The federal research and experimentation tax credit (referred to as both an “R&D credit” or “R&E credit”) can be a valuable tool for individuals and businesses that conduct research and development, including the invention of patented products and processes. It provides a 20 percent credit on selected research expenditures.
In order to qualify for the R&D credit, research activities must satisfy a four-part test established by Congress:
- Permitted Purpose: The goal of the activity must be to create a new or improve an existing business component in terms of functionality, performance, reliability, or quality. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
- Elimination of Uncertainty: A degree of uncertainty must exist concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
- Process of Experimentation: The taxpayer must undertake a process of experimentation designed to evaluate one or more alternatives to achieve a result.
- Technological in Nature: The experimental process must fundamentally rely on principles of the “hard sciences, including physical, biological sciences, engineering, or computer sciences.
As detailed by the Journal of Accountancy, a number of expenses can qualify for the R&D tax credit, including wages, supplies and contract research expenses. For instance, in-house wages attributable to qualified research and 65 percent of vendor expenses related to design and testing services are includable.
In addition, the tax credit has been interpreted to include not only developing prototypes or models, but also applying for patents. Accordingly, inventors may be able to use the tax credit to offset the increased application fees now required by the U.S. Patent and Trademark Office.
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