The R&D credit
comprises the following types of Qualified Research Expenses (QRE):
- Wages paid to employees for qualified services (including amounts considered to be wages for federal income tax withholding purposes)
- Supplies (defined as any tangible property other than land or improvements to land, and property subject to depreciation) used and consumed in the R&D process
- Contract research expenses paid to a third party for performing QRAs on behalf of the taxpayer, regardless of the success of the research, allowed at 65% of the actual cost incurred
- Basic research payments made to qualified educational institutions and various scientific research organizations, allowed at 75% of the actual cost incurred.
To qualify as research according to IRC section 41, the taxpayer must show that the activities—
- are intended to resolve technological uncertainty that exists at the outset of the project or initiative, related to the capability or methodology for developing or improving the business component or the appropriate design of the business component;
- rely on a hard science, such as engineering, computer science, biological science, or physical science;
- relate to the development of a new or improved business component, defined as new or improved products, processes, internal use computer software, techniques, formulas, or inventions to be sold or used in the taxpayer’s trade or business; and
- substantially all constitute a process of experimentation involving testing and evaluation of alternatives to eliminate technological uncertainty.
If the development is related to internal use software (IUS), there are an additional three tests that must be satisfied:
- The software must be innovative. If it results in a reduction of cost or an improvement in speed that is substantial and economically significant.
- Developing the software involves significant economic risk, requiring resources and uncertainty of recovery in a reasonable time period.
- The software is not commercially available. The taxpayer cannot purchase, lease, or license and use the software for the intended purpose without having to make significant modifications that satisfy the first two requirements.
There are numerous activities that are not within the definition of qualified R&D activities. There are 10 primary types of activities that are specifically excluded from the definition of qualified research:
- Research conducted after the beginning of commercial production or implementation of the business component (with some exceptions)
- Adaptation or duplication of existing business components
- Surveys, studies, or activities related to management functions or techniques
- Market research, testing, or development (including advertising or promotions)
- Routine data collection
- Routine or ordinary testing or inspection for quality control
- Computer software, except where developed for internal use
- Any research conducted outside the United States
- Any research in social sciences
- Funded research
The cost of acquiring fixed assets used in a taxpayer’s trade or business is also excluded.