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QUALIFIED RESEARCH ACTIVITIES (QRA)

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The R&D tax credit rewards taxpayers with a tax benefit for engaging in qualified research activities (QRA) by providing a credit for a portion of their qualified research expenditures (QRE) incurred when performing QRA. QRE expenditures must establish nexus to a QRA to be eligible for inclusion in the R&D tax credit computation. QRA relate to efforts undertaken to develop new products, enhance existing products, and to develop or improve processes. ​

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In order for an QRA to qualify for the research credit, the taxpayer must show that it meets all the requirements as described in section 41(d). Under IRC § 41(d), the term "qualified research" means research with respect to which expenditures may be treated as expenses under section 174 ("Section 174 Test / Elimination of Uncertainty Test"), which is undertaken for the purpose of discovering information which is technological in nature ("Technological in Nature Test"), and the application of which is intended to be useful in the development of a new or improved (e.g. new or improved function, performance, reliability or quality) business component of the taxpayer ("Permitted Purpose Test / Business Component Test"), and substantially all of the activities of which constitute elements of a process of experimentation ("Process of Experimentation Test").

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These four specific listed criteria are used to determine whether an activity is a QRA, also known as the "Four-Part Test" pursuant to IRC § 41(d)(1)(A)) and Treas. Reg. § 1.174-2(a)(1). Taxpayers must also be able to document that an activity passes each test as listed below.

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QRA / Four-Part Test Summary:

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1. Elimination of Uncertainty Test ("Section 174 Test"). The activities involve the elimination of uncertainty concerning the development or improvement of a product, so that the expenses of the activities may be deductible under IRC § 174 ("Section 174 Test") pursuant to IRC § 41(d)(1)(A);

2. Technological in Nature Test ("Discovering Technological Information Test"). The activities discover information that is technological in nature pursuant to IRC § 41(d)(1)(B)(i);

3. Permitted Purpose Test ("Business Component Test"). The activities are useful in the development of a new or improved business component pursuant to IRC § 41(d)(1)(B)(ii);

4. Process of Experimentation Test. Substantially, the activities are experimental in nature and conducted for a permitted purpose pursuant to IRC § 41(d)(1)(C).

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Note, Treas. Reg. § 1.41-4(a)(3)(iii) ("Patent Safe Harbor") states that the issuance of a patent by the Patent and Trademark Office under the provisions of 35 U.S.C. 151 is conclusive evidence that a taxpayer has discovered information that is technological in nature that is intended to eliminate uncertainty concerning the development or improvement of a business component. The issuance of such a patent is not a precondition for credit availability. However, the issuance of a patent is also not conclusive evidence of qualified research, as the taxpayer may still need to meet all the other activity requirements of IRC § 41(d).

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There are certain research activities that are specifically excluded from qualified research under IRC § 41(d)(4), Treas. Reg.  § 1.41 4(c), and Treas. Reg. § 1.174-2. The following types of activities are generally excluded as qualified research, subject to the underlying facts and circumstances.

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Exclusions include the following:

• (1) Research after the beginning of commercial production (IRC § 41(d)(4)(A); 

  • However, if uncertainty concerning the development or improvement of the product has not be eliminated after commercial production, subsequent activities may still be qualified.​ See Treas. Reg. § 1.174-2(a)(2).

  • When development of both a product and a manufacturing or other commercial production process for the product occurs, the potential exclusion applies separately for the activities relating to the development of the product and the activities relating to the development of the process. See Treas. Reg. § 1.41-4(c)(2)(iii).

  • Clinical testing of a pharmaceutical product prior to its commercial production in the United States is not treated as occurring after the beginning of commercial production even if the product is commercially available in other countries. Additional clinical testing of a pharmaceutical product after a product has been approved for a specific therapeutic use by the Food and Drug Administration and is ready for commercial production and sale is not treated as occurring after the beginning of commercial production if such clinical testing is undertaken to establish new functional uses, characteristics, indications, combinations, dosages, or delivery forms for the product. A functional use, characteristic, indication, combination, dosage, or delivery form shall be considered new only if such functional use, characteristic, indication, combination, dosage, or delivery form must be approved by the Food and Drug Administration. See Treas. Reg. § 1.41-4(c)(2)(iv).

  • See also Treas. Reg. § 1.41-4(c)(2).

• (2) Adaptation (e.g. routine customization without any technical uncertainty) of existing business component(s) to a particular customer’s requirement or need (IRC § 41(d)(4)(B));

  • See also Treas. Reg. § 1.41-4(c)(3)​.

• (3) Duplication (e.g. "reverse engineering" to create an identical replica of a competitor) research related to the reproduction of an existing business component (in whole or in part) from a physical examination of the business component itself or from plans, blueprints, detailed specifications, or publicly available information with respect to such business component (IRC § 41(d)(4)(C);

  • See also Treas. Reg. § 1.41-4(c)(4);​.

• (4) Foreign research performed outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States (IRC § 41(d)(4)(F);

  • See also IRC § 41(f)(6)(C) ("foreign energy research consortium")​; Treas. Reg. § 1.41-4(c)(7)​ ("foreign  apportionment rules"); Treas. Reg. § 1.41-4A(b). 

• (5) Research in the social sciences, arts, or humanities (IRC § 41(d)(4)(G);

  • “Research in the social sciences or humanities” encompasses all areas of research other than research in a field of laboratory science (such as physics or biochemistry), engineering or technology. Examples of research in the social sciences or humanities include the development of a new life insurance contract, a new economic model or theory, a new accounting procedure or a new cookbook. See Treas. Reg. § 1.41-4A(c).

  • See also Treas. Reg. § 1.41-4(c)(8)​​.

• (6) Research in connection with literary, historical, or similar projects involving the production of property, including the production of films, sound recordings, video tapes, books, or similar properties (Treas. Reg. § 1.174-2(a)(6)(vii));

• (7) Funded research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity) (IRC § 41(d)(4)(H));

  • See also Treas. Reg. § 1.41-4(c)(9)​​; Treas. Reg. § 1.41-4A(d).

• (8) Routine or ordinary testing or inspection of materials or products for quality control testing (IRC § 41(d)(4)(D)(iv)-(v);

  • Testing or inspection to determine whether particular units of materials or products conform to specified parameters is quality control testing. However, quality control testing ​does not include testing to determine if the design of the product is appropriate. See Treas. Reg. § 1.174-2(a)(7).

  • See also Treas. Reg. § 1.41-4(c)(5)(iv)-(v); Treas. Reg. § 1.174-2(a)(6)(i). 

• (9) Efficiency surveys (routine data collection), management studies (activity relating to management function or technique), consumer surveys (market research, subjective consumer taste preference testing, advertising or promotions studies) (IRC § 41(d)(4)(D));​

  • See also Treas. Reg. § 1.41-4(c)(5)(i)-(iii);​ Treas. Reg. § 1.174-2(a)(6).

• (10) Acquisition of another's patent, model, production or process (Treas. Reg. § 1.174-2(a)(6)(vi)); 

  • The IRS position states "since section 41 is more restrictive than section 174, expenses allowable under section 174 will still have to meet the other requirements of section 41(b) and (d) to be a QRE.  For example, patent procurement expenses generally qualify under section 174 but would not qualify under section 41."​ See Audit Techniques Guide: Credit for Increasing Research Activities (i.e. Research Tax Credit) IRC § 41* - Qualified Research Activities (June 2005) (Page Last Reviewed or Updated: 29-Jan-2019)

• ​(11) Exploration expenditures incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore, oil, gas or other mineral (IRC § 174(d));

  • See also ​Rev. Rul. 75-122, 1975-1 C.B. 87; Rev. Rul. 74-67, 1974-1 C.B. 63; Rev. Rul. 73-324, 1973-2 C.B. 72

• (12) Exclusion for wages to which Work Opportunity Credit applies and shall not include any amount taken into account in determining the Work Opportunity Credit under section 51(a). (IRC § 41(b)(2)(D)(iii)); or

• (13) **Internal-Use Software (IRC § 41(d)(4)(E)).

  • Software is developed by (or for the benefit of) the taxpayer primarily for the taxpayer's internal use if the software is developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer's trade or business may be subject to additional tests for qualification.

  • See Internal Use Software - Qualification Analysis summary link for additional details on evaluating qualification.