How to Qualify for R&D Tax Credits: The Four-Part Test

How to Qualify for R&D Tax Credits: The Four-Part Test

Posted by Jeffrey Feingold on 04.28.16

Watch this short video for an explanation of the four-part test.

 

The federal government implemented the Research and Experimentation tax credits in 1981 to create jobs and spur technology in the U.S. Known as R&D tax credits, the program was meant to be a temporary measure to give the economy a boost. However, the credit program was extended by Congress more than a dozen times until last December when the Protecting Americans from Tax Hikes (PATH) Act of 2015 made the R&D tax credit permanent.

See our blog: PATH Widens for R&D Tax Credit Opportunities.

The R&D tax credit originally pertained to basic research expenses, such as those occurring in a laboratory setting. Subsequent modifications simplified the credit and made it available to a wider variety of businesses.

Meeting the Four-Part Test

The R&D tax credit incentivizes 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 expense (QRE) in excess of a base amount. Expenses that qualify are more comprehensive than you may think—QREs can include the salaries of employees and supervisors who are conducting research, supplies and even some of the research that is contracted out. A simple four-part test helps to determine qualified R&D activity. 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. 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.
  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.

Request a free assessment to determine qualifying R&D tax credit eligibility.

What kinds of activities meet this 4-part test?

Here are 10 examples of qualifying research activities:

  1. Conduct testing of new concepts and technology
  2. Develop prototypes and models
  3. Develop new, improved or more reliable products, processes or formulas
  4. Develop or apply for patents
  5. Add equipment that improves a process
  6. Streamline your manufacturing process
  7. Develop new software
  8. Design for LEED/green initiatives
  9. Conduct environmental testing
  10. HVAC concept and design

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.

Find Out if Your Activities Qualify

The R&D tax credit can be a lucrative incentive for innovative businesses. Given the new permanent nature of the tax credit, now is the time to consider whether activities performed by your company qualify for major cash-saving tax credit opportunities. To learn more about whether your industry and company activities meet the R&D four-part test, request our free assessment today.

Tax Point Advisors, a firm with expertise in working with small and midsize companies, works with businesses that may qualify for R&D tax benefits. For more information, please leave us a message below.


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