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Patent Safe Harbor: Removing Uncertainty from R&D Tax Credit Claims


Jonathan Cardella

Strike Summary

  • There are certain restrictions when taking advantage of both Sections 174 deduction/capitalization and Section 41, which can be seen in Section 280C.
  • Businesses that choose to elect Section 280C for their federal taxes could also lower their state taxes as well.
  • Taxpayers that want to use Section 280C must plan ahead because it can only be used on an originally filed return.
  • The recent passage of the Tax Cuts and Jobs Act may have have affected whether a taxpayer should use Section 280C in their tax strategy.

Work with Strike to navigate tax changes with ease.

Schedule a MeetingBook a Consultation

Strike Summary

  • Filing a patent requires extensive documentation and proof from an entrepreneur or company.
  • If you have a patent, you have fulfilled three out of four elements of the 4-Part test.
  • Since the January 10, 2022 Chief Counsel Memorandum, companies engaged in research and development are under more stringent requirements to provide proof, which patents can produce.

The Research and Development (R&D) tax credit (IRC Section 41) was created in 1981 and made a permanent fixture of the tax code in 2015. The credit rewards U.S.-based innovation, and companies performing R&D activities can receive dollar-for-dollar federal and state tax credits (depending on the state) totaling up to 22% of their qualified research expenses (QREs). To be eligible for the credit, projects must satisfy the requirements of the 4-Part Test:

  1. Purpose: The research must impart new or improved functionality, performance, reliability, or quality to a product, process, formulation, software, patent, or technique.
  2. Technological: The activity undertaken must rely on the principles of “hard” sciences including physics, biology, engineering, chemistry, or computer science.
  3. Eliminating Uncertainty: The development team must encounter technical uncertainty regarding the optimal design, methodology, or capability to achieve project specifications.
  4. Experimentation: The activities constitute a process of experimentation with the intent to resolve the technical uncertainty through the systematic evaluation of alternate solutions

The Patent Safe Harbor Provision

Included in Section 41 is a provision known as Patent Safe Harbor (26 C.F.R. §41-4(a)(3)(iii)), which states that the issuance of a patent by the U.S. Patent and Trademark Office (under 35 USC §51) is conclusive evidence that a company “has discovered information that is technological in nature that is intended to eliminate uncertainty concerning the development or improvement of a business component.”

In other words, the issuance of a patent automatically satisfies three of the four qualifications of the four-part test. Part four, experimentation, requires that a taxpayer provide contemporaneous evidence that qualifying research activities were undertaken by a company to achieve its patentable product/process/technology. The documentation of this process of experimentation is the most important aspect of qualifying projects and associated expenses for claiming tax credits.

The taxpayer has the burden of proof to provide evidence that a process of experimentation was performed, and to demonstrate a connection between the qualifying activities and expenses. These include the associated employee wages, raw materials & supplies, cloud computer rental/lease costs, and 3rd-party contractor expenditures incurred throughout the various phases of development that led to the filing and granting of the patent.

Patents essentially convey to the IRS that the majority of the four-part test has been satisfied. Additionally, documentation collected in the preparation of a patent application can be used to support the research and development tax credit claim. An R&D tax professional should still be consulted for your company to correctly claim the credit.

Patents Improve Your R&D Claim

There are several key factors to consider for your R&D tax credit including not only your process of experimentation, but also proof and valuation of your credit (see Suder v. Commissioner, T.C. Memo. 2014-201).

Proper documentation of the activities a taxpayer conducted throughout the process of experimentation is critical when claiming R&D tax credits and should be analyzed by a qualified tax consultant in order to ensure you are claiming the credit as per the guidance of section 41 of the R&D tax code (Fudim v. Commissioner – T.C. Memo. 1994-235).

Further, gathering supporting documentation of your R&D activities has recently been shown to be key in providing substantiation for your R&D tax credit (see Siemer Milling Co. v. Commissioner, T.C. Memo. 2019-37).

Does your company have patented inventions or is it in the process of applying for a patent? You have done the hard work to develop your patented intellectual property, contact Strike Tax today to speak to an industry specialist to maximize your tax savings.

Work with Strike to navigate tax changes with ease.

Schedule a MeetingBook a Consultation

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