Passing the 4-Part R&D Tax Credit Test

When claiming the R&D tax credit, the IRS requires business owners to take a four-part test. The R&D tax credit test ensures that companies comply with the requirements to claim tax credits. We break down each section of the four-part test to put companies in an excellent position to get the most out of their R&D activities.

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New or Improved Business Component Test

A company must partake in an activity that involves creating or improving a business component. The IRS defines business components as:

i.            Product

ii.           Process

iii.          Technique

iv.          Invention

v.           Formula

vi.          Software

Research activity must directly involve the business components and be performed to improve functionality, reliability, quality, or performance. Improvements can be slight changes or complete overhauls of the business component. Non-technical changes, such as the product’s color, do not count as qualified research activities (QRAs). It is important to remember that R&D activities need not be successful to meet this test criterion.

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Technologically Oriented Activities Test

To ensure that discoveries are made through a scientific method, research expenditures must be in the hard sciences, such as:

• Engineering
• Physics
• Biology
• Chemistry
• Computer Science
• Mathematics

The research doesn’t have to exceed, expand, or refine common knowledge of these fields. QRAs only need to be new to the business component. Soft sciences that utilize theories and hypotheses, such as psychology or sociology, do not qualify as QRAs, nor do activities such as studies and surveys.

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Elimination of Uncertainty

This test section requires companies to prove that their QRAs attempt to eliminate technical uncertainty surrounding the business component’s functionality, reliability, quality, or performance. Businesses must identify the uncertainty they are trying to resolve and document the alternatives they are testing.

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Experimental Process

Lastly, businesses must demonstrate that they are evaluating alternatives for the desired result through experimentation. Companies must verify that alternative methods were tested through modeling, discussion, design, and simulation.

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Companies that meet all four criteria have a high chance of passing the R&D tax credit test. MainStreet verifies that your business activity meets all the test requirements and matches it with all applicable R&D tax credits. Contact us today.