The Research & Development Tax Credit - Can you Qualify?

By Jill Mazur, CPA, Director of Engineered Tax Services

 

The Research and Development Tax Credit is a permanent federal tax incentive meant to stimulate innovation, technical design and manufacturing within the U.S. Most states have a similar tax incentive as well.

The R&D Tax Credit has been available since 1981, and recently companies had to develop a product or process that was new to the world, and fast forward to today and companies no longer need to develop a product or process that is new to their industry, it only needs to be new to them.

In order to benefit from the R&D tax credit, a company has to have activities that qualify, and in order to determine if an activity qualifies or not, it has to pass a four part test.  If trying to determine if activities qualify seems daunting, rest easy, your CPA, and/or specialty tax provider, can determine this for you.

The four part test:

The four part test is explained in IRS Section 41 and 174, and is as follows:

  1. Permitted Purpose - The activity must relate to a new or improved business component which relates to function, performance, reliability, or quality, and computer software is included.
  2. Elimination of Uncertainly - The activity must be intended to discover information to eliminate uncertainly concerning the capability, method or design for developing or improving a product or process.
  3. Process of experimentation - The taxpayer must engage in an evaluative process that is capable of identifying and evaluating more than one alternative to achieve a result. This may include modeling, simulation or or a systematic trial and error methodology.
  4. Technological in Nature - The activity performed must fundamentally rely on principles of Physical or Biological Science, Engineering, Computer Science.

Your business may conduct activities that qualify and activities do not, but the taxpayer can still benefit from those actives that do qualify.  It is not all or nothing.  In addition, activities that result in failure can also qualify.

Generally, most companies are performing activities that qualify for the R&D tax credit if they:

  • Develop processes, products, techniques, inventions, formulations or software
  • Improve existing products, or processes
  • Have patents
  • Employ or use outside scientists, engineers, or designers

There are specific activities that do not qualify, and those excluded activities are:

  • Research after commercial production
  • Adaptation to a particular customer without completing the four part test
  • Reverse Engineering
  • Funded Research
  • Management activities, efficiency surveys, and market research
  • Routine data collection & quality control
  • Research conducted outside of the United States and its territories

Regardless of industry, if a company is performing activities that meet the four part test, they may be able to benefit from one of the most powerful tax incentives available today, the Research & Development Tax Credit.  If you are not claiming the credit, and have qualifying activities, chances are you are leaving money on the table.