The R&D tax credit, which was originally introduced by Congress in 1981, was intended to incentivize companies to develop new and improved products and processes. In addition to the federal tax credit, about 40 states provide their own R&D tax credit.
Businesses that utilize the R&D tax credit include all types of manufacturing companies, architectural and engineering firms, software development businesses as well as companies engaged in developing a particular technology to enhance their core business endeavors.
The federal R&D tax credit is a computed proportion of the Qualifying Research Expenses (QREs). The proportion or amount of the credit depends on several factors and is calculated using either the Regular Credit (RC) method or the Alternative Simplified Credit method.
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Intrepid Advisors is a team of technological specialists comprised of highly educated and qualified engineers, scientists, and accountants with broad industrial experience. For the past 25 years, we’ve been offering consulting services relating to federal and state Research & Development Tax Credits.
Qualifying Research Activities
Qualifying Research Activities relate to efforts undertaken to develop new products, enhance existing products, and to develop or improve manufacturing processes. In order to qualify for the R&D tax credit, the qualifying research activities must satisfy the Four Tests ascribed by the Internal Revenue Service. In addition, the company carrying out the work must bear the financial risk.
The Four Tests
The activity was undertaken for the purpose of discovering information that is technological in nature and fundamentally relies on principles of physical or biological sciences, engineering or computer science. The activity was intended to exceed, expand or refine the common knowledge of the skilled professionals in a particular field of science or engineering.
The activity related to the performance, quality or reliability of a product, process, software, technique, formula or invention to be held for sale, lease or license by the company or for carrying out the company’s trade or business.
The activity was undertaken to resolve uncertainty concerning the configuration, performance or methodology of the intended product, process, software, technique, formula or invention. It must be demonstrated the company did not know:
- if it could achieve the desired result, or
- how to achieve the desired result, or
- the appropriate design, process or systematic configuration to achieve the desired result of the product, process, software, technique, formula or invention being developed.
The activity involved a process of experimentation in which more than one hypothesis was evaluated attempting to achieve the desired result. The process of experimentation included the design of an experiment to test and analyze the hypothesis, conducting the experiment, refining or discarding the hypotheses as part of a sequential design process to develop or improve a product, process, software, technique, formula or invention.
It has been found that there are three types of R&D situations in which qualifying research activities occur:
Qualifying Research Activities typically include one or more of the following:
- Development of products or processes using specific know-how that is treated as a trade secret or is patentable.
- Development of new or improved products in which the state of the art is advanced and that required one or more design iterations to achieve.
- Development or incorporation of a new technology in order to catch up to a competitor.
- An attempt to develop a new or improved product or process that was eventually abandoned.
- Implementation of a new process or improvements to an existing process relating to manufacturing, testing or quality control.
- Development of new products in which technical uncertainties must be overcome in order to satisfy the requirements of a customer specification or performance requirement.
Qualifying Research Activities are performed by employees who directly conduct, directly supervise or directly support the development effort.
Directly Conduct R&D
Employees who directly conduct research activities are generally involved in hands-on efforts and engaged in identifying and resolving technical problems. Examples of employees directly conducting research activities are:
- A scientist performing laboratory experiments.
- A design engineer developing and evaluating new products and/or prototype systems.
- A process engineer developing and/or improving the performance of fabrication systems.
- A chemist formulating new chemical systems or processing methodologies.
- A computer programmer developing software code.
Direct R&D Supervision
Direct supervision of research activities concerns immediate supervision (first-line management) of qualified research activities, as in the case of an engineering manager who directly supervises a team of engineers and technicians, but who does not perform hand-on development work. Direct Supervision does not include supervision by a higher level manager of a first-line manager who directly supervises but does not conduct hands-on research activities. Examples include:
- Attending technical meetings in which specifications, concepts or results are discussed;
- Meeting directly with engineers involved in resolving technical issues;
- Defining technical challenges needing to be addressed;
- Project planning;
- Reviewing proposed design configurations or process methodologies;
- Managing the development process;
- Providing feedback to senior management regarding the ongoing research activities.
Direct R&D Support
Direct support of research activities refers to activities performed that support those employees directly conducting or supervising the qualified research activities. Examples of such activities include:
- A technician calibrating research equipment;
- A machine operator fabricating a prototype component;
- A system operator assisting engineers with process trials;
- A shop foreman providing technical feedback to the research team;
- A salesperson providing conceptual or technical information to the development team;
- A clerk typing technical reports;
- A maintenance worker cleaning up following an experimental process test;
- A quality assurance worker performing analysis and compiling information relating to prototype products;
- A purchasing agent investigating sources and procuring materials for use in a prototype product or new process system.
Frequently Asked Questions
Have a question about the research tax credit? Perhaps you’ll find the answer among the commonly asked questions below.
1. Foreign research undertaken outside the United States and its territories.
2. Research conducted in the social sciences, arts, or humanities.
3. Ordinary testing or inspection of materials or products for quality control.
4. Market and consumer research.
5. Research relating to style, taste, cosmetic, or seasonal design.
6. Advertising and promotional expenses.
7. Management studies and efficiency surveys.
8. Computer software for internal use of the taxpayer, unless it meets additional tests.
9. General managerial and administrative duties.
10. Accounting tasks (i.e. bookkeeping, A/R, A/P, payroll).
11. Customer service support;
12. Routine status update meetings.
13. Commercial production.
14. Giving or receiving training.
15. Personnel matters.
16. Budget preparation.
17. Recruiting employees.
18. Charitable fundraising.
19. Attending industry or professional conferences.
20. Attending partnering and alliance activities and meetings.
21. Non-R&D related supervisory functions.
22. Internal business process development.
23. Research to locate and evaluate mineral deposits, including oil and gas.
24. Acquisition and improvement of land and of certain depreciable or depleted property used in research, including the annual depreciation deduction.
25. Research conducted after the beginning of commercial production.
26. Research related to adaptation of an existing business component including the duplication of existing products, processes, software, techniques, formulas or inventions.
27. Research related to duplication of an existing business component from a physical inspection, plans, blueprints, detailed specifications, etc.
28. Funded research, including any research funded by any grant, time and materials contract, or otherwise by another person or governmental entity.
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Many companies are not aware they are conducting qualifying R&D activities. Click on the images below to see a sampling of success stories and discover if your company qualifies for research tax credits.