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The Four-Part Test | R&D Tax Credit

The R&D tax credit (research and development tax credit) is a state and federal tax credit that rewards companies that create, develop new products or processes, or improve an existing one. This incentive comes in form of a dollar-for-dollar tax credit. R&D expenditures used to calculate the R&D tax credit include the wages paid to employees for engaging in qualifying R&D activity within the U.S., including direct supervision and direct support of such activities. Also, up to 65% of outside contractor costs associated with qualifying R&D activities can count towards the credit calculation as well, as long as the contractors are based in the U.S.[1]

What is the Four-Part Test?

To qualify, the IRS has a four-part test you must pass to be eligible to claim the R&D tax credit. Most companies don’t know that the development and research activities they’re currently doing might already qualify for this tax credit, and below we will explain each section of the four-part test.

Part #1 - New or Improved Business Component for Permitted Purpose

The company needs to be trying to develop a new or improved business component. These activities do not need to be successful endeavors. Whether you’re successful or unsuccessful, these activities may still qualify for pass this part of the test. As defined in the IRS regulations, the business components include:

  • Product 
  • Process
  • Technique
  • Invention
  • Formula
  • Software

Part #2: - Activities Technological in Nature

The activities must be technological and must involve hard sciences such as:

  • Engineering
  • Physics
  • Biology
  • Computer Science
  • Chemistry

Part #3 - Elimination of Uncertainty

Qualified research activities must be performed to eliminate technical uncertainties. Even if the company knows the research project’s objectives can be achieved, expenditures can still qualify, provided there’s some uncertainty at the onset when the company is trying to develop a new or improved business component. However, there only needs to be uncertainty regarding one of three things:

  1. Can they do it?
  2. How would they do it?
  3. The ultimate or appropriate design of what they are trying to develop.

Part #4 - Process of Experimentation

The company must evaluate different alternatives when trying to develop the new or improved business component. Examples of this include: 

  • Systematic trial and error
  • Modeling
  • Simulation

Did You Pass the Four-Part Test for the R&D Tax Credit?

If you can answer yes on each of the four areas covered above, you might qualify and benefit from the R&D tax credit. If you’re still unsure that your business may or may not qualify, reach out to one of our specialty tax experts today.

Did You Pass the Four-Part Test for the R&D Tax Credit?

If you can answer yes on each of the four areas covered above, you might qualify and benefit from the R&D tax credit. If you’re still unsure that your business may or may not qualify, reach out to one of our specialty tax experts today.

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