R&D Tax Credits: The Four-Part Test Most Companies Get Wrong

The federal R&D tax credit is one of the most under-claimed credits in the tax code, and also one of the most frequently claimed incorrectly — usually because companies document the credit retroactively at tax time instead of contemporaneously as the work happens.

The IRS’s four-part test requires that qualifying activity: eliminate uncertainty about capability, method, or design; involve a process of experimentation; be technological in nature; and relate to a new or improved business component. Most software companies clear the technological-in-nature bar easily. Where claims fall apart under examination is the process-of-experimentation prong — the IRS wants to see evidence of alternatives evaluated and rejected, not just a description of what eventually shipped.

Our R&D credit studies start with a contemporaneous time-tracking system, not a year-end interview reconstructing what engineers remember working on. Reconstructed documentation is the single biggest reason R&D credit claims get reduced or denied on examination.