This blog was provided by EPSA USA, a premier sponsor of the PICPA.

By Ashley Chikes

Life sciences companies advance our understanding of biological systems, develop new treatments and therapies, and improve health care outcomes. The cost of all their research and development (R&D), however, can be a significant burden for these companies, making it challenging to remain competitive.  

To alleviate that pressure and bolster good outcomes for those companies and the public benefiting from their work, the federal government and several states provide tax incentives to encourage R&D investment through the Credit for Increasing Research Activities, also known as the R&D tax credit. This credit can be used to offset a company’s income tax liability, but it can also be used to offset payroll tax if it meets the eligible qualified small business requirements.

R&D tax credit rules and requirements can be found in Section 41 of the Internal Revenue Code. To qualify for this credit, a taxpayer must engage in activities that meet what is commonly referred to as the “four part test,” as further outlined below:

• New or improved business component – The research activity must relate to a new or improved product, process, software, formula, invention, or technique. For life sciences companies, this could include developing new drugs, medical devices, or biotechnology products, or improving existing products or processes.
• Technical uncertainty – For an activity to qualify, it must involve the resolution of a technical uncertainty. Technical uncertainty exists when a company is unsure whether it is possible to develop a product, process, software, formula, invention, or technique, or unsure about how to develop it to achieve the desired outcome. For example, a company may be researching a new treatment for a disease that has not yet been successfully treated.
• Process of experimentation – The company must undertake a process of experimentation to overcome the technical uncertainty to meet the qualification requirements of the R&D credit. This includes systematic trial and error, modeling, and simulation. In the case of life sciences companies, this may include testing different drug formulations or conducting clinical trials.  
• Technological in nature – The activities must rely on the principles of “hard science,” including engineering, computer science, or biology. For example, a life sciences company may be using advanced genetic engineering techniques to develop a new therapy.  

Once a company meets these requirements, it may be eligible to claim the R&D credit, which can provide a significant tax benefit. The credit is equal to a certain percentage of the qualified research expenses (QREs) incurred during the tax year, which may include wages, supplies, and contract research expenses as compared to the expenses for prior tax years. The federal R&D tax credit can offset federal income tax liability. If there is not enough tax liability in the current year, the credit can be carried back one year and carried forward for up to 20 years.  

As mentioned previously, a majority of states have an R&D tax credit, but the qualification and calculation varies dramatically. It’s important to look closely at each state’s requirements prior to claiming a credit.  

Ashley Chikes is the director of operations at EPSA USA, a tax consulting firm with offices in Philadelphia and Houston. She has specialized in the R&D tax credit for several years, and can be reached at achikes@epsa.com.

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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.