The R&D Tax Credit: A Basic Guide for Small Business Owners

4 Minute Read
Posted by Randy Eickhoff on Feb 25, 2020 12:05:17 PM

Founders of product and technology-based small businesses often find themselves straddling multiple internal functions. Most entrepreneurs are heavily involved in high-level corporate strategies, including designing, improving, and manufacturing merchandise. However, the list of action items doesn't end there. These business owners also often oversee other mission-critical tasks, such as marketing and selling their product lines.

Of course, many founder-led organizations also manage other peripheral responsibilities like accounting, HR, administration, purchasing, and maintenance. After performing multiple full-time jobs, there's still one looming task waiting for most small- to mid-sized business owners: taxes.

Acena Consulting Breaks Down R&D Tax Credit Basics

Sound familiar? If you're coordinating several internal functions in your organization, it's crucial to simplify whatever you can to streamline your efforts and free up bandwidth to focus on your core competencies. You can start with the research tax credit.

At Acena Consulting, we recognize that the innovation tax credit is complex. So we break down some of the basics of this lucrative, government-backed incentive to help small business owners understand the core concepts and potentially lower their federal tax burden. 

Critical Components of the Four-Part Test

Qualifying research and development activities must pass a battery of tests commonly referred to as the four-part test. At Acena, our team of skilled R&D tax credit professionals thoroughly examines every potentially eligible operation. However, understanding the basic requirements can help you pinpoint possible activities that require more in-depth analysis. The four-part test includes:

Business Component Test
The business component test identifies activities used to develop a "business component" or product, process, software, technique, formula, or invention either for sale or used by a client.

Elimination of Technical Uncertainty
At the beginning of the research and development process, business owners must address technical uncertainty related to capability in a variety of ways. A technical uncertainty is any important question that needs to be answered in order to develop the business component. Some common questions to ask during this process include:

  • Can we develop this? 
  • How can we develop this?
  • What is the correct design? 

Process of Experimentation
The best way to eliminate technical uncertainty is to evaluate one or more alternatives where technical uncertainty has been identified, and establish a process of trial and error to assess viable methods that advance research and development efforts. Businesses generally use iterative efforts to achieve desired (or even unexpected) outcomes that alleviate uncertainty. 

Scientific Principles
The Process of Experimentation also requires that 80 percent or more of the process of experimentation uses hard science principles to eliminate technical uncertainty. This particular component of the four-part test is defined as the principles of physical, biological, engineering, or computer science. 

Supporting Documentation
It's important to note that there's no such thing as "perfect documentation" when proving eligibility for the research and development tax credit. Every small business leverages a unique strategy to maintain product development records. Larger companies often have a standardized process or system in place to help track key details, such as expenses and operations. However, smaller businesses often struggle to keep thorough records that track their qualifying activities. 

Some documentation guidelines to help manage and support qualifying activities and innovation efforts include:

Project-Based Time Tracking 
This should be tracked and completed by employees performing eligible research and development operations. Weekly time tracking is ideal. However, if necessary, bi-monthly time tracking is acceptable as well. Employees should list specific tasks within the project to provide a big-picture glimpse into relevant activities.

Development Process
Documentation on the development process should outline specific steps of the project, from conception through completion. Whenever possible, every listed step should also include a short description of activities completed within the milestone. 

Project Description and Detail
Project documentation should also have an attached record that details the description of the initiative as well as a breakdown of the engagement as it relates to the four-part test. This is a specific area where Acena Consulting can provide support, direction, and guidance. 

There may also be other relevant documents needed to support a research and development tax credit claim. Emails, CAD drawings, meeting minutes, and any other pertinent papers should all be compiled with additional documentation to ensure an organization can demonstrate proof of all eligible expenses.

Contact Acena Consulting Today for More Information

We simplify the research and development tax credit process for small business owners in over 40 industries. Contact us today to hear more.

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Randy Eickhoff

Randy Eickhoff

Acena Consulting President Randy Eickhoff, licensed CPA, has partnered with more than 200 companies during more than 20 years of experience securing tax credits and other government incentives. His corporate partners range from multinational technology firms to smaller, privately held manufacturing, sports, and technology enterprises.