By the end of the 1970s, the writing was on the wall. U.S. businesses were falling behind. The auto industry had been eclipsed by Japan and American innovation dried up. What followed was an attempt by the government to hydrate the business sector. Entering the ’80s the nation’s economy took a turn for the worse. ERTA was signed up for action by President Ronald Reagan in 1981 and (thanks to Paul Harvey’s portmanteau) we began an era of “Reaganomics“. ERTA expired and was extended many times, but eventually made permanent in 2015. What did permanency achieve? It was advantageous to businesses whose gross receipts were sub-$50 million and helped up-and-coming businesses meet their payroll requirements with ease. Businesses are credited for incremental research progress rather than year to year astounding feats. These changes in policy introduced through the PATH Act of 2015 meant that more businesses overall could benefit from the Research and Development Tax Credit. 

The 4 Part Test

Forget the world! The changes to the R&D Credit meant that innovations in research did not need to be entirely new to the globe. This made the tax credit applicable to a broad spectrum of business activities operating outside the scientific laboratory setting it had overwhelmingly been confined to before. Unsuccessful research and incremental improvements in efficiency that had been flying under the radar were now able to bring businesses the credit they deserved. Industry verticals such as Software Development, Manufacturing, and Financial Services were able to qualify along with the more traditional Life and Food Science lab rat business models. In section 41 and 174, the IRS defined four distinct areas that help business owners and their financial teams understand which of their business activities qualify for the R&D Credit. The test is composed of four essential elements. Each business component that is improved upon or newly created must separately meet the requirements of the four-part test.


Permitted Purpose:  The IRS specifically defines “business components” in section 41 where the governmental body also lays out the four qualification categories. Crucially, businesses don’t need to make innovations that will shock the world, or even blow away the industry. The research of a new or improved business component simply must relate to:

  • function
  • performance
  • reliability
  • quality
  • composition 

Qualifying research will be done before commercial production, not made to an existing component in response to a customer’s request, and must be so original that it doesn’t borrow from existing business components or their creative resources such as existing blueprints, specs, or plans. Research relating to style, taste, cosmetic, or seasonal design factors is also out. 


Process of Experimentation:  Research employs a process of evaluation. Similar to the Scientific Method, business components are evaluated and different hypotheses are considered based on experimental outcomes. The business component should have been tested accordingly and should advance or correct the design of an existing product to such a degree that significant gains are made in the areas relating to Permitted Purpose.


Technological in Nature:  Research will be based on the principles of Physical or Biological Science, Engineering, or Computer Science.


Elimination of Uncertainty: This is the only element of the four not found in section 41 of the tax code. It is available in section 174. To eliminate uncertainty, the research goal will be to discover information that definitively impacts the capability, method, or composition of a business component.

Research Rules

 Some factors can affect whether your business qualifies for the R&D tax credit. Sources of funding, research localities, and research that utilizes reverse engineering may not qualify. Contact us for more information about qualifying for the R&D tax credit.