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Tax Blog

Research and development - Tax Credit

Has your company devoted time and resources to create a new or innovative product? Have they committed to improving a current product or process? If so, you may be eligible for a tax credit offsetting income tax, payroll tax, or even the alternative minimum tax.

The IRS allows businesses that perform qualified research and development activities to utilize the federal research and development tax credit and reduce their tax liability. Most states provide a similar credit. To qualify for this credit, business owners must demonstrate that their research and development activities meet the requirements of the credit.

Companies performing research in the course of business may qualify their activities for the tax credit if they meet the four-point test under Section 41:

  1. Permitted purpose

Research and development activities must develop or improve the functionality, performance, reliability, or quality of a new or existing business component. ​This may be accomplished through product, process, computer software, technique, formula, invention, etc.

  1. Elimination of uncertainty

The development or improvement of the business component must seek to discover information that would eliminate uncertainties about its appropriate design or the capability or method of its development. Uncertainty exists where publicly available information and knowledge cannot be applied to achieve the desired result.

Note: Uncertainties do not need to be resolved in the credit year and can span across multiple years.

  1. Process of experimentation

Taxpayers are required to identify technological uncertainty and then properly evaluate one or more alternatives to eliminate it. This may be accomplished through modeling, simulation, systematic trial, and error, etc.

  1. Technological in nature

Experimentation has to rely on principles of engineering, physical or biological science, or computer science and seek to discover information that is technological in nature.

Documentation can be key to claiming this credit, it is crucial to keep records that substantiate research and development activities to avoid IRS scrutiny. Some expenses may be estimated, but they must rely on a factual basis for the assumptions used to create the estimates. Documentation should be completed contemporaneously with the activity and dated accordingly.

The professionals at The Center are more than knowledgeable on tax credits and various other write-offs, for more information, please contact us at (618) 997-3436


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