The Process of Experimentation Test in Idaho: Comprehensive Tax Compliance and Technical Substantiation under Idaho Code §63-3029G and IRC §41

Executive Summary: The Process of Experimentation (POE) Test in Context

The Process of Experimentation (POE) Test requires that research activities follow a systematic approach of testing and evaluation designed to resolve technical uncertainties related to improving a business component.1 This methodical approach must fundamentally rely on principles of physical or biological sciences, engineering, or computer science.3

The POE is the methodological cornerstone of the mandatory Four-Part Test under Internal Revenue Code (IRC) Section 41(d), which defines Qualified Research. For Idaho taxpayers claiming the incremental Research Activities Credit (Idaho Code §63-3029G), the successful application of the POE test is non-negotiable, as state statute explicitly incorporates the federal definitions of “qualified research”.5 The POE requires compelling evidence that expenditures were incurred during non-routine, systematic efforts involving the evaluation of alternatives (through modeling, simulation, and structured trial-and-error) to overcome documented technological uncertainties.1 Robust documentation—including project notes, time tracking records, and detailed test logs—is required for audit defense, ensuring that Qualified Research Expenses (QREs) are directly linked to the iterative, scientific process of resolving technical unknowns.7

I. Statutory Foundations and the Idaho-Federal Nexus

A. Idaho’s Conformance with IRC §41

Idaho’s approach to incentivizing research activities is characterized by a high degree of conformance with the federal framework established under IRC Section 41, the Credit for Increasing Research Activities.

Mandatory Adoption of Federal Definitions

The Idaho research credit, authorized by Idaho Code §63-3029G 9, explicitly uses the federal definitions for key terms. Idaho Admin. Code r. 35.01.01.720 unequivocally mandates that the Idaho credit must be computed utilizing the same definitions for “qualified research expenses,” “qualified research,” “basic research payments,” and “basic research” as those found in IRC Section 41.5 This statutory alignment means that all federal case law, Treasury Regulations, and Internal Revenue Service (IRS) Audit Guidelines regarding the Four-Part Test—particularly the Process of Experimentation requirement—are directly applicable and enforceable by the Idaho State Tax Commission.

This principle of conforming compliance dictates that Idaho taxpayers cannot argue for a less stringent definition of experimentation or uncertainty than that applied by the IRS. For instance, the federal requirement for systematic trial-and-error methodology 1 must be satisfied rigorously for an activity to constitute qualified research in Idaho. Compliance preparation must therefore incorporate the comprehensive technical standards used for federal audit defense.1

Critical Scope Limitation: Idaho-Sourced Activities

While the definitions are federal, a critical limitation is imposed: only the amounts related to research conducted in Idaho qualify for the state credit.5 This geographical restriction imposes an additional documentation requirement, demanding precise sourcing of Qualified Research Expenses (QREs) to Idaho facilities and personnel.

B. Idaho Calculation Mechanics and Unique Parameters

The Idaho Research Activities Credit provides a nonrefundable incentive against taxes imposed by Idaho Code sections 63-3024, 63-3025, and 63-3025A.9

Credit Structure and Carryforward

The credit is calculated in two parts:

1. Incremental QREs: Five percent (5%) of the excess of qualified research expenses for research conducted in Idaho over the taxpayer’s base amount.9
2. Basic Research Payments (BRP): Five percent (5%) of basic research payments allowable under IRC §41(e) for basic research conducted in Idaho.9

The Idaho credit is nonrefundable, meaning it offsets Idaho income tax liability but cannot generate a refund. However, its value is preserved through a generous fourteen (14) year carryforward period for unused credits.11 Taxpayers calculate the credit using Idaho Form 67.12

Base Amount Calculation and Idaho Gross Receipts

The calculation of the base amount uses the federal fixed-base percentage methodology but modifies the input data to reflect Idaho activity. The base amount is calculated by multiplying the fixed-base percentage by the average annual Idaho gross receipts for the previous four years.11 Idaho gross receipts include only those gross receipts attributable to sources within the state, as provided in Idaho Code §63-3027(12) and (13).9

The Irrevocable Start-Up Election

Idaho provides a significant strategic advantage through its unique rules for start-up companies. Notwithstanding IRC §41(c), which imposes strict historical requirements for the start-up election, Idaho permits a taxpayer to elect to be treated as a start-up company regardless of whether they meet the federal requirements related to historical QREs and gross receipts.9 This election, made on Form 67, is irrevocable 9 and allows the use of a fixed-base percentage capped at 16%.11

This state policy choice represents a strategic move to incentivize early-stage research and development within Idaho by removing federal barriers to the incremental credit calculation. New Idaho businesses that might otherwise struggle to calculate a historical base period can immediately elect a more favorable, simplified base calculation, thereby maximizing the credit available in early years and prioritizing stimulating new technological growth by lowering the immediate qualification threshold for incremental credit calculation.

II. The Four-Part Test for Qualified Research: POE as the Execution Prong

For any expense to be a Qualified Research Expense (QRE) and thus eligible for the Idaho credit, the underlying activity must satisfy all four prongs of the federal test.8 The Process of Experimentation (POE) serves as the definitive methodological demonstration that the other three requirements have been satisfied.

A. Permitted Purpose (The Business Component)

The research activity must be undertaken for a permitted purpose—specifically, the goal must be the development or improvement of the functionality, performance, reliability, or quality of a new or existing business component.2 A business component is broadly defined, encompassing any product, process, computer software, technique, formula, or invention that the taxpayer intends to hold for sale, lease, or use in its trade or business.4

B. Elimination of Uncertainty (The Technical Barrier)

Activities must seek to discover information that would eliminate uncertainties regarding the appropriate design of the business component, the capability of its development, or the method of its development.2 Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the component, or the appropriate design of the component.3

It is important to note that uncertainty may exist even if the taxpayer knows that achieving the ultimate goal is technically possible. The uncertainty often lies in determining the precise method or appropriate design required to reach that goal.4

C. Technological in Nature (The Scientific Constraint)

The research efforts must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science.2 Idaho State Tax Commission guidance explicitly reinforces this technical requirement, stating that the process of experimentation used to discover information must fundamentally rely on these hard sciences.3 This mandate ensures the research is genuinely innovative and not merely related to management functions, social sciences, or commercial optimization.14

D. Process of Experimentation (POE): The Methodological Mandate

The POE is the practical articulation of the research effort. I.R.C. § 41(d)(1) requires that substantially all of the activities of the research must constitute elements of a process of experimentation.1

The elimination of uncertainty (Part 2) establishes the technical risk that necessitates the research, while the POE (Part 4) establishes the how—the systematic execution used to overcome that uncertainty. If documentation fails to articulate the specific technical unknowns (such as design flaws or methodological barriers), the subsequent experimental activities will likely be deemed routine development rather than qualified research. Consequently, project descriptions must clearly define the technical risk at the project’s inception, providing a foundational justification for the resources spent on the systematic experimentation that follows. The POE requires a structured, systematic process, such as modeling, simulation, or systematic trial-and-error methodology.1

Table 1: The Four-Part Test: Idaho Compliance Matrix

III. Detailed Technical Analysis of the Process of Experimentation (POE)

The POE is the most frequently scrutinized element during an audit because it provides tangible, verifiable evidence of the required systematic effort.

A. Judicial and Regulatory Interpretation of Systematic Trial-and-Error

Evaluation of Alternatives

The POE necessitates an evaluative process that is generally capable of assessing more than one alternative design or approach to resolving the technical uncertainty.1 Research expenditures are unlikely to qualify if they simply refine an existing, known solution. Qualified experimentation must involve a genuine effort to evaluate alternatives intended to eliminate the documented uncertainty.1

This process includes modeling and simulation, which are integral elements of a systematic POE, particularly in engineering and software development. These activities count as experimentation, provided they are tied to resolving a technical uncertainty, such as the systematic testing and evaluation of several different algorithms in the development of software.15

Case Law Requirements for Methodical Plans

Judicial precedent emphasizes the need for a documented, methodical plan. For example, the Tax Court upheld R&D claims for Union Carbide largely because the company provided detailed documentation of its structured experiments, including test logs, design iterations, and analysis.16 Conversely, in Trinity Industries, Inc. v. United States, the court emphasized that the POE must involve a methodical plan comprising a series of trials to resolve uncertainty, reinforcing that claims fail if this systematic structure is absent.16

To satisfy auditors, testing must go beyond standard Quality Control (QC) or routine acceptance testing. A systematic POE must incorporate analysis of failures and subsequent modifications (iterations) that demonstrate learning and movement toward resolving the uncertainty. Testing that merely confirms a known design works is insufficient for qualification; activities must center on the discovery of information to determine the appropriate method or design under conditions of technical risk.

B. Temporal Boundaries and Statutory Exclusions Affecting POE

The timing and nature of the research activities are constrained by statutory exclusions in IRC §41(d)(4), which Idaho also enforces.14

The Post-Production Exclusion

A primary limitation is that research conducted after the beginning of commercial production of the business component is expressly excluded from qualification.14 This establishes the temporal limit for qualified POE activities. Manufacturers and product developers must draw a clear line: once commercial production begins, subsequent refinements or routine tooling updates are often disqualified. Any experimentation occurring after this point must be justified as resolving a major, unanticipated technical barrier or developing a distinctly new business component. Otherwise, auditors may deem the activities to be routine production refinement rather than discovery-oriented research.

Routine Activities and Adaptations

Certain activities are excluded even if they involve some degree of testing:

• Adaptation: Work done on adapting an existing product to meet a specific customer’s requirements.14
• Duplication: Research aimed at duplicating an existing business component.14
• Surveys and Management: Surveys, studies, and research related to management functions or social sciences.14
• Foreign Research: Research conducted outside the United States is excluded (though Idaho’s requirements further restrict activity to Idaho).14

Internal-Use Software (IUS)

Research for software that is developed primarily for internal use is subject to heightened scrutiny and is often excluded, though exceptions exist. For all software development (whether for internal use or commercial sale), IRS guidelines emphasize the application of the POE test of IRC § 41(d)(1)(C), requiring evidence of a systematic trial and error methodology or the evaluation of alternatives.1

IV. Idaho State Revenue Office Guidance on POE and Compliance

Compliance with the Idaho Research Activities Credit requires adherence to specific guidance issued by the Idaho State Tax Commission (IDTC) and Idaho Administrative Code (IDAPA).

A. Administrative Confirmation of Technical Standards

IDTC guidance actively confirms the scientific basis required for the POE. To satisfy the “technological in nature” requirement, the process of experimentation must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science.3 This regulatory confirmation signifies that claims based on non-scientific or incremental adjustments, such as those related purely to market testing or financial modeling, will face high scrutiny. This is a clear regulatory effort to maintain the integrity of the credit as an incentive for genuinely technological advancements.

Furthermore, Idaho administrative decisions clarify that uncertainty exists if the information available does not establish the capability, method, or appropriate design of the improvement.4 This requires documentation to focus on discovering information to resolve a technical question, not merely testing for marginal efficiency gains. Taxpayers benefit from including expert reports or technical memoranda that specifically cite the scientific or engineering principles underpinning the systematic trials performed (e.g., thermodynamics, computer science algorithms) to demonstrate compliance with this standard.

B. Idaho Apportionment and Compliance Administration

The state credit’s eligibility criteria create a dual documentation burden for taxpayers operating across multiple states.

Sourcing of Qualified Research Expenses

As mandated by Idaho Code, QREs—which include wages, supplies, and contract research expenses—must be physically performed or consumed within Idaho borders.5

• Wages: Wages paid to employees who perform research and development activities must be allocated based on the time spent performing those qualified activities in Idaho.13 This is a frequent area of audit adjustment for multi-state employers.
• Supplies: Costs of materials used and consumed during the experimentation process must be traced to their consumption in Idaho facilities.13

The geographical limitation of the Idaho credit means that taxpayers must not only prove the POE occurred but also prove the expenditure supporting the POE was physically incurred in Idaho. Failure to isolate payroll hours or supply consumption to Idaho facilities using detailed, reliable records is a primary target for audit adjustments. Time tracking systems must incorporate geographic data or jurisdiction coding, and financial reports must segregate invoices for supplies purchased or consumed at Idaho sites that were directly used in the documented POE activities.

Compliance Form and Carryovers

The Idaho Research Activities Credit is claimed using Idaho Form 67.12 The credit is nonrefundable and any excess may be carried forward for up to 14 tax years.11 Corporations included as members of a unitary group may elect to share the credit earned but not used with other members of the unitary group, provided the claiming corporation first maximizes its own usage of the credit.8

V. Substantiation Requirements and Audit Defense of the POE

Effective audit defense relies on a clear, chronological link between the financial records (QREs) and the technical narrative of the experimentation process (POE).

A. Linking QREs to Experimental Steps

The most critical aspect of substantiation is proving that the expenditures are commensurate with, and directly attributable to, the systematic POE activities.

• Wages: Employee time records must clearly indicate the research project, the specific phase of the POE (e.g., modeling, testing, iteration analysis), and the time spent performing the qualified activity.7 Time spent by engineers analyzing test results or developing alternatives to resolve uncertainty are prime examples of qualified wages.16
• Supplies: The costs of tangible materials used and consumed during the experimentation, such as prototypes, raw materials for test batches, or specialized chemicals, are QREs.13 These must be mapped via inventory records and invoices to specific experimental trials documented in the POE process.
• Contract Research Expenses: Payments to third parties for qualified research must be supported by the contract, and the third party’s work product must also demonstrate a systematic POE related to research conducted in Idaho.17

B. Criticality of Technical Documentation

Technical documentation provides the narrative proof of the POE, connecting the initial uncertainty to the ultimate solution.

• Trial Documentation: Mandatory documentation includes detailed test logs, encompassing parameters used, variables tested, raw data output, and chronological entries for each trial and experiment.16
• Failure Analysis and Iteration: The documentation must explicitly explain why an attempt or design alternative failed and detail the technical rationale for the next experimental step. This process proves the iterative, systematic nature of the POE.1 The methodology must demonstrate a continuous cycle of hypothesis, evaluation, failure, analysis, and revision.
• Project Reports and Journals: Technical reports, design change notes, and engineering journals serve as narrative summaries, linking the scientific process utilized to overcome the technical barriers identified in the uncertainty prong.7

Case studies reveal that many businesses fail to adequately document the POE, despite investing heavily in innovation. This oversight often leads to credit denial because the experimental journey—the core of the R&D definition—was not properly captured.8 A structured, prospective compliance program is necessary, ensuring engineers and scientists document technical decisions, test failures, and design changes in real-time, specifically mapping these activities to the Four-Part Test criteria.

VI. Practical Example: Documenting POE for an Idaho Manufacturing Improvement

This example details the required POE documentation for an Idaho-based process enhancement, illustrating how a claim satisfies all elements of the Four-Part Test.

A. Scenario: Enhancing Idaho Semiconductor Wafer Etching Process

• Context: An Idaho semiconductor firm (ID-Semi) seeks to improve the yield (performance and quality) of its silicon wafer etching process. The current process exhibits unacceptable uniformity variance across the wafer surface, negatively impacting quality metrics (Permitted Purpose).18 QREs include wages for Idaho-based process engineers and specialized chemical supplies.
• Uncertainty (Part 2): ID-Semi is uncertain about the appropriate design of a new chemical injector nozzle and the method (flow dynamics, pressure, temperature profile) required to achieve a precise, uniform etching depth without compromising wafer structural integrity. This technical uncertainty necessitates scientific discovery.4
• Technological Basis (Part 3): The efforts fundamentally rely on principles of fluid dynamics, chemical engineering, and computer science modeling to analyze material stress and flow patterns.3

B. Step-by-Step Application of the POE (Part 4)

1. Initial Hypothesis and Design Alternatives: Engineers hypothesize that modifying the injector nozzle geometry will resolve the non-uniformity. They design and model three distinct nozzle configurations (N1, N2, N3). (POE: Evaluation of Alternatives).
2. Simulation and Modeling: Finite Element Analysis (FEA) simulations are run on the proposed N1, N2, and N3 designs to predict fluid dynamics and etching uniformity under operational conditions. Modeling indicates that N2 provides the optimal theoretical flow profile. (POE: Modeling/Simulation).
3. Physical Trials (Systematic Trial-and-Error):

• Trial Batch 1 (N1 Prototype): 100 wafers processed using N1. Results show minimal improvement over the baseline, with excessive chemical usage and continued uneven etching depth. The Failure Analysis Report determines that N1’s geometry causes localized turbulent flow, violating the initial hypothesis. (Documentation: Test Logs, Wafer Metrology Reports, Failure Analysis).
• Trial Batch 2 (N2 Prototype): 100 wafers processed using N2. Improved uniformity is observed, but the nozzle material exhibits unexpected early degradation due to chemical-thermal stress, introducing a new material capability uncertainty. (Documentation: Material Stress Test Logs, Engineer notes identifying failure mode based on chemical engineering principles).
• Iteration (N2-Prime): Engineers modify N2 by selecting a specialized silicon carbide material and structurally reinforcing critical stress points to address the material uncertainty. (POE: Systematic Iteration, using new QREs for specialized supplies).
• Trial Batch 3 (N2-Prime): 200 wafers processed under varying pressure methods (Method Uncertainty resolved). The optimal pressure setting, $P_{opt}$, is determined after a series of systematic trials, yielding a 15% better results than the original baseline process. (Documentation: Final Process Control Data, Summary Report of Optimal Pressure Method).

C. Required Documentation Linkage

The documentation must explicitly link the technical activities performed in Idaho with the Qualified Research Expenses incurred.

Table 2: POE Documentation and Audit Linkage (Idaho Semiconductor Process Improvement)

For process improvements, the primary evidence of experimentation is the comparison of quantifiable results (yield, quality metrics) across different tested parameters (nozzle design, flow rates, pressure settings). The documentation must emphasize the measurable metrics and the scientific justification for changing parameters between trials. The most important documents for audit defense are the time tracking records proving the Idaho-based engineers were performing these iterative analyses, which constitute the core of the POE.

VII. Conclusion and Strategic Recommendations for Idaho Taxpayers

The Idaho Research Activities Credit provides a compelling state-level incentive, structured as a 5% credit on incremental QREs with a 14-year carryforward.11 However, the foundational eligibility for the credit rests entirely on a documented and defensible Process of Experimentation that conforms strictly to the definitions and methodologies required under IRC Section 41.

The analysis confirms that taxpayers must overcome two distinct compliance hurdles: satisfying the rigorous technical standards of the federal Four-Part Test, and strictly adhering to Idaho’s geographical limitations on QREs.

Strategic Compliance Recommendations:

1. Mandate Prospective POE Documentation: Compliance cannot be a retroactive exercise. Taxpayers must implement a structured, real-time system for capturing the iterative steps of the research. Documentation must include detailed test protocols, chronological logs, raw data collection, and, critically, formalized reports explaining the rationale for failures and the technical justification for subsequent design iterations. This ensures the methodological execution (POE) is always linked back to the elimination of technical uncertainty.
2. Enforce the Technological Nexus: Explicitly tie all POE activities (modeling, testing, analysis) to the foundational principles of physical sciences, engineering, or computer science. Idaho administrative guidance emphasizes this scientific constraint 3; therefore, the supporting narrative should articulate the specific scientific disciplines applied, distinguishing the activity from routine or non-technical optimization efforts.
3. Strict Geographical Sourcing of QREs: Multi-state taxpayers must adopt highly granular time tracking and expense allocation methodologies to segregate QREs exclusively to research physically conducted in Idaho.5 Financial records and payroll systems must provide clear, auditable evidence that the labor and supplies claimed occurred within Idaho boundaries, mitigating the significant audit vulnerability associated with apportionment rules.
4. Evaluate the Start-Up Election: New businesses should conduct an immediate cost-benefit analysis regarding the irrevocable election to be treated as a start-up company on Idaho Form 67. This unique state provision provides a guaranteed base calculation methodology, maximizing the incremental credit opportunity without requiring the stringent historical data typically demanded by federal law.9

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