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. We also looked at what it means for your business’ activities to have a permitted purpose. Now, let’s look at activities that involve a process of experimentation.
A qualifying activity must involve a process of experimentation, which the IRS outlines as simulation, evaluation of alternatives, confirmation of hypotheses through trial and error, testing, modeling, or refining or discarding of hypotheses.
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.
How do I know my activity qualifies?
Businesses of all shapes and sizes come up against technical uncertainty. The process of experimentation rule relates to the hands-on process of testing, failing, tinkering, and comparing your way to a new solution, or the realization that your business should stick to its status quo.
There are three steps to making sure your business qualifies, and they also serve as convenient reminders of the other parts of the IRS’ four-part test.
First, make sure you’ve identified an uncertainty regarding the development or improvement of a business component. Next, identify one or more alternatives intended to eliminate the uncertainty you’ve discovered. Finally, identify and conduct a process of evaluating your possible alternatives.
Experiments in vain still qualify for credits at the same level as successful endeavors. Hatmaker Janessa Leone successfully lowered its environmental footprint by developing new materials for its products. But even if the new materials were ultimately unsuccessful, the company would still qualify for the credit because it went through the process of experimenting and trying alternatives before arriving at the conclusion. And pharmaceutical companies that look for new compounds or chemicals to make their products cleaner or cheaper qualify because of the time spent trying, not their ultimate success.
If you succeed in eliminating this uncertainty, you likely qualify for the R&D tax credit. If you fail, there’s a good chance you’ve qualified anyway.
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.