R&D Tax Credit: The 4-Part Qualification Test Explained

MARCH 15, 2021

12:00 AM

By Blake Garvey

The R&D Tax Credit is a federal incentive that rewards innovative companies that improve or develop a new product and/or process. To make sure that companies are staying compliant, the IRS has enforced a four part test that must be met by companies aiming to claim the R&D Tax Credit.

Alternatively, companies that aren’t sure if they qualify may actually find themselves innovative once they look at the four part test. An activity that meets the 4-part test is a qualifying research activity and can potentially qualify for the R&D Tax Credit.

What is the 4-Part Test?

1. Permitted Purpose (or Qualified Purpose/Business Component Test)

An activity intended to develop new or improved business component:

  • Improves function, performance, quality, or reliability
  • It could be a product, process, technique, formula or software

Has your company demonstrated that the information being discovered was to develop a new or improved product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or further used in its trade or business?

2. Elimination of Uncertainty

An activity intended to eliminate technical uncertainty concerning:

  • Capability
  • Optimal methodology
  • Appropriate design
  • Process or product improvement

Has your company demonstrated that it tried to learn something new about the product or process being changed in order to improve it and has it demonstrated that the product or process could not be improved without going through this discovery process?

3. Process of Experimentation

Implementation of a systemic approach to identify and evaluate different alternatives to achieve a desired result by:

  • Trying different technologies
  • Several iterations
  • Modeling and simulation

Has your company demonstrated that it went through a process of elimination, trial and error, or other evaluation of alternatives in order to arrive at the new or improved product or process?

4. Technological in Nature

Application of hard sciences principles, such as:

  • Engineering
  • Physics
  • Chemistry
  • Computer Sciences
  • Other disciplines

Can your company demonstrate that its development of a business component relied upon the principles of the physical or biological sciences, engineering, or computer science?

If you answered yes to these 4 questions, we have great news for you! There is high chance that your business can take advantage of the R&D Tax Credit.

Not sure whether your business passes the 4-Part Test? Reach out to our tax experts today! We understand that the 4-Part Test can be complicated, that’s why we are here to help. The R&D Tax Credit legislation is much broader than people often assume. Several industries perform R&D activity on a daily basis without realizing it.


About Leyton:

Founded in 1997, Leyton is a global innovation funding consultancy dedicated to helping our clients improve their business performance. In the US, our specific expertise is in optimization of Federal and State Research & Development (R&D) Tax Credits. As a business, we want to help unleash our clients potential and be a strategic partner in their evolution and growth.


Author

Blake Garvey, LL.M.

Blake Garvey

Senior Tax Attorney

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