Claiming the Research and Development (R&D) Tax Credit can potentially increase cash flow, reduce your Federal tax rate, and give you a Federal and State dollar-for-dollar income tax reduction. But before you complete IRS Form 6765 to claim the R&D tax credit, it’s important to know that it can only be applied to qualifying research activities.
What is Qualified Research Activity?
Also known as a QRA, a qualified research activity is defined as a specific effort to develop new products, fabrication processes, or software, or improve existing ones. The IRS has established a Four-Part Test (as outlined in IRC §41(d)) to determine if research activities are eligible, which include:
1. Business Component Test
The activity must be related to the performance, quality, reliability, or new or improved function of a business component of the taxpaying company. A business component is defined to be “any product, process, software, technique, formula or invention used by the taxpaying company in trade or business.”
2. Technological Uncertainty Test
The activity must involve the elimination of uncertainty. An activity entails uncertainty if the taxpayer did not know one or more of the following:
- Whether the desired results could be achieved
- The specific means of achieving the desired result
- The appropriate design of the business component being developed
3. Process-of-Experimentation Test
“Substantially all” of the activity must involve a “process of experimentation” involving more than one possible approach toward achieving the result, where the capability or method of achieving the result is uncertain at the outset of the activity.
4. Technological‐in‐Nature Test
Activities that are undertaken to discover information must be technological in nature. For example, experiments used to eliminate uncertainty must rely on principles of physical or biological sciences, engineering, or computer science.
Examples of Qualified Research Activities
The following are examples of general activities that qualify for the R&D tax credit:
- Creating improved products, processes, formulas, software, and techniques
- Automating or improving internal manufacturing processes
- Designing tools, jigs, fixtures, and molds
- Integrating new equipment
- Development of data center, big data, and data mining tools
- Integration of APIs and other technologies
- Development of financial or pricing models
- Hiring outside consultants to perform any of the listed activities
- Manufacturing new or improved products
- Developing prototypes, first articles, models
- Evaluation of alternative materials
- Development of firmware
- Network hardware and software development and optimization
- Developing simulators
- Development of risk management systems
Activities such as providing training, customer service support, payroll, research relating to style or cosmetic design, attending conferences, and management studies are not considered qualified research activities.
Examples of Expenses That Qualify as Research Activities
The following expenses can qualify for research activities:
- Employee compensation
- Materials
- Contracted services
Payroll records, financial records, vendor invoices, and/or contract research expenses are often needed as proof of the expenses.
It can be difficult to know exactly which activities qualify as research activities, which is why it’s beneficial to work with professional R&D tax advisors.
How We Can Help
GOAT.tax is powered by Source Advisors, a leading tax consulting firm providing R&D tax credits for over 4 decades. Source Advisors can assist your small business with:
- Identifying your qualifying development activities and expenses
- Computing your R&D tax credits
- Preparing any supporting documents that are needed
- Assisting with the payroll tax offset
Founded on the basic principle that the R&D tax credit should be available to companies of all sizes without fees burdening the benefit, the GOAT.tax automated software platform is backed by 350+ years of collective R&D tax credit experience. This is what sets us apart from any other platform. Our people and our experience.
Now is a good time to reexamine prior, current, and future R&D activities in order to take advantage of the R&D tax credit, regardless of industry. If you think your company might be performing work that qualifies, don’t let the potential tax savings go unclaimed. GOAT.tax can help you claim vital tax savings to reinvest in your business and fuel your next big project.
Automated Software vs. Traditional R&D Tax Credit Consulting
GOAT.tax was created to educate businesses on the R&D tax credit and help those who qualify successfully claim it on their own. Our nationwide team has over 350 years of collective R&D tax credit experience, and our mission is to take the guesswork out of this credit so you can focus on your core business.
The Three Types of Research and Development
Businesses should consider claiming the Research and Development tax credit for various reasons, but eligibility must be determined and three types of R&D align with the business's nature.
Common Challenges When Claiming R&D Tax Credits
Although claiming this credit can offer considerable benefits for companies engaged in R&D efforts, the process can be challenging.