The four-part test, in plain English.
A practical overview of the framework tax professionals use when evaluating qualified research activities.
All four requirements generally must be evaluated for the relevant activity or project. Meeting a simplified description on this page does not establish eligibility.
What is the Four-Part Test?
Businesses improve products, processes, software, formulas, techniques, and methods every day. Not every improvement activity is qualified research.
The Four-Part Test helps tax professionals distinguish potentially qualified research from routine business activity, ordinary adaptation, duplication, and other excluded work. The requirements are evaluated based on the specific facts and circumstances of the activity.
All four are generally evaluated together for the relevant project or business component.
Section 174: The work addresses uncertainty.
The activity generally involves efforts to discover information that would help eliminate uncertainty about the capability, method, or appropriate design for developing or improving something.
Questions a tax professional may examine
- Was it uncertain whether the intended result could be achieved?
- Was the method for achieving it uncertain?
- Was the appropriate design uncertain?
- Was the work connected to developing or improving the business activity or product?
Plain-English example
A manufacturer wants to reduce defects in a production line but does not know which tooling configuration, operating settings, or process design will produce a reliable result.
Ordinary business uncertainty—such as uncertainty about customer demand, price, funding, or profitability—is not necessarily the technical uncertainty addressed by this requirement.
The work is technological in nature.
The information being developed generally relies on principles of the physical or biological sciences, engineering, or computer science.
Possible disciplines
- Engineering
- Computer science
- Chemistry
- Physics
- Biology
- Material science
- Food science, where applicable to the technical work
Plain-English example
A software team evaluates database structures and processing methods to solve a performance or scalability problem.
Using computers or technical equipment does not automatically make an activity technological in nature. The underlying uncertainty and evaluation must relate to technological principles.
The work has a permitted purpose.
The research must generally be intended to develop a new or improved function, performance, reliability, or quality of a product, process, software, technique, formula, invention, or other business component.
Improvements that may relate to a permitted purpose
- Function
- Performance
- Reliability
- Quality
The improvement generally does not need to be new to the world. The analysis focuses on the taxpayer's own business component and circumstances.
Plain-English example
A food company tests formulation and processing changes intended to improve shelf stability, consistency, or production performance.
Changes based only on style, taste, cosmetic preference, or seasonal design may require a different analysis and should not be presented as automatically meeting this requirement.
The work involves a process of experimentation.
A substantial portion of the research activities generally must involve a process designed to evaluate one or more alternatives for resolving the identified uncertainty.
Evaluation may include, depending on the facts
- Modeling
- Simulation
- Systematic trial and error
- Prototyping
- Testing
- Analysis of alternatives
Plain-English example
An engineering team develops several prototype configurations, tests their performance, compares the results, and revises the design based on what it learns.
A successful final result is not required for an experimentation process to have occurred. Failed tests and rejected alternatives may still be important documentation, but their tax treatment must be evaluated professionally.
Common misconceptions and exclusions
A few clarifications worth knowing before documenting potential R&D activity—and activities that often require careful review.
R&D has to be new to the world.
The activity may involve developing or improving something for the company, but the specific facts still require professional evaluation.
Only laboratories and scientists perform R&D.
Potential research activity can occur in manufacturing, software, food production, engineering, construction-related design, product development, and many other industries.
If the project succeeded, there was no uncertainty.
Uncertainty is generally evaluated based on what was known when the development work began—not only by looking at the final outcome.
Testing something once is automatically a process of experimentation.
The facts should show how alternatives were identified, evaluated, tested, analyzed, or revised.
Using advanced technology makes an activity qualified research.
The work must still be evaluated under all four requirements and applicable exclusions.
Documentation can always be recreated at tax time.
Contemporaneous records are usually more reliable and useful than attempting to reconstruct technical work months later.
Depending on the circumstances, activities requiring careful review may include:
- Work performed after commercial production begins
- Adapting an existing product or process to a particular customer
- Duplicating an existing product or process
- Surveys or routine studies
- Certain internal-use software
- Research conducted outside the United States
- Research in the social sciences, arts, or humanities
- Routine quality control or ordinary troubleshooting
- Cosmetic or stylistic changes
This is not a complete list, and the treatment of an activity depends on the specific facts and applicable law.
The test is legal. The evidence is practical.
A tax professional evaluates the legal requirements. The business must still be able to explain what it attempted, what was uncertain, which alternatives were considered, what testing occurred, who performed the work, and which costs were connected to it.
Documentation categories
- Project goals
- Technical uncertainties
- Alternatives considered
- Tests and results
- Design changes
- Employee involvement
- Contractor involvement
- Supplies and expenses
- Supporting files and communications
The quality, timing, and consistency of documentation can materially affect the ability to evaluate and support a position.
R&D Ledger documents the work. Your CPA evaluates it.
R&D Ledger
- Organizes projects and tax years
- Records people and project-related costs
- Preserves evidence and experiment records
- Helps identify possible documentation gaps
- Prepares organized records for review
Qualified tax professional
- Reviews the facts and circumstances
- Applies the Four-Part Test
- Evaluates exclusions and limitations
- Determines which activities and expenses may qualify
- Makes tax-filing and claim decisions
R&D Ledger is a documentation platform. It does not provide tax advice, determine eligibility, calculate a guaranteed credit, or replace a CPA or tax advisor.