The research and development (R&D) tax credit is one of the most valuable tools businesses can use to incentivize innovation, offset tax liabilities, and stimulate growth. However, the R&D tax credit comes with specific rules and criteria.
As many of you know, the US Research and Development (R&D) Tax Credit is a valuable incentive enabling businesses to recoup costs associated with their innovation and development activities. The rules for the R&D tax credit are pretty broad, and this is excellent news for many taxpayers looking to reduce their tax bill. However, certain activities don't qualify for the R&D tax credit, and it's important to know what those are.
Outlined below are critical exclusions related to the R&D Tax Credit that you should be aware of:
- Research Funded by Third Parties: If a third party (e.g., a client or government agency) fully funds your research activities, the associated expenses are not eligible for the R&D Tax Credit. However, suppose you bear some financial risk (for example, you are paid on a lump sum basis or contingent upon the work/research being successful). In that case, a portion of the expenses may qualify.
- Research Conducted Outside the US: The R&D Tax Credit applies exclusively to research activities in the United States. Expenses related to research conducted in foreign countries are not eligible for this credit. The project can be for a foreign country, but the physical location of the expenses needs to be in the US.
- Routine Data Collection and Testing: While testing and data collection are integral to research, routine quality control testing, data collection for regulatory compliance, or standard product testing do not qualify for the R&D Tax Credit.
- Management Studies and Surveys: Activities such as efficiency surveys, management studies, consumer surveys, and routine market research do not fall under qualified research activities for the R&D Tax Credit.
- Adaptation of Existing Products: Customization or adaptation of an existing product to meet a specific customer's needs is generally excluded from the R&D Tax Credit unless the changes meet the 4-part test.
- Research in Social Sciences, Arts, and Humanities: Social sciences, arts, and humanities activities are excluded from the R&D Tax Credit. The credit focuses on developing new or improved products, processes, or software with a technological base.
- Commercial Production: Any activities after a business component is developed to the point where it is ready for commercial sale or use or meets the basic functional and economic requirements for the component's sale or use would not qualify.