R&D Tax Credit Overview & Calculator
R&D Tax Credit

Research & Development Tax Credit

The R&D Tax Credit rewards companies that invest in innovation, providing dollar-for-dollar reductions in federal and state tax liability for qualifying research activities, from software development to product engineering.

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Foundations

Overview of the R&D Tax Credit and how qualifying research activities generate tax savings.

Definition

What Is the R&D Tax Credit?

The Research & Development Tax Credit is a federal incentive that reduces tax liability for businesses that invest in innovation. Companies can claim a credit for qualified research expenses (QREs) related to developing new or improved products, processes, software, or techniques.

Qualifying activities typically include:

  • Product development for new or improved functionality, performance, or reliability
  • Software engineering and development of new algorithms or applications
  • Process improvements that enhance efficiency, reduce costs, or solve technical challenges
  • Prototyping and testing of new designs, formulations, or manufacturing techniques

Mechanics

How the Credit Works

The R&D Tax Credit is calculated based on qualified research expenses (QREs), which include wages for technical employees, contractor costs for qualified research services, and supplies used directly in research activities.

Key calculation methods include:

  • Regular Research Credit (RRC) based on a fixed-base percentage of historical spending
  • Alternative Simplified Credit (ASC) using 14% of current year QREs minus 50% of the prior three-year average
  • Small business credits that can offset payroll taxes for qualifying startups
  • State-level R&D credits available in many states as additional incentives
Who Qualifies

Industries and business activities where R&D tax credits are commonly claimed.

Industries

Who Typically Claims R&D Credits?

The R&D Tax Credit applies to a wide range of industries. Any business that invests in developing, improving, or testing products, processes, or software may qualify, regardless of whether the research is successful.

Common industries include:

  • Software development and technology companies
  • Manufacturing and industrial engineering
  • Architecture, engineering, and construction
  • Life sciences, pharmaceuticals, and biotechnology
  • Food and beverage product development
  • Aerospace and defense contractors
  • Automotive and transportation industries
  • Agricultural technology and food science
  • Chemical engineering and materials science

Qualification Requirements

The Four-Part Test

To qualify for the R&D Tax Credit, activities must meet the IRS four-part test. All four criteria must be satisfied for expenses to be considered qualified research expenses.

The four requirements are:

  • The activity must be permitted purpose — undertaken to discover information that is technological in nature
  • The activity must rely on principles of physical or biological sciences, engineering, or computer science
  • The activity must involve a process of experimentation to evaluate alternatives
  • The activity must be undertaken to eliminate uncertainty about capability, method, or design
Eligible Expenses

Types of costs that qualify as research expenses for calculating the credit.

Expense Categories

Qualified Research Expenses (QREs)

  • Wages: Salaries paid to employees directly engaged in or supervising qualified research activities
  • Contractor Costs: 65% of amounts paid to contractors for performing qualified research on behalf of the company
  • Supplies: Tangible property used in research, including materials, prototypes, and testing equipment
  • Cloud Computing: Certain cloud services used directly in the research and development process

Requirements

Documentation Best Practices

Maintaining proper documentation is essential for substantiating R&D Tax Credit claims. The IRS expects contemporaneous records that demonstrate qualifying activities and expenses.

  • Project documentation describing technical objectives and uncertainties
  • Time tracking records showing employee hours spent on qualified activities
  • Expense records linking costs to specific research projects
  • Technical designs, drawings, specifications, and test results
  • Meeting notes and project management documentation