R&D Tax Credits 101 : Permitted Purpose

In this deep-dive series, we’re taking a close look at each part of the IRS four-part test to help companies understand if they qualify for the R&D tax credit. We previously examined how companies conduct activities that are technological in nature, that eliminate uncertainty, and that involve a process of experimentation purpose. Now, let’s look at what it means for your business’ activities to have a permitted purpose .

An activity with a permitted purpose must provide a new or improved functionality, improved performance, increased reliability or quality for a business component.

As with the other pieces of the four-part test, this activity cannot pertain to the marketing or advertisement of your business’ goods or services. The R&D activity must involve a business component and must take place within the U.S.

What is a business component?

A business component is the key to unlocking R&D tax credits. As defined by the IRS, a business component is a process, product, formula, science, technology, or anything else directly related to what you offer customers or use to create revenue for your business.

It doesn’t have to be something tangible, your results don’t have to be perfect, and you don’t have to offer a new or innovative product to market.

If a pharmaceutical company has a unique blend of chemicals for their version of an over-the-counter medicine, that’s a business component. If a competitor refines its formula to make it cleaner, more efficient, or reduce its impact on the environment, that activity qualifies, too.

If your company’s activities have been centered around processes or software intended primarily for internal use, these activities can also qualify under specific circumstances. For example, software that your company developed to run project management or sales management. You can learn more about how these processes qualify in our blog post.

Your goals matter

The IRS doesn’t reserve R&D credits for companies that innovate. The goal is to offer your customers something new or significantly improved. For example, adding new modules and features to existing software would likely qualify, but general repairs and maintenance would not because it does not offer something new.

As long as you identify an area to improve, set a goal to improve the function, performance, reliability, quality or composition thereof, and undertake steps to meet your goal, your business should qualify for benefits. You don’t even have to meet your goals to qualify: The R&D tax credit is meant to incentivize innovation by encouraging businesses to pursue it, not to merely reward the successful.

Who can help me determine if my company qualifies?

A general tax consultant, CPA or your company’s CFO may not have the specialized knowledge needed to qualify for an R&D tax credit. At Ardius, we’re focused on this specific credit and know from broad experience what activities do or don’t qualify. Think of it like the difference between a general care physician and a neurologist. Our team has more than 100 years of combined experience spanning Deloitte, PWC, EY and KPMG. We can work with your company to quickly determine whether you qualify and maximize your credit.

We hope our series on the four-part test has been helpful and informative. Best of luck qualifying and getting the most out of your tax returns!

Think you may qualify for the R&D tax credit? Reach out to our team today.

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