Taxpayers’ Research Tax Credit per Sect. 41(d)
According to The Joint Committee of Taxation, federal tax expenditures for the research tax credit will reach $16.4 billion in the fiscal year 2023. For many businesses, the credit for increasing research activities is a big federal tax incentive that falls under Sec. 41(d).
Any business component must adhere to the four-part test:
- A permitted purpose, which includes a new or improved function, performance, reliability, or quality, related to a product or process;
- An intent to discover information that is technological in nature by relying on the principles of hard science;
- Technical uncertainty at the project’s outset regarding capability, method, or design; and
- A process of experimentation to attempt to resolve technical uncertainties.
Substantially all (80% or more) of research activities exercised by the taxpayer must be done through a process-of-experimentation. When the initial result is uncertain, this required process provides taxpayers to focus and examine additional alternatives when achieving results.
In April 2019, the U.S. Tax Court found that the taxpayer of Siemer Milling Co. did not correctly support its R&D credit, and therefore, rejected the R&D credit claim from previous tax years, per the four-part test.
For that matter, the taxpayer failed to create a systematic plan to retest the hypothesis and provide documentation that the research activities were under conduct with a process of experimentation. Their claim also had not been technological in nature due to unestablished and unspecified principles.
While the taxpayer argued that its machinery business component “relied on principles of engineering and the physical and biological sciences,” the court believed their changes were small adjustments.
The IRS has argued that Siemer failed the four-part test because of simple trial and error, and the court must now distinguish between “systematic” trial and error and “simple trial error.”