Does My Business Qualify for the R&D Tax Credit? The 4-Part Test Explained

Part 1: Section 174 Test and Technical Uncertainty

The first part of the R&D tax credit 4-Part Test considers whether research or experimentation was undertaken to eliminate uncertainty surrounding the development or improvement of a business component.

In practical terms, your team may have known what it wanted to accomplish without knowing exactly how to accomplish it.

For example, a manufacturer may want to increase production capacity but be uncertain about the equipment configuration required. A software company may know what an application needs to do but be uncertain about the appropriate architecture.

When evaluating technical uncertainty, consider:

• What didn't we know when the project began?
• Were we uncertain about the appropriate design, method, capability, or process?
• Did technical challenges require us to develop and evaluate potential solutions?

Simply following an established process when the method and outcome are already known generally does not present the same type of technical uncertainty.

Part 2: What Does "Technological in Nature" Mean for the R&D Tax Credit?

The technological in nature test requires the research process to rely on principles of physical or biological sciences, engineering, or computer science.

A company does not need scientists or a formal R&D department to meet this requirement.

A manufacturer testing production configurations may rely on engineering principles. A software team evaluating algorithms or database structures may rely on computer science. A food manufacturer experimenting with formulations may rely on chemistry or other applicable sciences.

The important consideration is how the team attempted to solve the technical problem, rather than the job titles of the employees performing the work.

Part 3: What Is a Business Component for the R&D Tax Credit?

Qualified research must relate to a business component, which can generally include a:

• Product
• Process
• Computer software
• Technique
• Formula
• Invention

The business component does not necessarily need to be completely new. A company may be attempting to improve something it already develops, produces, uses, or sells.

Those improvements generally need to relate to function, performance, reliability, or quality.

For example, a manufacturer redesigning a production process to reduce defects may be attempting to improve the reliability or quality of its existing manufacturing process.

This is one reason companies sometimes overlook R&D tax credit opportunities. Qualified research isn't limited to inventing something groundbreaking.

Part 4: What Is the Process of Experimentation for the R&D Tax Credit?

The process of experimentation test focuses on how the business attempted to resolve technical uncertainty.

This may involve evaluating alternatives through:

• Prototypes or alternative designs
• Modeling or simulations
• Trial production runs
• Software testing
• Material testing
• Changing technical variables
• Analyzing results
• Revising and retesting designs or processes

For example, a manufacturer developing an automated production process might test multiple equipment configurations, measure output, identify failures, adjust settings, modify the design, and conduct additional trials.

Simply making a change isn't necessarily qualified research. The key consideration is whether the company evaluated alternatives as part of a process intended to resolve technical uncertainty.

Using GOAT.tax to Apply the R&D Tax Credit 4-Part Test

GOAT.tax is R&D tax credit software built for businesses that want a structured way to prepare their own R&D tax credit study. Rather than making the qualification decision for you, GOAT.tax provides a guided workflow for evaluating activities, organizing project information, identifying associated qualified research expenses, and developing supporting documentation. Each business component in GOAT.tax runs through an eligibility check built on these same four parts: what's being developed or improved, the technical uncertainties, the sciences relied on, and the process of experimentation.

You bring the knowledge of what happened within your business. GOAT.tax provides the structure for turning that information into an organized R&D tax credit study. The completed study includes the report along with federal and applicable state forms and filing instructions. For taxpayers with complex projects or those who aren't comfortable making their own qualification determinations, GOAT.tax also supports collaboration with your CPA and review by Source Advisors' R&D specialists.

Either way, the starting point is the same: understand the R&D tax credit 4-Part Test, evaluate the actual activities performed, and document the basis for the position taken.