The Business Component and the Four-Part Test: A Comprehensive Analysis of the Maine Research Expense Tax Credit

A business component is the specific product, process, software, formula, technique, or invention that serves as the focal point for qualifying research activities under the Maine Research Expense Tax Credit. To qualify, this component must satisfy the federal four-part test, ensuring the research is technological in nature, intended to eliminate technical uncertainty, and conducted through a systematic process of experimentation.1

The Maine Research Expense Tax Credit, codified under 36 M.R.S. § 5219-K, represents a significant pillar of the state’s fiscal strategy to encourage innovation and high-tech industrial growth.1 By aligning state definitions with the federal standards found in Internal Revenue Code (IRC) § 41, Maine provides a framework where the “business component” serves as the fundamental unit of analysis for determining eligibility.1 This alignment ensures that taxpayers who are already familiar with the federal Credit for Increasing Research Activities can navigate the state-level requirements with a degree of consistency, although the Maine credit imposes strict geographic limitations, requiring that all qualifying activities be conducted within the state.1 The complexity of the business component definition, combined with the rigorous requirements of the four-part test, necessitates a nuanced understanding of how technological uncertainty is identified and resolved through a systematic process of experimentation.2

Statutory Foundation and the Bridge to Federal Standards

The legal architecture of the Maine Research Expense Tax Credit is designed to piggyback on federal definitions while maintaining a strictly local application. Under 36 M.R.S. § 5219-K, the terms “qualified research expenses,” “qualified organization base period amount,” “basic research,” and other terms affecting the calculation of the credit have the same meanings as they do under IRC § 41.5 This statutory bridge ensures that any evolution in federal tax law—specifically the standards used by the Internal Revenue Service (IRS) to audit research activities—is reflected in the Maine tax environment.1 However, the state deviates from the federal model in its calculation rates and its geographic restriction, which mandates that the credit apply only to expenditures for research conducted in Maine.5

The Maine credit is calculated as 5% of the excess of qualified research expenses (QREs) over the base amount, plus 7.5% of basic research payments determined under IRC § 41(e)(1)(A).5 The base amount is defined as the average amount per year spent on qualified research expenses over the previous three taxable years.1 This incremental design is intended to reward businesses for increasing their investment in innovation within the state.10

The interaction between state and federal law creates a dual-layered compliance burden. Taxpayers must first satisfy the federal criteria for a “business component” and the “four-part test” to identify their QREs.2 Once these expenses are identified, they must be pruned to exclude any work performed outside Maine’s borders.1 This selective incorporation of federal law means that Maine Revenue Services (MRS) effectively delegates the primary definitions of innovation to the federal code while retaining administrative control over the final credit allowance and carryforward limitations.10

Defining the Business Component

At the heart of any R&D tax credit claim is the identification of the “business component.” This is the discrete unit of analysis to which the four-part test is applied.3 Under IRC § 41(d)(2)(B), a business component is defined as any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business.2

The categorization of a business component is not merely a formality; it dictates the scope of the research and the nature of the experimentation required.20 For example, a “product” component involves research into the physical or functional attributes of an item intended for sale, whereas a “process” component might involve research into internal manufacturing methodologies designed to improve efficiency or reduce waste.8

The Six Categories of Business Components

1. Product: This is the most common category, encompassing tangible items sold to customers. In Maine’s manufacturing sector, this could range from a new type of composite hull for the maritime industry to a specialized medical device.12
2. Process: This refers to the methods used in production or operations. Research into an automated assembly line that reduces errors in the fabrication of syringes is a classic example of a process business component.12
3. Computer Software: Software qualifies if it is developed for sale or for internal use that meets certain high-innovation thresholds. This includes everything from proprietary algorithms for financial services to control systems for robotic manufacturing.19
4. Technique: A technique is a specialized method of performing a task. This might include a novel welding technique developed by a Maine shipyard to handle advanced alloys.23
5. Formula: Formulas are particularly relevant to the biotechnology and chemical sectors. Developing a new chemical compound for renewable plastics or a pharmaceutical recipe for a drug would fall under this category.16
6. Invention: An invention represents a novel device or mechanism that is often subject to patenting. While a patent is not required for the R&D credit, the invention itself must be the result of a discovery of technological information.3

The “shrink-back rule” is a vital administrative tool used when a larger business component fails to meet the four-part test as a whole.3 Under this rule, if the entire product does not qualify, the taxpayer may “shrink back” the analysis to the most significant subset of elements that does meet the test.3 For instance, if a company is developing a new aircraft, and the overall design is considered routine, the company may shrink back to a novel wing flap mechanism or a unique avionics software module that independently satisfies the four-part test.27 This hierarchy ensures that innovation within a larger, non-innovative system still receives the tax benefits it deserves.3

The Four-Part Test: The Gateway to Qualification

For a business component to generate a tax credit, the research activities associated with it must pass four rigorous tests established by the IRS and adopted by Maine.2 These tests are designed to filter out routine business activities and ensure the credit only rewards true technological advancement.3

1. The Permitted Purpose Test

The first limb of the test requires that the research be undertaken to discover information that is intended to be useful in the development of a new or improved business component.2 The research must relate to a “qualified purpose,” which is defined as improving the function, performance, reliability, or quality of the component.8

In the context of a professional services firm or a manufacturer in Maine, this means the activities cannot be related to style, taste, or cosmetic design.2 For example, changing the color of a consumer electronic device’s casing would fail the permitted purpose test, while redesigning the internal circuitry to increase battery life by 20% would pass, as it improves performance.3

2. The Elimination of Uncertainty Test

The research must be undertaken to eliminate uncertainty regarding the development or improvement of a business component.8 Uncertainty exists if the information available to the taxpayer at the start of the project does not establish:

• The capability of developing or improving the component;
• The method for developing or improving the component; or
• The appropriate design of the component.3

Technical uncertainty is distinguished from business uncertainty.3 A company may be uncertain whether a product will sell (business uncertainty), but for tax purposes, the uncertainty must relate to the technical feasibility or the precise engineering path required to achieve the goal.7

3. The Process of Experimentation Test

This test requires that “substantially all” (defined as 80% or more) of the research activities must constitute a process of experimentation.2 A process of experimentation involves the systematic evaluation of one or more alternatives designed to achieve a result where the capability, method, or design is uncertain.8

The evaluation of alternatives can take several forms:

• Modeling and Simulation: Using software to predict how a component will react to stress or environment.8
• Prototyping: Building physical versions of the component to test its functionality in the real world.7
• Trial and Error: A systematic approach of testing a hypothesis, refining the design based on results, and testing again.4

Critically, routine testing or inspection for quality control does not qualify as a process of experimentation.1 The experimentation must be directed at resolving the identified technical uncertainty.3

4. The Technological in Nature Test

The process of experimentation used to discover information must fundamentally rely on principles of the “hard sciences”.2 These include physical or biological sciences, engineering, or computer science.2

Research that relies on the social sciences, economics, or humanities is explicitly excluded.8 For a Maine-based software firm, this means the research must go beyond simple web design or standard UI/UX adjustments and involve the application of computer science principles—such as database optimization, cryptography, or machine learning algorithms.20

Maine Revenue Services Guidance and Administrative Rules

Maine Revenue Services (MRS) provides specific guidance to ensure that taxpayers correctly apply these federal standards to their state returns. The credit is administered through the normal tax filing process under 36 M.R.S. § 5219-K, and taxpayers are required to submit the Maine Research Expense Tax Credit Worksheet for the applicable tax year.6

Apportionment and Rule 801

One of the most complex areas of MRS guidance involves Rule 801, which governs the apportionment of income for businesses operating both within and without Maine.31 For the purposes of the R&D credit, apportionment is critical because only expenses for research conducted in Maine qualify.5

In 2025, MRS proposed significant amendments to Rule 801 to clarify the sourcing of receipts from the performance of services.33 The rule shifts toward market-based sourcing, determining the location of a service based on “where the services are acquired or experienced”.33 For a research firm providing contracted R&D services, this means the sourcing of their revenue (and consequently the allocation of their expenses for the credit) must align with where the customer actually experiences the benefit of that research.33 This is distinct from the traditional “cost of performance” methodology, which looked at where the work was physically done.31

Combined Returns and Controlled Groups

Maine allows the State Tax Assessor to aggregate the activities of corporations that are members of a “controlled group” as defined by IRC § 41(f)(1)(A).5 In the case of corporations filing a combined return, a credit generated by an individual member must first be applied against the tax due attributable to that specific company.5 However, if that member has an excess credit, it may be applied against the tax due of another group member, subject to the statutory limitations.5

Specific Documentation and Filing Instructions

MRS requires that taxpayers claiming the credit attach a copy of their federal Form 6765, Credit for Increasing Research Activities, to their Maine return.6 The information on the state worksheet must be consistent with the federal form, though adjusted for Maine-specific QREs.1 Supporting documentation must be maintained and attached when requested to substantiate the claim.7

Recommended documentation includes:

• Project records and lab notes;
• Photographs or videos of prototyping and testing;
• Testing protocols and results of analysis;
• Tax invoices for supplies and contract research.7

Exclusions: What Activities Do Not Qualify?

Even if a project involves significant technical effort, it may be excluded from the Maine R&D tax credit if it falls into certain statutory categories. Both IRC § 41 and Maine’s interpretation exclude the following 3:

1. Research After Commercial Production: Any research conducted once the business component has been developed to the point of being ready for commercial sale or use is ineligible.8 This includes routine troubleshooting or seasonal design changes after the product has launched.3
2. Adaptation of Existing Components: Research related to adapting an existing component to a specific customer’s requirement or need is excluded.3 This is often a grey area in custom manufacturing or software development.20
3. Duplication of Existing Components: Reproduction of an existing component from a physical examination, blueprints, or publicly available information (reverse engineering) is not “discovery” and therefore does not qualify.3
4. Surveys and Studies: Efficiency surveys, management studies, market research, or routine data collection are excluded.3
5. Foreign Research: Any research conducted outside the United States is excluded from the federal credit, and Maine further restricts this to research conducted outside of Maine.6
6. Funded Research: To the extent that the research is funded by a grant, contract, or another person (including a governmental entity), it may be excluded unless the taxpayer retains substantial rights and bears the economic risk of failure.2

Calculation and Financial Limitations

The Maine R&D tax credit is a nonrefundable credit, meaning it can reduce tax liability to zero but cannot result in a tax refund (except for certain payroll tax offsets for small businesses at the federal level, which do not translate directly to the state income tax credit).1

The Corporate Limit

For corporations, the credit is subject to a specific limitation structure under 36 M.R.S. § 5219-K(3):

• First $25,000: The credit can offset 100% of the first $25,000 of tax due (calculated before other credits).
• Excess over $25,000: For tax liability exceeding $25,000, the credit is limited to 75% of that excess amount.1

Carryforward Rules

Any credit that is not used in the current taxable year due to these limitations or a lack of tax liability may be carried forward for up to 15 years.1 This is particularly valuable for startups that may incur heavy R&D expenses in their early years but do not become profitable (and thus do not have a tax liability to offset) until later stages.1

$$Maine\_Credit = (0.05 \times (Current\_QRE – Base\_Amount)) + (0.075 \times Basic\_Research\_Payments)$$

1

The “base amount” is the average of the prior three years’ Maine QREs.1 For a new business with no prior research expenses, the base amount is zero, allowing for a credit on 5% of all current-year Maine-based R&D expenditures.1

The Impact of the 2025 One Big Beautiful Bill Act (OBBBA)

In 2025, the federal landscape of R&D taxation shifted with the passage of the One Big Beautiful Bill Act (OBBBA).22 This law permanently restored full and immediate expensing for domestic R&D expenditures under a new Section 174A, reversing the mandatory capitalization requirement enacted by the Tax Cuts and Jobs Act (TCJA).22

Retroactive Relief and Maine Conformity

The OBBBA allows “eligible small businesses” (those with average annual gross receipts of $31 million or less) to retroactively deduct R&D expenses for the 2022, 2023, and 2024 tax years by filing amended returns.22

For Maine taxpayers, the 2025 Maine Tax Alert provided critical updates on state conformity to these federal changes 38:

• Small Business Conformity: Maine has authorized the State Tax Assessor to allow small businesses that file amended federal returns for 2022-2024 to claim a corresponding deduction on their Maine returns.38
• 2025 and Beyond: As of the latest guidance, Maine has not yet conformed to the federal accelerated expensing for R&D costs incurred after 2024. For the 2025 tax year, Maine instructions will reflect nonconformity with accelerated expensing for research expenses, meaning taxpayers may need to continue amortizing these costs for state purposes even if they deduct them immediately for federal purposes.38

This lack of full conformity creates a “timing difference” for Maine businesses, requiring them to track their R&D amortization separately for federal and state tax returns.38

Example Calculation: Manufacturing vs. Biotechnology

To illustrate how these rules apply in practice, we compare two hypothetical Maine-based businesses.

Example A: Augusta Manufacturing Co. (Industrial Syringes)

Augusta Manufacturing Co. (AMC) is developing a new, needle-free injection system.12

• Business Component: The Needle-Free System (Product) and the Automated Assembly Line (Process).3
• Technical Uncertainty: Uncertainty exists regarding the pressure required to deliver the medication through the skin without causing bruising (Design Uncertainty).3
• Process of Experimentation: AMC builds three prototype nozzles with varying diameters and tests them on synthetic skin models, measuring pressure and penetration (Evaluating Alternatives).7
• QREs: AMC spends $500,000 on Maine wages for engineers and $100,000 on supplies.1

Example B: Portland Biotech (Biofuel Development)

Portland Biotech (PB) is working to develop a more efficient enzyme for converting seaweed into biofuel.16

• Business Component: The novel enzyme (Formula).16
• Technical Uncertainty: It is uncertain whether a specific protein sequence will survive the high-temperature fermentation process (Capability Uncertainty).3
• Process of Experimentation: PB uses computer modeling to predict protein folding and then conducts laboratory tests to observe the enzyme’s reaction to heat (Technological in Nature).7
• QREs: PB pays the University of Maine $50,000 for basic research and spends $200,000 on in-house Maine wages.1

Economic Context and OPEGA Evaluation

The effectiveness of the Maine R&D tax credit is a subject of ongoing scrutiny. In March 2022, the Office of Program Evaluation and Government Accountability (OPEGA) released a detailed evaluation of the credit.10

Key Findings from OPEGA

1. Innovation as an Economic Driver: OPEGA confirmed that research supports innovation as a key economic driver, but noted that the specific impact of the Maine credit on the state economy is difficult to measure due to lack of readily available data.11
2. Maine’s Performance: Data indicated that Maine has performed poorly over time on R&D metrics. The state ranked 47th in the nation in total R&D performed and 31st in the percentage of the workforce holding Science, Engineering, and Health (SEH) doctoral degrees.42
3. Credit Accessibility: OPEGA found that the incremental structure—rewarding only spending that exceeds a three-year average—excludes businesses with significant but steady R&D spending.10 Furthermore, as a non-refundable credit, it does not provide immediate cash flow to startups with no current tax liability.1

Legislative Proposals for Expansion

Following the OPEGA report, several bills were introduced in the 130th and 131st Legislatures to strengthen the credit.14 Proposed changes (such as those in LD 308 and LD 1974) included:

• Doubling the incremental rate from 5% to 10%.14
• Increasing the basic research credit from 7.5% to 15%.43
• Doubling the corporate offset limit from the first $25,000 to the first $50,000.43
• Making the credit refundable or transferable for certain sectors like visual media.43

While many of these bills were tabled or carried over, they reflect a bipartisan recognition that Maine’s current R&D incentive may need to be more aggressive to compete with neighboring states like Massachusetts or Rhode Island.43

Audit Risks and the “Section G” Requirement

The administrative burden of the R&D credit is increasing due to new IRS reporting requirements that Maine taxpayers must also follow.24 For tax years beginning in 2024 and 2025, Form 6765 has been expanded to include a new “Section G,” which requires audit-level detail for each business component claimed.20

Mandatory Disclosure for Each Business Component

Starting in 2025 (and optional for some in 2024), taxpayers must report for each business component:

• The category (product, process, software, etc.) 20;
• Documentation of what the research sought to discover 20;
• The specific alternatives evaluated during the experimentation phase 20;
• Breakdown of wages by type (direct research vs. supervisory vs. support).24

This shift toward “business component as the unit of analysis” means that companies can no longer lump their R&D costs into broad categories.3 They must build robust tracking systems that tie every dollar of expense to a specific technological challenge.20 For Maine businesses, this means that their internal project management and time-tracking systems must be aligned with the four-part test from the very start of a project.20

Conclusion: Strategies for Maine Businesses

The Maine Research Expense Tax Credit provides a significant financial incentive for companies willing to invest in the technical future of the state. However, the rigor of the “business component” definition and the “four-part test” means that the credit is not a reward for “business as usual,” but a targeted benefit for true technological discovery.2

To successfully claim and defend the Maine R&D credit, businesses should:

• Identify discrete business components early: Do not wait until tax season to categorize projects. Assign each technical initiative to one of the six categories (Product, Process, etc.) as part of the project charter.3
• Document the “Why” and the “How”: It is not enough to show that money was spent. A company must show that it faced a technical design challenge and that it systematically tested multiple solutions to solve it.8
• Track Geography Precisely: Maintain separate cost centers for Maine-based R&D activities to ensure that non-Maine expenses do not pollute the state credit claim.1
• Monitor Legislative Conformity: Given the ongoing changes at the federal level (OBBBA) and the state level (Rule 801), businesses must stay informed about how Maine’s conformity choices will affect their amortization and deduction timing.33

By integrating these technological and administrative requirements into their everyday operations, Maine’s innovative firms can maximize their tax benefits, fuel their growth, and contribute to the state’s broader goal of becoming a regional leader in the high-tech economy.11

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