Analyzing research and development projects to identify activities that qualify for the federal R&D tax credit may seem daunting, time-consuming and difficult. But with the right approach and reference material, it can actually be relatively simple and quick.
The first key to success is to analyze each project according to the product development, project management or software development lifecycle framework your company uses. We find it easier to select a step or phase and classify activities across all projects, but you might prefer to look at each project individually. It’s amazing how many of the activities fall into natural clusters when you approach it this way. The second key is to have your reference materials handy, such as the criteria from the four-part test and associated examples.
Once done, it’s helpful to review the list of qualifying activities considering what doesn’t qualify instead of what does. If you want to create your own list, you can start with these five categories of research that rarely qualify for the federal R&D tax credit. Where it makes sense, some sample activities are included as well.
- Soft-Science Research
Before you invest in developing a new product, you might conduct a management study or perform market research to justify the proposed expense. Because this kind of research is based on economic, social and behavioral science principles, the activities don’t qualify for the tax credit. Some tasks that might fall into this category include:
- Surveying customers to identify opportunities for new products,
- Conducting market research to gather input on customer preferences,
- Testing products with customers to collect feedback about style, taste, cosmetic or seasonal design factors,
- Testing advertising and promotional campaigns or
- Reviewing and summarizing literary or historical information.
- Post-Production Research
When you reach a point where the product you created meets your functional requirements and is ready for production, there’s no more uncertainty to eliminate. It’s rare to have qualifying activities once production begins. Post-production research activities include:
- Planning for the production of a finished product,
- Gearing up for production,
- Running trial runs for manufacturing production,
- Collecting and analyzing production data,
- Resolving anomalies in processes or equipment,
- Debugging problems with the final product and
- Installing a solution using the customer’s equipment.
- Adapting or Duplicating an Existing Product for Another Customer
If you are simply adapting or duplicating an existing product for another customer without improving the functionality or performance in any way, that’s not sufficient to qualify for the credit. If, however, you are adding new functionality or improving performance, reliability or quality of that existing product, then those activities may qualify.
- Foreign Research
Any research that you or a third party conduct outside the United States is automatically ineligible for a tax credit. Period, end of story.
- Funded Research
If the research you’re performing is funded by another group or organization, you usually have to exclude those activities. However, “funded research” as it applies here is a term of art. Just because you get paid for your research activities doesn’t automatically mean your research is “funded.” After all, the purpose of the credit is to incentivize businesses to invest more in developing new products for sale. The key here is to analyze the contract with your customer to determine 1) whether you retain rights to the research and 2) whether you bear the risk of loss for all or at least part of the research if the research ultimately proves unsuccessful.
Looking at research activities from the opposite perspective is a great way to feel confident you’ve done a thorough job of determining the activities that do qualify for the federal tax credit. When you match people to these activities, don’t forget you can only include the time when people are actually performing the research, directly supporting those performing the research or supervising those performing the research. Happy qualifying!