The Research and Development Tax Credit incentivizes certain research activities by reducing a company’s liability for spending money on research. The credit is equal to a percentage of a business’ qualified research expense (QRE) in excess of a base amount.
The 4 Part Test
Expenses that qualify are more complex than one might think—QREs can include the salaries of employees and managers that conduct research, supplies and even some research that is contracted out. The 4 Part Test helps businesses determine qualified R&D activity. R&D tax credit eligibility depends on whether the work the business is conducting meets the criteria established by the IRS in the test.
1. Permitted purpose
This component of the test ensures that the purpose of your spending was directly related to researching and developing improvements of your business. The activity or project must have created, improved, or attempted to improve a business component’s flexibility, performance, reliability, or quality. What can you consider a “business component”? That would be any product, process, technique, invention, formula, or software that you are going to sell, lease, license or use in your own business.
2. Elimination of uncertainty
You must be able to show that one of your goals was to eliminate uncertainty regarding the development or improvement of the business component. That means that if you lacked information that would improve your product, and therefore you conducted research to learn that information, you have conducted eligible research as it relates to this part of the test.
3. Process of experimentation
You also must have gone through a trial-and-error process of gathering information and testing theories that gave you the information you needed to eliminate uncertainty regarding your product.
4. Technological in nature
When you were undertaking the experimentation process, you must have relied on information that could be gathered through the physical or biological sciences, engineering, or computer science. That does not mean that you had to create new methods in these sciences for researching and testing for your product, as it is fine to use existing, established principles of these sciences to conduct your research.
If you’re still unsure about whether or not your company’s projects can be claimed for R&D credit, consider that all of the following could potentially count:
- Salaries for the individuals who managed or conducted R&D in your company.
- Contracted labor and research.
- Leased equipment costs.
- Supplies purchased.
- Cloud storage costs for data and research.
In short, the huge credits that remain unclaimed are the result of businesses not realizing that work they are already doing is claimable.
Check out our free PDF Guide on Claiming Your Research & Development Tax Credit to learn how the credit works and how you can leverage it for your business.