1. Technological in Nature
Activities must rely on principles of physical or biological sciences, engineering, or computer science.
R&D Tax Credits
The Research & Development (“R&D”) Tax Credit is one of the most valuable dollar-for-dollar tax incentives available under the Internal Revenue Code. Designed to encourage innovation and investment in the United States, the credit rewards businesses that design, develop, or improve products, software, or processes. Companies across a wide range of industries may qualify, often without realizing it.
Understanding R&D Tax Credits
The R&D Tax Credit allows eligible businesses to reduce their federal and state income tax liabilities by claiming credits for qualified research activities within the United States. Businesses may qualify for a credit of up to 10% on eligible expenses, including wages, supplies, cloud services, and contractor payments.
Many businesses are surprised to learn they qualify for R&D tax credits, even without operating in a traditional “lab” environment. In fact, many companies in software development, manufacturing, engineering, and other innovation-driven industries are eligible. Qualifying activities generally involve technical uncertainty and experimentation aimed at improving the functionality, performance, reliability, or quality of products, processes, or software.
In addition to offsetting federal income taxes, eligible businesses may use the R&D tax credit to offset the employer portion of payroll taxes (i.e., FICA/Medicare), allowing companies to benefit from the credit even if they are not yet profitable.
To qualify for the payroll tax offset, a company must meet the following criteria:
- Incurred gross receipts for five years or less
- Generated less than $5 million in gross receipts in the year the credit is claimed
The Four-Part Test for Qualified Research
A formal R&D Tax Credit study typically evaluates projects against the IRS four-part test to determine eligibility. To qualify for the R&D Tax Credit, a project must meet all four of the following criteria:
Examples of Qualifying R&D Activities
R&D activities exist across many industries. The examples below highlight the various activities that many businesses perform daily that can qualify for the R&D Tax Credit.
Product Development
Designing new products, prototypes, or models
Software Development
Creating, testing, or enhancing software, including artificial intelligence and machine learning
Manufacturing Improvements
Developing more efficient, automated, or environmentally friendly manufacturing processes
Engineering and Design
Creating technical designs, blueprints, and CAD models
Testing and Evaluation
Conducting feasibility studies, beta testing, and quality control on new or improved designs
Material Evaluation
Testing alternative materials to improve durability or performance
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