The Complete Guide To Understanding & Receiving The Research & Development Tax Credit

Businesses that develop new or improved products, processes, or technologies may qualify for the federal Research & Development (R&D) Tax Credit. Eligible businesses can use the credit to reduce their federal income tax liability, offset certain payroll taxes, or lower their alternative minimum tax.

This guide explains who qualifies for the R&D tax credit, how it’s calculated, and how to claim it on your tax return.

What Is The Research & Development Tax Credit?

The Research & Development (R&D) Tax Credit is a federal business tax credit that rewards companies for developing new or improved products, processes, software, or technologies. Businesses of all sizes—including startups and small businesses—may qualify if they incur eligible research expenses.

Originally introduced in 1981 and made permanent through the Protecting Americans from Tax Hikes (PATH) Act in 2015, the credit can reduce a business’s federal income tax liability. Eligible small businesses may also be able to use the credit to offset certain payroll taxes or alternative minimum tax.

Many states also offer their own R&D tax credits, though eligibility requirements and credit amounts vary. This guide focuses on the federal R&D tax credit.

Consult with a CPA or tax professional to learn more about state R&D credits available to your business.

Who Qualifies For The R&D Credit?

Businesses that incur qualified research expenses while developing or improving products, processes, software, formulas, or other business components may qualify for the federal R&D tax credit.

Common qualifying activities and expenses include:

• Developing new or improved products, software, or manufacturing processes
• Creating prototypes, formulas, patents, or techniques
• Improving existing products or processes
• Developing intellectual property
• Employee wages for qualifying research activities
• Contractor costs related to qualified research
• Supplies used during qualified research

To qualify, the research activities must satisfy the IRS’s four-part test under Section 41 of the Internal Revenue Code.

The Four-Part Test

Qualified research must meet all four of the following requirements:

• Business Component: The research must relate to creating or improving a product, process, software application, formula, invention, or technique used in your business.
• Elimination of Uncertainty: The project must aim to resolve uncertainty about a product’s design, capability, or method of development.
• Process of Experimentation: The business must evaluate alternatives through testing, modeling, prototyping, simulation, or other iterative methods.
• Technological in Nature: The research must rely on principles of engineering, computer science, biology, chemistry, physics, or another hard science.

Who Can Use The Credit To Offset Alternative Minimum Tax?

Certain eligible small businesses may use the R&D tax credit to offset alternative minimum tax (AMT).

To qualify, a business generally must:

• Be an eligible corporation or partnership
• Meet the IRS’s gross receipts requirements
• Not be a tax-exempt organization
• Otherwise qualify for the federal R&D tax credit

Who Qualifies For The Payroll Tax Election?

Qualified small businesses may elect to apply a portion of their R&D tax credit toward the employer portion of payroll taxes instead of income tax.

To qualify, a business generally must:

• Meet the IRS’s definition of a qualified small business
• Have less than the applicable annual gross receipts threshold
• Meet the four-part test for qualified research
• Satisfy the IRS requirements for making the payroll tax election

Who Doesn’t Qualify For The R&D Credit?

Not all research activities qualify for the R&D tax credit. In general, the following activities are not eligible:

• Duplicating an existing product or process
• Market research, surveys, and studies
• Research conducted after commercial production begins
• Adapting an existing product or process for a specific customer
• Certain internal-use software development
• Research conducted outside the United States, Puerto Rico, or U.S. territories
• Research funded by another person, business, or government entity
• Research in the arts, humanities, or social sciences

Businesses also won’t qualify if their research activities fail to meet the IRS’s four-part test for qualified research.

How Does The R&D Tax Credit Work?

The R&D tax credit reduces a business’s federal income tax liability based on its qualified research expenses. Eligible businesses may also be able to use the credit to offset alternative minimum tax (AMT) or, in some cases, the employer’s share of payroll taxes.

For many businesses, the credit is worth roughly 7% to 10% of qualified research expenses, though the exact amount depends on the calculation method and the nature of the qualifying activities.

Businesses claim the credit on their federal income tax return. If you qualified for the credit in a previous tax year but didn’t claim it, you may be able to file an amended return to receive the credit retroactively.

Because the IRS has strict qualification, documentation, and calculation requirements, many businesses work with a CPA or R&D tax credit specialist to determine eligibility and prepare their claim.

What Is The Deadline For Claiming The R&D Tax Credit?

The federal R&D tax credit is permanent, so businesses can continue claiming it as long as they meet the eligibility requirements.

The credit is typically claimed on your annual federal income tax return. If you qualified in a previous year but didn’t claim the credit, you may be able to file an amended return for an open tax year — generally within three years, though exceptions may apply.

If your business can’t use the entire credit because it doesn’t have enough tax liability, you may be able to carry unused credits forward for up to 20 years.

How To Calculate The R&D Credit

The IRS allows businesses to calculate the R&D tax credit using one of two methods: the Regular Credit (RC) or the Alternative Simplified Credit (ASC).

Regular Credit

The Regular Credit generally equals 20% of qualified research expenses that exceed a calculated base amount. The calculation takes into account factors such as your business’s age, historical gross receipts, and qualified research expenses from prior years.

Alternative Simplified Credit (ASC)

The Alternative Simplified Credit is the easier and more commonly used method. It compares your current qualified research expenses to your average expenses over the previous three years to determine the credit amount.

The IRS recommends calculating the credit using both methods and claiming whichever provides the larger tax benefit.

Because both methods require detailed records and complex calculations, many businesses work with a CPA or R&D tax credit specialist to ensure they’re claiming the maximum credit available.

How To Claim The R&D Credit

Businesses claim the R&D tax credit by filing IRS Form 6765, Credit for Increasing Research Activities, with their federal income tax return.

The section of Form 6765 you complete depends on how you calculated the credit. Businesses using the Regular Credit complete Section A, those using the Alternative Simplified Credit complete Section B, and businesses making the payroll tax election complete Section D.

If you qualified for the credit in a previous tax year but didn’t claim it, you may be able to file an amended return to claim the credit retroactively for eligible open tax years.

Before claiming the credit, make sure you have documentation that supports your qualified research activities and expenses. Because the eligibility rules and calculations can be complex, many businesses work with a CPA or R&D tax credit specialist to maximize their credit and ensure the claim is filed correctly.

Is The R&D Tax Credit Taxable Income?

The R&D tax credit is not considered taxable income. Instead, it is a dollar-for-dollar credit that reduces a business’s federal income tax liability.

However, claiming the credit can affect how your business deducts qualified research expenses. Because the tax rules are complex, many businesses work with a CPA or tax professional to ensure the credit and related deductions are calculated correctly.

The Bottom Line On The Research & Development Credit

The Research & Development Tax Credit can provide valuable tax savings for businesses that invest in qualifying research activities. While the eligibility rules and calculations can be complex, the credit may significantly reduce your tax liability or, for some businesses, offset payroll taxes.

If you think your business may qualify, consult a CPA or R&D tax credit specialist to determine your eligibility and ensure you claim the full credit available.