Taxpayers must be engaged in carrying on a trade or business for in-house research expenses or contract research expenses to qualify for R&D tax credit consideration. This is an issue that bears consideration as start-up companies pursue R&D tax credits.
The “trade or business” and “in carrying on” requirements for research credit purposes are generally the same as established in Section 162. Two requirements must be met for an activity to be considered a “trade or business” under Section 162:
The “in carrying on” element requires the research expenses relate to a particular trade or business being carried on by the taxpayer at the time the expenses are paid or incurred to qualify for R&D tax credit consideration.
Expenses paid or incurred before commencing a new business are not paid or incurred “in carrying on” a trade or business. Research expenses paid or incurred by a taxpayer in developing a product, the sale of which would constitute a new trade or business for the taxpayer, are not paid or incurred “in carrying on” a trade or business, but rather are paid or incurred “in connection with” a trade or business.
The “in carrying on” element is disregarded for start-up companies engaged in qualified research to be used in a future business endeavor if at the time the expenses are paid or incurred the taxpayer’s principal purpose in making the expenditures is to use the research in the active conduct of a future trade or business of the taxpayer. This qualifying element is only disregarded for in-house research expenses (wages and supplies) and not for contract research expenses.
Start-up companies should closely examine if they are actively involved in carrying on a trade or business, as this assessment will impact whether contract research expenses can be included in the R&D tax credit calculation.
Earnd can help you qualify whether your business actively meets the carrying on a trade or business for R&D tax credit purposes.