The Research & Development (R&D) Tax Credit represents an opportunity for many businesses to open the door to additional tax savings. Unfortunately, businesses have developed misconceptions about the credit including qualification, eligibility of internal activities, need for a formal R&D department, and that only certain industries such as manufacturing, software, and engineering can benefit. For this reason, many companies do not seriously investigate the R&D tax credit and are missing out on significant savings. This is especially true when combined with the recent tax changes designed to help companies during the COVID-19 pandemic
When determining if a business qualifies for the tax credit, there are important guidelines to consult. The most prominent, the Four-Part Test, comes from the Internal Revenue Code and determines whether certain expenses can be considered as qualifying research activities. To help clients, prospects, and others, Calvetti Ferguson has provided a summary of the test criteria below.
Four-Part Test for R&D Tax Credit Qualification
The combination of these four tests reveals whether a project has conducted qualifying research activities.
- New or Improved Business Component Developed for a Permitted Purpose – To satisfy this test, the purpose of the R&D should be to apply the information discovered to develop a new or improved business component. An improved business component can include a product, process, software, or formula which is to be used internally or offered for commercial purposes. Practically speaking this includes new or improved functionality, performance, reliability, or quality of a product, process, etc.
- Elimination of Uncertainty – To satisfy this test, it is necessary to illustrate activities were intended to discover information that could eliminate technical uncertainty about the design, methodology, or capability of development or improvement of a product or process.
- Process of Experimentation – To satisfy this test, the business must be able to demonstrate there was a process used which included the evaluation of alternatives to achieving the desired outcome. Examples may include ongoing testing, modeling, simulation, and systematic trial and error.
- Technological in Nature – To satisfy this test, the process of experimentation used to discover the information must rely on principles of the physical or biological sciences, engineering, or computer sciences. This ensures that any new information uncovered used a scientifically and approved process and not through other methods.
Important Exclusions to Qualification
There are certain activities that automatically exclude a project from qualification. This includes funded research, research conducted after the launch of commercial production, research conducted outside the U.S., and any research in economics, business management, behavioral sciences, and arts do not qualify.
How We Can Help
The R&D tax credit can result in significant savings for qualifying United States companies. Many of these companies are likely eligible for both a state and federal tax credit! Given the challenges ushered in by the COVID-19 pandemic combined with new tax-saving opportunities, now is the time to take a fresh look at the credit. If you have questions about the information outlined above or need assistance with another tax credit, Calvetti Ferguson can help.
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