FAQs About the Research Credit
Companies that invest in research and development may qualify for a valuable federal tax credit. The rules are complex and not all research activities are eligible, but the tax savings can be significant. Here are answers to the most common questions about this potentially lucrative tax break.
What Is the R&D Tax Credit Worth?
The federal research credit, also called the research and development (R&D) credit, rewards businesses for increasing their research activities. It is generally equal to 20% of the amount by which qualified research expenditures (QREs) in a tax year exceed a base amount derived from your company’s historical research spending. Alternative computation methods are available for start-ups and businesses without sufficient historical data.
QREs include:
- Wages paid for qualified research activities
- Supplies used in qualified research
- Certain consulting and contract research fees
The credit is non-refundable, it cannot generate a tax loss, but unused credits may be carried back one year or carried forward up to 20 years. General business credit rules also limit the use of credits to prevent full elimination of tax liability.
Payroll Tax Offset for Start-Ups
Start-ups may elect to apply up to $500,000 in research credits against employer-paid payroll taxes. For this purpose, a start-up is generally a business in operation for fewer than five years with less than $5 million in gross receipts.
Alternative Minimum Tax Relief for Small Businesses
Sole proprietors and owners of small pass-through entities, including S corporations, partnerships, and most LLCs, may use the research credit to reduce their alternative minimum tax (AMT) liability. “Small” businesses are generally those with average gross receipts of $50 million or less for the three preceding tax years.
What Research Costs Qualify?
The R&D tax credit is not limited to traditional scientific research. To qualify, a research activity must generally meet all four of the following criteria:
- Relate to the development or improvement of a “business component” — such as a product, process, technique, or software program
- Strive to eliminate uncertainty over whether and how the business component can be developed or improved
- Involve a “process of experimentation” using techniques such as modeling, simulation, or systematic trial and error
- Be technological in nature — meaning it must rely on engineering, computer science, physics, chemistry, or biology
To claim the credit, your business must bear the financial risk of the research and retain substantial rights to the results. Research funded by a third party is ineligible.
Examples of Qualifying Activities
These broad criteria can apply to a wide range of business activities, including:
- Developing new products or product lines
- Improving existing manufacturing processes
- Developing software for internal use
- Improving financial or business processes that involve computer technology
Domestic Research Only
Only domestic research costs qualify for the federal research credit. Foreign research expenses are excluded and must be capitalized and amortized over 15 years. For IRS guidance on qualified research activities, see IRS Section 41 Overview.
Can You Claim Both a Research Credit and an R&E Deduction?
Research-related expenses may qualify for two separate tax benefits: the research credit and the deduction for research and experimental (R&E) costs. However, you cannot claim both tax breaks for the same expenses.
Businesses may immediately deduct domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024.
In general, expenses that qualify for the research credit are narrower than those eligible for the R&E deduction. If you claim the research credit, you must reduce the amount otherwise deductible for R&E costs. Under the One Big Beautiful Bill Act, the deductible amount is reduced by the full amount of the research credit — a simplified calculation compared to the more complex rules in effect under prior law.
Related reading:
👉 Which Business Expenses Are Really Tax-Deductible?
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Do States Also Offer Research Tax Credits?
Many states offer research and development tax incentives in addition to the federal credit. These vary significantly by state in terms of eligibility rules, credit rates, and refundability. Businesses operating in multiple states should evaluate each state’s credit independently. See the IRS state tax resources for links to individual state tax agencies.
Is Your Business Leaving R&D Tax Credits on the Table?
Many businesses overlook the federal research credit because of its complexity — but the tax savings can be substantial. If your business invests in developing or improving products, processes, or software, now is the time to assess your eligibility.
Contact our team today to assess your eligibility, quantify potential benefits, and ensure your research-related tax breaks are properly documented and claimed.
