In the United States, companies that engage in technical research activities such as designing or developing new products or making substantial improvements to existing products can apply for research tax credit refund from the Internal Revenue Service as long as they meet certain conditions.

1. What are Qualified Research Activities?
   
   Under the Internal Revenue Code (IRC), there are Four-part tests used to help companies determine whether research activities qualify for the credit and must be adequately documented.
   
   

   (1)	Section 174 test Qualified research means research for which expenses may be treated as section 174 expenses. The R&D expenses must be related to the taxpayer’s trade or business and in the sense of experiment or laboratory. The expenditure must be used to eliminate uncertainty in the development or improvement of products or business components.
   (2)	Business component test To pass this test, the organization must intend to apply the discovered information to develop new or improved business components for the taxpayer. A business component is a component that is sold, leased, or licensed to or used by the taxpayer in trade or commerce.
   (3)	Process of experimentation test Qualified research must be research in which substantially all elements constitute an experimental process related to new or improved functionality, performance, reliability, or quality. The research activities carried out by the organization must be guided by the principles of engineering, physics, chemistry, biology, computer science or similar sciences, focus on the technical nature of the activities and evaluate alternatives through modelling, simulation and other methods to eliminate uncertainties.
   (4)	Technological in nature test This test must rely on hard science (such as engineering or computer science) to complete. For this test, there is no requirement that the R&D project be successful or that the taxpayer obtain information beyond the common sense of a skilled professional in the field.

   
   
2. How to Record Research Activities?
   
   Taxpayers applying for R&D credits must maintain records to demonstrate that expenditures qualify for the credit. Failure to maintain records in a sufficiently usable form is a basis for disallowing the credit. Recorded rules at least include:
   
   

   (1)	Activities should be documented simultaneously, including projects, descriptions of the four-part test and other rules, and the research activities that occurred.
   (2)	Estimates should be used with caution and only when it is clear that the taxpayer is conducting qualified research activities.
   (3)	Documents should be organized, including documents, contracts, and testimony from taxpayers and employees.
   (4)	The information should be organized by project and employee, as well as time spent on qualifying and non-qualifying activities.

   
   
   
3. How to Calculate R&D Credits?
   
   Taxpayers can calculate the R&D credit using either the regular research credit (RRC) or the alternative simplified credit (ASC).
   
   The RRC method is a 20% credit obtained by comparing the current year's expenditures to a fixed-base formula average of the previous four years.
   
   The ASC method is where the credit is equal to 14 percent of the qualified research expenses (QRE) for the taxable year over 50 percent of the average QREs for the 3 taxable years preceding the credit year.  If the taxpayer did not have QREs in any of the preceding three years, the credit is calculated at 6% of the QRE for the current tax year.
   
   Taxpayers should consider both the RRC and the ASC to select which method yields the higher credit. Once elected, the ASC applies to the current tax year and all later years. A current tax year's ASC election may not be revoked.
   
   
4. How to Use the Research Activity Credit?
   
   

   (1)

   Eligible Small Business (For Purposes of Offsetting AMT Only)           Eligible small businesses (ESB) include partnerships, sole proprietorships, and corporations whose stocks aren’t publicly traded. For ESB, the average annual gross receipts cannot exceed $50 million for the three-tax year period preceding the tax year for which the tax credit is applied. In addition, If the total number of months in the tax year is less than 12, the gross receipts of the small businesses are multiplied by the gross short-term receipts by 12, and then the results are divided by the total number of months in the tax year.

   (2)

   Qualified Small Business (Payroll Tax Credit Election) A qualified small business (QSB) is a corporation (including an S corporation) or partnership that has gross receipts of less than $5 million for a taxable year and has no gross receipts in any taxable year that is 5 years prior to the taxable year ending in that taxable year. QSB can choose the payroll tax credit election, and only be done for five tax years. An increasing research activities tax credit of up to $500,000 for tax years beginning after December 31, 2022, can be used to offset the portion of employers’ social security liability and medicate tax. Therefore, starting in the first quarter of 2023, the payroll tax credit is first used to reduce the employer's share of social security tax up to $250,000 per quarter and any remaining credit reduces the employer's share of Medicare tax for the quarter. Any remaining credit, after reducing the employer's share of social security tax and the employer's share of Medicare tax, is then carried forward to the next quarter. Form 8974 is used to determine the amount of the payroll tax credit that can be used in the current quarter.

   
   
5. How to Apply for R&D Credits?
   
   Beginning January 10, 2022, to be eligible for a refund claim involving the increased research credit under I.R.C. § 41 (Research Credit), taxpayers must provide the following information when filing a refund claim with the IRS:
   
   

   (1)	Identify all the business components to which the Section 41 research credit claim relates for that year.
   (2)	For each business component, identify all research activities performed.
   (3)	Name the individuals who performed each research activity.
   (4)	The information each individual sought to discover.
   (5)	Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year. This may be done using Form 6765, Credit for Increasing Research Activities.

   
   Items 1 through 5 above are referred to as the “five items of information.”  The IRS has provided a grace period until January 10, 2025, during which taxpayers will have 45 days to perfect their research credit claim to receive a refund before the IRS makes a final determination on the claim.
   
   Please note that effective June 18, 2024, the IRS will no longer require taxpayers to provide the following two pieces of information on refund applications involving the research credit: the name of the individual who performed each research activity and the name of each individual who attempted Information found. However, this information may be requested if a refund application involving research credits is selected for review.
   
   Keep in mind that identifying and substantiating QRE that qualify for research credit is a complex area. Please reach out and discuss with our professional consultants for details.
   

Reference:
https://www.irs.gov/businesses/corporations/research-credit-claims-section-41-on-amended-returns-frequently-asked-questions
https://www.irs.gov/businesses/small-businesses-self-employed/qualified-small-business-payroll-tax-credit-for-increasing-research-activities