The Credit for Increasing Research Activities, or as it’s more commonly known, the Research and Development (R&D) credit, is a federal tax credit designed to benefit businesses who conduct certain qualifying R&D activities. With the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015, the R&D credit has now been made permanent for all tax years beginning on or after January 1, 2015. Prior to that, it was renewed on an annual basis as part of the annual tax extenders package. Now that the R&D credit is permanent, businesses can plan and conduct research activities confidently and know for certain that their activities will qualify them for a credit at tax-time.
In order to determine which activities qualify for the R&D credit, the IRS adopts a four-part test. First, the activity must be undertaken for the purpose of developing a new or improved product and/or business component. If improving a product or business component, the improvement must increase performance, quality, reliability, etc.; a purely cosmetic change would not constitute an improvement. Second, the activity must be undertaken for the purpose of discovering new information intended to eliminate uncertainty relating to the method of development or plausibility of the product design. Third, the activity must be technological in nature and fundamentally rely on the principles of physical or biological sciences, engineering, or computer sciences. Fourth, the activity must involve a process of experimentation during which the business creates and tests hypotheses, evaluates alternatives, and ultimately draws conclusions based on results.