Federal Research & Development Tax Credit (IRC Section 41)

Program overview

Enacted in 1981 and made permanent by the PATH Act of 2015, the federal research credit rewards businesses that invest in technical experimentation on US soil. Taxpayers may compute the credit under the regular method or the Alternative Simplified Credit (ASC) method, and qualified small businesses may elect to apply a portion of the credit against payroll taxes rather than income tax. Claims are supported by contemporaneous documentation of qualified research expenses (QREs), including wages for employees performing or directly supervising research, supply costs consumed in the research process, contract research paid to US-based third parties, and certain cloud computing costs.

Eligibility

Any US taxpayer conducting activities that satisfy the four-part test: a permitted purpose, technological in nature, elimination of technical uncertainty, and a process of experimentation. Funded research, research conducted outside the US, routine quality control, market research, and post-commercial-production activities are excluded.

Benefits

Dollar-for-dollar reduction of federal income tax liability. Qualified small businesses (gross receipts under $5M and no gross receipts more than five years back) may elect to offset up to $500,000 of payroll taxes annually.

Federal IDR questions

What an examiner is likely to ask about this credit. F1–F10 apply to every federal claim.

1. F1Describe each business component and the new or improved function it was meant to achieve.
2. F2What technical uncertainty existed at the start of each business component?
3. F3Describe the process of experimentation used to resolve that uncertainty.
4. F4Which principles of engineering or the physical sciences did the work rely on?
5. F5Reconcile qualified wages to payroll records for each employee claimed.
6. F6Show how each employee's time was allocated between qualified and non-qualified activities.
7. F7Provide invoices and usage records for supplies claimed as consumed in research.
8. F8Provide contracts for contract research, showing who bore the economic risk and held substantial rights.
9. F9Show the calculation of the base amount under the method elected (regular or ASC).
10. F10If the payroll tax election was made, show the qualified small business tests are met.

Draft questions for illustration, reviewed by a specialist before any engagement.