Process of Experimentation (Qualified Research Test)

The process of experimentation refers to a systematic evaluative procedure designed to resolve technical uncertainty by evaluating design alternatives through testing, modeling, or trial and error. Under Utah law, this serves as the definitive test to verify that innovation expenses result from rigorous scientific methodology rather than routine activity.

The Utah Research and Development (R&D) tax credit is a complex fiscal instrument designed to incentivize high-level innovation within the state’s borders by reducing the tax liability of entities engaged in qualified research. Governed by Utah Code § 59-7-612 for corporate taxpayers and § 59-10-1012 for individual taxpayers and pass-through entities, the credit serves as a cornerstone of the state’s economic strategy to maintain the “Silicon Slopes” and other industrial clusters. While the credit is a powerful tool for financial growth, its eligibility hinges on a rigorous four-part test adopted from the federal standard under Internal Revenue Code (IRC) § 41(d). Central to this test is the “Process of Experimentation,” a requirement that demands more than simple innovation; it requires a documented, systematic approach to solving technical problems that relies on the principles of the hard sciences.

Statutory Foundations of the Utah R&D Tax Credit

The legal landscape for research incentives in Utah is built upon a philosophy of federal conformity with strategic local modifications. The primary statutes, Utah Code § 59-7-612 and § 59-10-1012, establish the eligibility requirements for corporations and individuals, respectively. These statutes explicitly tie the definition of “qualified research” to IRC § 41(d), essentially incorporating decades of federal treasury regulations and judicial precedents into the Utah tax code. However, the state introduces a critical geographical nexus: only research conducted within the state of Utah is eligible for the credit.

Statute Reference	Taxpayer Category	Credit Components	Carryforward Period
Utah Code § 59-7-612	Corporations	Incremental (5%), Basic (5%), Volume (7.5%)	14 Years (excluding Volume)
Utah Code § 59-10-1012	Individuals/Trusts/Estates	Incremental (5%), Basic (5%), Volume (7.5%)	14 Years (excluding Volume)
Utah Admin. Code R865-6F-14	All Entities	Federal Conformity Policy	Not Applicable
Utah Admin. Code R865-6F-27	All Entities	Order of Credit Application	Not Applicable

The Utah State Tax Commission (USTC) further clarifies these requirements through administrative rules. Rule R865-6F-14 is particularly significant, as it states that the commission’s policy in matters involving the determination of income—and by extension, the credits applied against that income—is to follow federal requirements as closely as possible. This means that when Utah auditors examine a claim for a “Process of Experimentation,” they are looking for the same evidence of systematic trial and error required by the Internal Revenue Service (IRS). Yet, the commission reserves the right to deviate from federal interpretations if state law or specific commission rulings dictate a different treatment.

Deconstructing the Process of Experimentation (The Qualified Research Test)

To understand the meaning of the Process of Experimentation, one must view it as the final and most demanding gatekeeper of the four-part test. While the first three parts of the test—the Section 174 test (expenditure must be research in the experimental sense), the Technological in Nature test (must rely on hard sciences), and the Business Component test (must improve a specific product or process)—establish the “what” and the “why” of the research, the Process of Experimentation test establishes the “how”.

The Core Elements of Experimentation

Under IRC § 41(d)(1)(C), as adopted by Utah, a process of experimentation is defined as a procedure designed to evaluate one or more alternatives to achieve a result where the capability, method, or appropriate design of that result is uncertain at the beginning of the research activities. The regulation focuses on the resolution of technical uncertainty through a systematic evaluative process. This process must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science.

The evaluative process typically involves three distinct phases that must be documented to satisfy an auditor. First, the taxpayer must identify the uncertainty regarding the development or improvement of a business component. Second, the taxpayer must identify one or more alternatives intended to resolve that uncertainty. Third, the taxpayer must identify and employ a systematic method of evaluating those alternatives, such as through modeling, simulation, or a disciplined trial-and-error approach.

The Distinction Between Technical and Business Uncertainty

A frequent pitfall for Utah taxpayers is the failure to distinguish between technical uncertainty and business or market uncertainty. The Process of Experimentation is only valid if the uncertainty is technical in nature. For example, if a Utah manufacturing firm is uncertain whether a new product will sell in the European market, that is a business uncertainty. If the firm is uncertain whether they have the financial resources to build a factory, that is a financial uncertainty. Neither of these triggers a qualified process of experimentation.

In contrast, if the firm is uncertain about the structural integrity of a new alloy under extreme thermal stress, or if they are uncertain whether a new software algorithm can process data within a specific millisecond threshold, they are facing a technical uncertainty. The process used to resolve this uncertainty—such as conducting heat trials on different alloy mixtures or running stress tests on multiple algorithm versions—constitutes the “experimentation”.

Type of Uncertainty	Definition	R&D Credit Eligibility
Capability Uncertainty	Whether the company can technically achieve the result.	Highly Eligible
Method Uncertainty	The specific sequence of technical steps to achieve the result.	Highly Eligible
Design Uncertainty	The optimal configuration of the final business component.	Eligible
Market Uncertainty	Whether customers will purchase the finished product.	Not Eligible
Style/Aesthetic Uncertainty	Whether the product looks appealing to the consumer.	Not Eligible

State Revenue Office Guidance and Administrative Application

The Utah State Tax Commission (USTC) provides several layers of guidance that dictate how the law is applied in practice. Beyond the statutory language, taxpayers must navigate administrative rules, Tax Bulletins, and form instructions that outline the “burden of proof” required for a successful claim.

The Burden of Proof and Documentation Standards

In Utah, the burden of proof rests entirely with the taxpayer to demonstrate that the activities in question meet the rigorous requirements of the four-part test. The USTC emphasizes that contemporaneous documentation is essential. This refers to records created at the time the research was performed, rather than retrospectively estimated years later. In USTC Appeal No. 16-1707, the commission sustained an assessment against a taxpayer precisely because they could not provide sufficient evidence to show that the wages paid for Utah projects met the federal definition of “qualified research”.

Guidance from the commission implies that a simple list of project names or a general description of innovation is insufficient. Instead, the revenue office looks for project-specific files that contain technical reports, laboratory notebooks, test logs, and email correspondence discussing technical failures and course corrections. These documents serve as the evidence of a “process” of experimentation. If a company claims it performed experimentation but cannot show the “alternatives” it evaluated or the “test results” it analyzed, the credit will likely be disallowed upon audit.

Specific Guidance for Pass-Through Entities

For Utah’s many pass-through entities (S-Corporations, LLCs, Partnerships), the guidance for claiming the credit is found in the instructions for Form TC-20S and Form TC-65. The credit is calculated at the entity level but is claimed by the individual partners or shareholders on their own tax returns using code 12 on Schedule TC-40A. This requires a high degree of coordination, as the individual taxpayer must possess enough information from the entity to substantiate the credit if their personal return is audited.

The commission also provides guidance on the “Order of Credits.” Under Rule R865-6F-27, nonrefundable credits must be applied in a specific sequence: nonrefundable credits without a carryforward are used first, followed by nonrefundable credits with a carryforward, and finally refundable credits. Because Utah’s 7.5% volume credit cannot be carried forward, while the 5% incremental credit can, taxpayers must carefully manage their tax liability to ensure they do not lose the volume-based benefit.

The “Substantially All” Rule and the 80 Percent Threshold

A critical nuance of the Process of Experimentation test is the “substantially all” requirement. Under IRC § 41(d)(1)(C), as adopted by Utah, substantially all of the research activities must constitute elements of a process of experimentation. In this context, “substantially all” is defined as 80 percent or more of the taxpayer’s research activities for a specific business component.

Measuring Research Activities

The 80 percent threshold is measured on a cost or other consistently applied reasonable basis, such as employee hours. This means that if 85 percent of the hours an engineer spends on a new project are dedicated to identifying and resolving technical uncertainties through testing and modeling, the entire cost of that engineer’s wages for that project may qualify for the credit. However, if only 60 percent of the activity is experimental and the remaining 40 percent is routine data collection or market research, the “substantially all” test is failed for that component, and the taxpayer may only be able to claim the specific 60 percent related to experimentation.

This rule creates a significant documentation challenge. Taxpayers must track the specific activities of employees to prove that the vast majority of their time was spent in a systematic process of trial and error. Utah auditors frequently target this threshold, requiring detailed time-tracking logs or employee surveys to verify that the “experimental” phase of a project was not dwarfed by routine production or administrative tasks.

Direct Support and Direct Supervision

The scope of experimentation extends beyond the individuals actually performing the tests. IRC § 41(b)(2)(B) includes “qualified services,” which encompasses not only the direct performance of research but also the “direct supervision” or “direct support” of those activities. For instance, a research scientist who supervises a laboratory experiment but does not physically operate the equipment is providing direct supervision. Similarly, a lab technician who cleans specialized equipment used only for research, or a machinist who fabricates a specific part for an experimental prototype, is providing direct support. These wages are eligible for the Utah credit, provided they are tied to a documented process of experimentation conducted within the state.

Jurisprudence and the Evolution of the Experimentation Test

Judicial decisions in both federal and Utah courts have significantly shaped the modern understanding of the Process of Experimentation. For Utah taxpayers, the most important recent development is the case of Intermountain Electronics, Inc., which has challenged how production-level expenses are treated under the experimentation test.

The Intermountain Electronics Precedent

Intermountain Electronics, a Utah-based company that designs and manufactures custom electrical equipment for heavy industry, filed a claim for the R&D credit based on the development of “pilot models”—large-scale custom units that were essentially first-of-their-kind designs. The IRS denied the claim, arguing that the production expenses incurred while building these units were not “research in the experimental or laboratory sense”.

In a major development for the manufacturing sector, the Tax Court in 2024 denied the IRS’s motion for summary judgment. The court ruled that production activities—such as fabricating a physical component—are not categorically excluded from the “substantially all” calculation of experimentation. If the act of building the unit is necessary to resolve design uncertainty and evaluate alternatives, those production costs can be included in the numerator of the experimentation fraction.

This case is a “silver lining” for Utah manufacturers. It establishes that the “real-world” construction of a prototype is part of the experimental process, provided the company can document that the build was an evaluative step and that technical uncertainty remained until the unit was completed and tested. This shift emphasizes that experimentation is not limited to a “white coat” laboratory but occurs on the factory floors of Utah’s industrial parks.

The Cautionary Tale of Appeal No. 16-1707

While Intermountain Electronics offers hope, the USTC’s decision in Appeal No. 16-1707 provides a sobering reminder of the importance of documentation. In this case, a construction-related firm claimed research credits but was unable to satisfy the “Process of Experimentation” test because they lacked project-specific records. The commission noted that the taxpayer relied on broad narratives of innovation rather than evidence of a systematic trial-and-error process.

The commission’s ruling emphasized that the calculation of the “base amount”—the historical level of research spending that must be exceeded to claim the incremental credit—is a complex formula under IRC § 41(c). If a taxpayer cannot prove their current-year QREs through a documented process of experimentation, the commission will not even reach the stage of calculating the base amount; the credit is simply disallowed in its entirety.

Case Name	Outcome/Key Takeaway	Impact on Utah Taxpayers
Intermountain Electronics	Production costs may qualify as experimentation.	Eases the path for custom manufacturing credits.
Little Sandy Coal Co.	Production workers must be part of an evaluative process.	High bar for including 100% of production wages.
Appeal No. 16-1707	Disallowed credits due to lack of project-specific records.	Reaffirms the “burden of proof” on the taxpayer.
Grigsby v. US	Reaffirmed the “Business Component” requirement.	Prevents grouping unrelated research into one claim.

Specific Industry Applications in Utah

The meaning of the Process of Experimentation is highly contextual, varying across the diverse industries that comprise the Utah economy. Local revenue office guidance must be applied differently depending on whether the business is developing software, manufacturing aerospace parts, or conducting life science research.

Software and Silicon Slopes

For software firms, the experimentation test is often used to exclude “routine programming” or “web design”. To qualify, a software developer must be attempting to resolve technical uncertainties related to system architecture, algorithm performance, or cross-platform integration that have not been addressed by existing code libraries.

The 2016 final regulations on Internal Use Software (IUS) are particularly relevant. IUS—software developed primarily for the taxpayer’s own administrative or financial tasks—must pass an “additional innovation test”. This requires the software to be “intended to result in cost savings or efficiency improvements that are substantial” and involve a “high degree of technical risk”. For software to meet the experimentation requirement, the developer must document the evaluation of different software designs, such as testing different database structures or parallel processing methods to find the most efficient solution.

Advanced Manufacturing and Aerospace

In Utah’s manufacturing sector, experimentation typically focuses on material science, structural engineering, and process optimization. Activities such as 3D modeling, material testing, and the construction of “pilot models” or prototypes are standard qualified research activities.

A common area of guidance for manufacturers is the “Post-Commercial Production” exclusion. Under IRC § 41(d)(4)(A), research conducted after the beginning of commercial production of the business component is excluded. The Process of Experimentation must occur before the design is finalized for production. Routine quality control testing, “tooling up” for production, and debugging existing products are not qualified activities. However, if the firm is developing a new manufacturing process to improve the efficiency or safety of an existing product, that process itself is a separate business component, and the experimentation used to develop it may qualify for the credit.

Life Sciences and Biotechnology

The life sciences industry in Utah is arguably the best-aligned with the “experimental or laboratory sense” required by the law. Research in pharmaceuticals or medical devices fundamentally relies on the scientific method. To satisfy the Process of Experimentation test, biotech firms must document their hypotheses, the alternative chemical or mechanical designs they evaluated, and the results of their clinical or laboratory trials.

One critical area for this industry is “Funded Research.” Under IRC § 41(d)(4)(H), research is not qualified if it is funded by another person or entity. In Utah, this often applies to contract research organizations (CROs). If a biotech company is paid to conduct research for a client, and the client retains the rights to the results and the economic risk of failure, the CRO cannot claim the credit. The Process of Experimentation must be performed at the taxpayer’s own financial risk for it to be eligible for the Utah credit.

Calculating the Utah Credit: A Hybrid Approach

Once the qualified research activities (QRAs) have been identified through the Process of Experimentation test, the taxpayer must calculate the credit. Utah’s calculation is unique because it offers three separate nonrefundable components.

The 5% Incremental Component

This credit is equal to 5% of the taxpayer’s Utah-based QREs that exceed a “base amount”. The base amount calculation is rigorous, requiring the taxpayer to determine their historical research intensity. Utah follows the federal “Fixed-Base Percentage” method, which for most established companies is the ratio of research expenses to gross receipts from a specific historical period, capped at 16%.

For “start-up” companies—defined as those that did not have both gross receipts and QREs for at least three years between 1984 and 1988—the code provides a phased-in fixed-base percentage. Utah law specifically allows a taxpayer to elect to be treated as a start-up even if they do not meet the strict federal definition, provided they make the election and do not revoke it. This election can simplify the base amount calculation for newer Utah tech firms.

The 7.5% Volume Component

Added as a significant enhancement to the state’s innovation policy, the 7.5% volume credit is calculated based on total Utah QREs for the current year, regardless of historical spending. While this offers a larger potential benefit for many companies, it is a “use it or lose it” credit. Unlike the other components, it cannot be carried forward to future years. This reflects the state’s intent to provide an immediate incentive for current-year investment while requiring larger growth to qualify for the long-term carryforward benefit.

The 5% Basic Research Component

This credit applies to payments made to “qualified organizations”—typically Utah-based universities or research consortia—for basic research. Like the incremental credit, it applies to payments that exceed a base amount and carries a 14-year carryforward period. This encourages collaboration between the private sector and Utah’s academic institutions, such as the University of Utah and Utah State University.

Credit Type	Rate	Base Amount Required?	Carryforward
Incremental QRE Credit	5.0%	Yes (historical ratio)	14 Years
Volume QRE Credit	7.5%	No (total current year)	No
Basic Research Credit	5.0%	Yes (historical ratio)	14 Years

The Meaning of Experimentation: A Comprehensive Example

To synthesize the legal standards and administrative guidance, consider the example of “Summit Tech Solutions,” a mid-sized engineering firm based in Sandy, Utah.

The Problem: Technical Uncertainty

Summit Tech is developing a new specialized control system for geothermal power plants. The system must operate reliably at temperatures that would melt standard industrial electronics. The engineering team is uncertain whether a new silicon-carbide semiconductor can handle the voltage spikes at these temperatures (Capability Uncertainty) and are uncertain which heat-sink geometry will provide the most efficient cooling within the small casing (Design Uncertainty).

The Process of Experimentation

To resolve these uncertainties, Summit Tech initiates a systematic process:

1. Modeling: The team uses 3D computer-aided design (CAD) software to model four different heat-sink designs.
2. Simulation: They run thermal simulations on each design to predict heat dissipation under load.
3. Prototyping: They fabricate two prototypes—one using a fin-based cooling design and another using a liquid-cooled jacket. The cost of materials for these prototypes and the wages of the machinists who built them are tracked as QREs.
4. Testing: The prototypes are placed in a high-heat test chamber in their Sandy facility. The team records the failure points of each design, documenting the results in a laboratory logbook. This is the “Systematic Trial and Error” required by the law.
5. Iteration: Based on the test results, they refine the liquid-cooled design and re-test it until it meets the required threshold.

Applying Utah Revenue Office Guidance

Summit Tech maintains a project folder containing the CAD models, the simulation data reports, the test logs from the Sandy lab, and the payroll records for the engineers and machinists involved. This contemporaneous documentation provides the “how” to satisfy a state auditor. Because the project was conducted entirely in Utah, and the activities directly involved resolving technical uncertainty through an evaluative process, the wages, supplies, and prototype costs qualify as QREs.

When filing their Utah return, Summit Tech calculates that their total Utah QREs for the year are $500,000. They have a base amount of $200,000.

• Incremental Credit: 5% of ($500,000 – $200,000) = $15,000.
• Volume Credit: 7.5% of $500,000 = $37,500.
• Total Benefit: $52,500.

The $15,000 incremental credit can be carried forward for 14 years if their tax liability is low, while the $37,500 volume credit must be used in the current tax year.

Audit Defense and the Future of Utah R&D Claims

As the Utah tech economy continues to mature, the state revenue office has become increasingly sophisticated in its auditing of R&D credits. The “Process of Experimentation” has become the primary battleground.

Common Audit Triggers

Auditors often look for specific red flags that suggest a lack of a systematic process. These include:

• High Percentage of Non-Technical Staff: If a claim includes a large number of administrative or marketing employees, auditors will challenge whether “substantially all” of their time was spent on experimentation.
• Generic Project Descriptions: Descriptions that sound like marketing copy (“We developed a groundbreaking, user-friendly interface”) are often rejected because they fail to identify the technical uncertainty and the scientific process used to solve it.
• Lack of Version Control: In software audits, the absence of a version control history (e.g., Git logs) can be fatal to a claim, as these logs provide the chronological proof of the iterative testing and refinement process.

The Impact of Federal Tax Law Changes (OBBBA and Section 174)

Recent changes to federal law, such as the 2025 One Big Beautiful Bill Act (OBBBA), have complicated the R&D landscape. One of the most significant changes is the requirement under IRC § 174 that research and experimentation expenditures be capitalized and amortized over five years (for domestic research) or fifteen years (for foreign research), rather than being immediately expensed.

Because Utah law follows federal income definitions, Utah taxpayers must now adjust their tax returns to reflect this amortization. While the credit remains a valuable dollar-for-dollar offset of tax liability, the deduction for the underlying expenses is now spread over several years. This has increased the net cost of research for many small and mid-sized Utah firms, making the documentation of a valid “Process of Experimentation” even more critical to ensure that the credit is not lost upon audit, which would leave the taxpayer with the burden of capitalization without the benefit of the credit.

Final Thoughts: The Standard for Utah Innovation

The meaning of the Process of Experimentation in Utah is a marriage of scientific methodology and rigorous tax accounting. It requires that innovation be more than just “new” or “better”; it must be the product of a systematic, hard-science-based inquiry that identifies and resolves technical uncertainty through an evaluative process of trial and error.

For the Utah taxpayer, navigating the local revenue office guidance requires a commitment to contemporaneous documentation and an understanding of the state-specific rules regarding the three-part credit structure and the “substantially all” threshold. The judicial landscape, particularly the Intermountain Electronics ruling, has opened new doors for manufacturers to include physical production costs in their experimental numerator, but only if they can present a detailed, evidence-based narrative of their evaluative process.

As Utah continues to position itself as a global leader in technology and manufacturing, the R&D tax credit remains its most potent tool for fueling that growth. However, only those firms that can look beyond the financial benefit and commit to the disciplined “Process of Experimentation” will be able to successfully claim and defend these lucrative incentives in the face of increasing regulatory scrutiny. The successful R&D claim is not built in the tax department at year-end; it is built in the lab and on the factory floor, one documented experiment at a time.