Last week, we began dissecting the four-part test that the Internal Revenue Service (IRS) uses to qualify research & development (R&D) activities for the federal R&D tax credit, formally called the Credit for Increasing Research Activities. 

Businesses can claim this credit by documenting qualified R&D activities, capturing qualified research expenses (QREs) – including wages for qualified services and supply costs – and reporting the calculated credit amount via Form 6765 when filing their annual tax returns.

Today, we’ll examine the second subtest, called Technological in Nature, while keeping in mind that activities need not succeed to qualify as R&D.

What is Technological in Nature?

The law states in 26 Code of Federal Regulations (CFR) § 1.41-4 that information is Technological in Nature when its discovery depends upon a Process of Experimentation (PoE) fundamentally reliant on the principles of hard sciences, engineering, or computer science.

We will discuss the PoE in greater detail next week: it’s the third subtest of the four-part test. Suffice it to say that the PoE is a systematic means of testing, analyzing, and evaluating alternatives to achieve an outcome. At least 80 percent of research activities must support the PoE.

Taking these two definitions together, being Technological in Nature means that research activities must not only be grounded in scientific principles, but also apply this knowledge in a structured way to solve technical challenges.

Let’s explore a real-world example: engineers developing a new type of solar panel. Engineers experiment with different materials and coatings to improve the efficiency of converting sunlight into electricity. Researchers may test alternative combinations of coated materials, analyze their performance in different environments, and evaluate the results to optimize the panel design. This PoE would be considered Technological in Nature: its use of engineering principles supports a systematic approach to discovery.

R&D in Unexpected Places

While this description may conjure images of lab coats and microscopes, it’s important to remember that a broader range of industries engage in qualified research than traditional high-tech companies and laboratories alone.

Acena partners with businesses in sectors such as:

Still uncertain? Solicit a second opinion!

At Acena Consulting, our team of tax professionals includes engineers who can ask the right questions and identify the scientific principles underlying your business’ hard work. 

Schedule a free consultation today to receive immediate assistance from Randy Eickhoff, CPA, Acena's Founder & Head Coach.

Four-Part Test Recap (So Far)

Last week, we learned that to have a Permitted Purpose, R&D activities must innovate or improve a business component held for sale, lease, or license to taxpayers, or intended for taxpayers’ use during business or trade.

This week, we learned that R&D activities must be Technological in Nature, supporting a PoE that fundamentally relies on the principles of hard sciences, engineering, or computer science.

Stay Informed

Next week, we’ll explore how qualified R&D must pass the third subtest: the Process of Experimentation.

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• If you missed it, read our explainer on the first subtest: Permitted Purpose. 

Interested in building your professional fluency in R&D tax incentives? 

• Sign up for our free, interactive webinar on December 17: “Cracking the (Tax) Code for R&D.”
  • This workshop provides one CPE credit for professionals keeping up with continuing education.
    

Reminders: 

• Arizona taxpayers applying for the state’s refundable R&D credit should immediately request a user name to file applications electronically via the ACA’s Electronic Application System (i.e., Easy Portal).

• The deadline for fourth-quarter 2024 estimated tax payments is January 15, 2025. Taxpayers may pay online via the IRS website.

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Edited by Randy Eickhoff, CPA, Founder & Head Coach at Acena Consulting. Photo courtesy of James Webb Space Telescope on Flickr.