Research and Development (R&D) Credit
The Research & Development Tax Credit, which was established in 1981, is a federal incentive that allows businesses to decrease their income tax liability for the current tax year and receive a cash refund for taxes paid over the previous three years. Additionally, numerous states have created their own R&D Tax Credit, allowing qualified businesses to receive both credits. The PATH Act made the R&D Tax Credit permanent and expanded eligibility criteria, allowing small businesses to claim the Payroll Tax Credit.
Despite being accessible to businesses of any size or industry, many businesses are unaware that they qualify for the Tax Credit based on their daily operations. The R&D Tax Credit (26 U.S. Code §41) provides businesses with dollar-for-dollar cash savings for conducting activities related to product, process, formula, or software development, design, or improvement. This credit can be used to hire additional employees, expand R&D, and expand facilities.
R&D Four-Part Test
The Four-Part Test is a set of criteria that a business must meet to be eligible for the Research and Development Tax Credit. Here are the four parts:
- Permitted Purpose: The activity being performed must be related to the development of a new or improved product, process, formula, or software. In other words, the research must be intended to create something new or improve something that already exists.
- Process of Experimentation: The business must demonstrate that it is conducting a process of experimentation that involves systematic trial and error, or a process of evaluating different options, alternatives, and hypotheses. This means that the research must involve a structured and documented process of experimentation, rather than just trying things out at random.
- Technological in Nature: The activity being performed must rely on principles of engineering, science, or computer science. This means that the research must involve the use of technical expertise or specialized knowledge in a scientific or engineering field.
- Uncertainty: The business must demonstrate that there is uncertainty as to the outcome of the research or development activities. This means that the business must be able to show that it did not know if the research would be successful, or that there was a level of technical uncertainty that made the outcome of the research uncertain.
If a business can satisfy these four criteria, it may be eligible for the Research and Development Tax Credit.
Claiming the R&D Credit
Contact us for a free consultation to discuss your business, the ways in which you might qualify, and how we can assist with your R&D credit claim.