R&D Tax Credits

What is It?

The Research & Development (R&D) Tax Credit is a permanent federal incentive that rewards US businesses for investing in innovation and technical advancements. Enacted permanently through the PATH Act of 2015, the credit allows companies of all sizes—including startups—to reduce their federal income tax liability for qualified research expenses (QREs). These expenses must support activities focused on developing or improving products, processes, software, or technologies.

R&D Tax Credits provide companies with dollar-for-dollar cash savings for performing activities related to research and development. These credits encourage companies both large and small to increase spending on R&D within the country for driving long-term technological change and innovation. The credit is available to a wide range of industries and can be claimed retroactively, making it a powerful tool for businesses to offset the costs of developing new products, processes, or technologies.

Many states offer their own versions of the Research & Development (R&D) Tax Credit, designed to complement the federal incentive. These state-level credits vary in terms of eligibility criteria, credit rates, and calculation methods but the majority of these states use criteria similar to the federal credit (IRC §41).

Who Qualifies?

R&D Tax Incentives are available for businesses that have qualified research and development practices that operate either globally, at a federal, and multi-state level. Presently, there are over a hundred countries and over forty states offering these valuable incentives. It remains one of the excellent sources for companies to tremendously cut down their tax liability.

The R&D tax credit applies to a wide variety of activities, not just in traditional fields like engineering or software development.

Qualifying activities can include:

Product Development - Creating new products or improving existing products
Process Improvement - Developing new manufacturing or operational processes
Software Development - Developing new software applications or improving existing ones
Prototype Development - Building prototypes to test or refine new ideas
Experimental Design - Testing and experimenting with new techniques or materials

The credit is available to businesses in a wide range of industries, including manufacturing, healthcare, aerospace, energy, software, food and beverage, and more.

Thorough documentation is essential to support and defend any R&D Tax Credit claim. To qualify, activities must meet the Four-Part Test, which includes:

Permitted Purpose - Purpose of the research activity was to improve a product or process
Technical Uncertainty - Uncertainty relating to the development or design
Process of Experimentation - Process of experimentation to resolve the uncertainty
Technological in Nature - Activity is based on principals of a hard science

Each of these criteria must be clearly demonstrated through records and supporting documentation.

What Services are Included?

What are the Benefits?

Lower effective tax rate
Increased cash flow and profitability
Encourages innovation and growth
Enhanced ability to compete
Reduces risk of innovation
Retroactive claims for open tax years (typically 3–4 years back)
Potential to offset both federal and state taxes

What are the Savings?

Dollar-for-dollar reduction in federal and state income taxes
Startups (with no income tax yet) can apply the credit against payroll taxes (up to $500,000/year starting 2023)
It's not a deduction, it’s a credit i.e.. If you owe $100,000 in taxes and have a $50,000 R&D credit, you now only owe $50,000
Most companies save about 6% to 14% of their qualified R&D spending
Carry forward the unused credit up to 20 years as a Deferred Tax Asset on your Balance Sheet

How Do I Claim the R&D Tax Credit?

The R&D Tax Credit is claimed by filing IRS Form 6765 with your timely filed federal tax return, including extensions. Businesses can also amend prior returns, typically up to three years back to claim missed credits. Form 6765 should be filed for the tax year in which the qualified research expenses (QREs) were paid or incurred.

Taxpayers have two options when calculating the R&D tax credit:

Regular Credit (RC) Method
Alternative Simplified Credit (ASC) Method

Each method has its own advantages, and businesses can generally choose the approach that provides the greatest benefit each year. To claim the credit, all four sections of IRS Form 6765 must be properly assessed and completed.