If you have not read our last installment on who can take the R&E Credit, please click here to read that first.

Any “research” towards the development of new or improved product, processes, techniques, formulas, inventions, or software could potentially qualify, but we must dig deeper. First, we must determine what “research” means to the IRS and then determine what the IRS sees as “qualified research.”

Research is not clearly defined in the code. The dictionary definition of research is “the systematic investigation into and study of materials and sources in order to establish facts and reach new conclusions.” New conclusions, in this case, are new or improved products, processes, techniques, formulas, inventions, or software. 

The IRS has created a four-part test to determine what qualifies as research for the credit. 

1. The activity must be for a permitted purpose. The new or improved business component must be changed or created to perform a specific function, to increase the performance, to increase the reliability, or to better the quality. 
2. There has to be an elimination of uncertainty. The activity is performed to eliminate the uncertainty in the development of new and improved product, processes, techniques, formulas, inventions, or software. 
3. A process of experimentation is applied. While performing the activity, you are evaluating one or more alternatives in an attempt to resolve uncertainty. You can apply trial and error or a formalized process where you evaluate alternatives, develop hypothesis, test that hypothesis, evaluate the results, refine the hypothesis, and then determine success or failure. 
4. The activity must be technological in nature. A form of hard science must be applied whether it’s physical science, biological science, engineering, or computer science. 

We could go beyond this four-part test to say that there must be an economic risk for the entity claiming the credit. This means that the company cannot be reimbursed for their efforts; they can have an agreed-upon price up front, but they cannot have contractual terms stating that they will be reimbursed for whatever time and material they expunge while working on the project. 

The IRS has set criteria on what qualifies. Having an expert to navigate the rules of the credit ensures you are claiming the credit for the appropriate activities and provides documentation in case of an IRS audit. To learn more about the R & E Credit, click here.