities Qualify

The R&D tax credit can be a lucrative incentive for start-up businesses. To learn more about whether your industry and company activities meet the R&D four-part test, request our free assessment today.

Though calculating the R&D credit is not complicated; knowing which expenses qualify and whether you have the correct documentation to back them up, is more difficult for many small businesses. Your accountant or qualified R&D tax credit expert can help you determine whether your business activities meet the criteria of the test by conducting a tax credit study.

Tax Point Advisors provides R&D tax credit study services and other specialty tax services to CPA firms and their clients throughout the U.S. To learn more about R&D tax credits from the experts at Tax Point Advisors, please call us at (800) 260-4138 or please leave us a message below.


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