The Research and Development Tax Credit (R&D Tax Credit), offered by the U.S. government to incentivize and reward companies’ innovation efforts, is a tax credit that provides tangible tax savings to many companies that engage in efforts to make improvements. If you have used your resources to improve your company, or even if you tried and were unsuccessful in your efforts, you could be eligible for tax savings. Improving your company’s products, processes or software may qualify you to take advantage of tax saving benefits, but it can be difficult to navigate the formalities and stipulations of what qualifies, what doesn’t qualify and how to tell the difference.
The R&D Tax Credit can be used to offset the costs associated with conducting research, but it can also serve as a financial reward for conducting specific activities. That’s why the IRS separately outlines specific qualified research expenses (QREs) and qualified research activities. Understanding these two categories can help to clarify how companies can qualify for the R&D Tax Credit.
What are Qualified Research Expenses?
QREs are determined by the IRS as the costs a company pays in association with conducting research activities that will fit within the stipulations of the R&D credit. According to the IRS in Section 41(b), QREs include:
- Employee compensation for performing certain qualified services;
- Materials necessary for conducting qualified research and development;
- Payments to secure the use of computers for the use of conducting research; and
- A percentage of the compensation paid to contract employees for conducting qualified research activities.
It’s important to note that, while they may qualify, these expenses may not be covered in full by the Research and Development Tax Credit. Certain expenses, such as contracted employee wages, may only return a percentage of their cost through the credit, though savings can still be exponential.
What are Qualified Research Activities?
The IRS specifies which actions can be viewed as qualified research activities by providing criteria for individual projects that a company is completing.
Four Part Test
To determine if a project meets the criteria for receiving the R&D Tax Credit, the IRS employs a four-part test. If your company’s latest project fulfills each of the four provisions in this checklist, it may qualify you for the R&D credit.
- Elimination of Uncertainty: Your project’s efforts have sought to dismiss ambiguity associated with your project’s development or improvement and eliminate uncertainty. Your innovation goes beyond cosmetic designs or adjustments and seeks to improve functionality in a new way by gaining information and reducing any ambiguity associated with its development. You have the information to show that your improvements were implemented or to prove that your improvements can be implemented.
- Process of Experimentation: Your company has explored multiple avenues to reach a certain goal, and you can prove that you utilized some type of experimentation to determine the best way to move forward in your innovation. Your improvements can be traced back to information that you gained in trial and error, modeling or other experiments. You have tried several ways to achieve your innovation goals for your project.
- Technological in Nature: Your project and methods for evaluating your success were based in the hard sciences, such as physics, engineering, computer science or chemistry. This doesn’t necessarily mean that your research must only be about technology or technological products or processes, but it does mean that you used scientific principles in your efforts to improve your company.
- Qualified Purposes: Your project’s goal was to make improvements to your company, regardless of whether you were creating or refining products, processes or software. You attempted to improve accuracy, speed, quality or another performance factor. According to the IRS, your project needs to be “intended to be useful in the development of a new or improved business component of the tax payer.”
What Doesn’t Qualify
Even though many research activities qualify, it’s important to note that some projects that require research may not qualify your company for the Research and Development Tax Credit. Things like duplicating a project your company has previously completed, reviewing management and administrative functions for effectiveness or conducting activities outside of the United States may not make your business eligible in themselves. Any research, surveys, data collection or other activities geared toward the social sciences will not qualify for the R&D Tax Credit either. For projects that you have already begun, the status of your project’s completion and your funding may also affect qualification.
Regardless, it’s important to remember that each company is different, each project is different and the R&D credit will apply differently to everyone. Warren Averett’s Quali-Finder™ process can help provide more information about the R&D Tax Credit, research and development activities s and how to know if your company could be eligible. In addition to the R&D credit, Quali-Finder may also uncover other potential areas of tax savings for your company. Begin the Quali-Finder process today with Warren Averett’s tax experts to see what tax credits your company could be overlooking and how to take advantage of them.