To become eligible for the Research and Development (R&D) tax credit, your client must meet certain criteria as outlined in § 41 of the Internal Revenue Code.
Firstly, your client must have "qualified research expenses" as defined in Subsection 41(b). These expenses include "in-house research expenses" and "contract research expenses". In-house research expenses are defined as wages paid to an employee for qualified services performed by such employee, any amount paid for supplies used in the conduct of qualified research, and any amount paid to another person for the right to use computers in the conduct of qualified research. Contract research expenses are defined as 65 percent of any amount paid by the taxpayer to any person (other than an employee of the taxpayer) for qualified research.
Secondly, the credit can also be applied to amounts paid to eligible small businesses, universities, and Federal laboratories for qualified research. In these cases, the percentage applied is 100 percent instead of 65 percent.
Thirdly, if your client is a qualified small business, they can elect to apply the credit to the payroll tax portion of the credit. A qualified small business is defined as a corporation or partnership with gross receipts less than $5,000,000 for the taxable year and did not have gross receipts for any taxable year preceding the 5-taxable-year period ending with such taxable year.
Lastly, the research conducted by your client must meet the definition of "qualified research" as outlined in Subsection 41(d). This means the research must be undertaken for the purpose of discovering information which is technological in nature and the application of which is intended to be useful in the development of a new or improved business component of the taxpayer. Substantially all of the activities of such research must constitute elements of a process of experimentation for a purpose that relates to a new or improved function; performance; or reliability or quality.
It's important to note that the determination of whether the research is undertaken for the purpose of discovering information that is technological in nature depends on whether the process of experimentation utilized in the research fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.In conclusion, to become eligible for the R&D tax credit, your client must have qualified research expenses, conduct qualified research, and if applicable, be a qualified small business.
Sources:
N(35)000-161
FAA 20131102F
§ 41. Credit for increasing research activities
CCA 200038013
Rev. Proc. 2017-41
T.D. 9786
