The four-part test: what counts as qualified research
Four tests, applied to each business component separately, worked on one hypothetical piece of software.
Research is qualified research only if it passes four tests, and the tests are applied to each business component separately: each product, process, piece of software, technique, formula or invention.
- 1. Section 174The costs are §174A domestic research expenditures.
- 2. Technological in natureThe work relies on engineering, computer science, or the physical or biological sciences.
- 3. Business componentIt's meant to develop a new or improved business component.
- 4. Process of experimentationSubstantially all of it is a process of experimentation for function, performance, reliability or quality.
The fourth test does most of the work. A process of experimentation starts from something uncertain, whether it can be done, how, or what the right design is, and evaluates alternatives to resolve it: modeling, simulation, systematic trial and error. Using a computer doesn't make work research, and neither does uncertainty alone.
"Substantially all" has a number. At least 80% of the research activities for a business component, measured by cost or another consistent basis, must be elements of that process. The purpose has to be functional too: research into style, taste, cosmetic or seasonal design doesn't qualify.
Wrong
All engineering is R&D, so all engineering payroll goes on the credit.
Right
Name each business component (StockMatch's matching engine), show it passes all four tests, then count only the costs of the qualified activities.
The test is applied business component by business component, and within each one only the qualified activities count. A team can do qualified research and non-qualified work in the same week.
In this lesson: the eight kinds of work that never qualify, with internal-use software's extra test, have a page of their own.
Pages in this lesson
1 page goes deeper, about 6 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- IRC §41(d)(2)(B) (opens in a new tab)Qualified research is tested one business component at a timeFree to read
- IRC §41(d)(4)(A) (opens in a new tab)Activities for which the credit is not allowedFree to read
- Federal regulation
- Treas. Reg. §1.41-4(a)(5)(i) (opens in a new tab)Process of experimentationFree to read
- Treas. Reg. §1.41-4(a)(6) (opens in a new tab)Substantially all of the activities: 80%Free to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Qualified researchResearch whose costs are §174A domestic research expenditures, undertaken to discover information that is technological in nature, intended to be useful in developing a new or improved business component, where substantially all (80% or more) of the activities form a process of experimentation for a functional purpose — applied to each business component separately, and excluding research after commercial production, adaptation, duplication, surveys, most internal-use software, foreign research, social sciences and funded research
- Business componentThe unit qualified research is tested and reported in: a product, process, computer software, technique, formula or invention held for sale, lease or license or used in the taxpayer's own business — listed one by one in Form 6765, Section G
- Process of experimentationEvaluating one or more alternatives to achieve a result whose capability, method or appropriate design is uncertain at the start, by modeling, simulation or systematic trial and error grounded in the physical or biological sciences, engineering or computer science
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- The R&D tax credit and Section 174A for startupsEngineering salaries can earn a federal R&D credit against payroll tax, and Section 174A lets you deduct US research again. What qualifies, what to track.
- R&D tax creditA federal credit for qualified research spending, such as wages for engineers building new software. A young company with little revenue can apply part of it against payroll tax instead of income tax.