# The four-part test: what counts as qualified research

> Four tests, applied to each business component separately, worked on one hypothetical piece of software.

Source: https://lopifi.com/learn/four-part-test-qualified-research
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**Does my startup's work qualify for the R&D tax credit? What is the four-part test?** Four tests, applied to each business component separately, worked on one hypothetical piece of software.

Research is [qualified research](https://lopifi.com/md/glossary/qualified-research) only if it passes four tests, and the tests are applied to each [business component](https://lopifi.com/md/glossary/business-component) separately: each product, process, piece of software, technique, formula or invention.

1. Section 174 (The costs are §174A domestic research expenditures.) → 2. Technological in nature (The work relies on engineering, computer science, or the physical or biological sciences.) → 3. Business component (It's meant to develop a new or improved business component.) → 4. Process of experimentation (Substantially all of it is a process of experimentation for function, performance, reliability or quality.)

The four-part test, §41(d)(1). Fail any one and the activity's costs don't count.

> “The term “business component” means any product, process, computer software, technique, formula, or invention which is to be— (i) held for sale, lease, or license, or (ii) used by the taxpayer in a trade or business of the taxpayer.”

— [IRC §41(d)(2)(B)](https://www.law.cornell.edu/uscode/text/26/41), Qualified research is tested one business component at a time

The fourth test does most of the work. A [process of experimentation](https://lopifi.com/md/glossary/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.

> “For purposes of section 41(d) and this section, a process of experimentation is a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities.”

— [Treas. Reg. §1.41-4(a)(5)(i)](https://www.law.cornell.edu/cfr/text/26/1.41-4), Process of experimentation

"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.

> “The substantially all requirement of section 41(d)(1)(C) and paragraph (a)(2)(iii) of this section is satisfied only if 80 percent or more of a taxpayer's research activities, measured on a cost or other consistently applied reasonable basis (and without regard to section 1.41-2(d)(2)), constitute elements of a process of experimentation for a purpose described in section 41(d)(3).”

— [Treas. Reg. §1.41-4(a)(6)](https://www.law.cornell.edu/cfr/text/26/1.41-4), Substantially all of the activities: 80%

**Use case — Qualifies: the matching engine.** StockMatch's matching engine qualifies. At the start, nobody knows whether part numbers can be matched accurately enough on messy supplier data. The engineers try exact rules, then fuzzy matching, then a trained model, and score each against a held-out set of real supplier invoices. The uncertainty is technical, the alternatives are evaluated, and the result is a function the product didn't have.

**Use case — Doesn't qualify: the new color scheme.** Redesigning StockMatch's screens in Northwind's brand colors doesn't, however carefully it's done. It's cosmetic, and §41(d)(3)(B) excludes it. Neither does configuring StockMatch for one reseller's catalog: that's adapting an existing component to a customer's need.

**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.

*[Figure: cpa review]*

Illustrative: like a reviewer reading one file at a time, the test reads one business component at a time.

In this lesson: [the eight kinds of work that never qualify](https://lopifi.com/md/learn/four-part-test-qualified-research/excluded-activities), with internal-use software's extra test, have a page of their own.

## Pages in this lesson

- [What's excluded from the credit](https://lopifi.com/md/learn/four-part-test-qualified-research/excluded-activities) — 6 min. What activities are excluded from the R&D tax credit?

## Where this lesson's rules come from

- [IRC §41(d)(2)(B)](https://www.law.cornell.edu/uscode/text/26/41) — Qualified research is tested one business component at a time (statute)
- [Treas. Reg. §1.41-4(a)(5)(i)](https://www.law.cornell.edu/cfr/text/26/1.41-4) — Process of experimentation (regulation)
- [Treas. Reg. §1.41-4(a)(6)](https://www.law.cornell.edu/cfr/text/26/1.41-4) — Substantially all of the activities: 80% (regulation)
- [IRC §41(d)(4)(A)](https://www.law.cornell.edu/uscode/text/26/41) — Activities for which the credit is not allowed (statute)

## Read further

- https://lopifi.com/md/startups/rd-tax-credit-and-section-174
- https://lopifi.com/md/accounting/rd-tax-credit

- **Track:** [R&D tax credit](https://lopifi.com/md/learn/rd-credit)
- **Lesson:** Lesson 2 of 9 — 10 min
- **Terms taught:** [Qualified research](https://lopifi.com/md/glossary/qualified-research), [Business component](https://lopifi.com/md/glossary/business-component), [Process of experimentation](https://lopifi.com/md/glossary/process-of-experimentation)
- **Previous:** [What the R&D tax credit is, and who can use it, R&D credit · Lesson 1](https://lopifi.com/md/learn/what-is-the-rd-tax-credit)
- **Next:** [What's excluded from the credit](https://lopifi.com/md/learn/four-part-test-qualified-research/excluded-activities)
- **The course:** https://lopifi.com/md/learn