Many businesses overlook the federal research and development (R&D) tax credit because of its complexity. But the tax savings can be substantial — and in many cases, state incentives may be available in addition to the federal, making the opportunity even more valuable than you may think. Here are answers to commonly asked questions about this potentially lucrative tax break. 

What’s the R&D Tax Credit Worth? 

The R&D credit is for increasing research activities. Generally, it’s 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 expenditures. (There are alternative computation methods for startups and other companies without sufficient historical data.)  

What Expenses Qualify for the R&D Tax Credit? 

QREs include wages, supplies, and certain consulting and contract research fees related to qualified research activities. Identifying and documenting these costs accurately is key to calculating the credit. 

What Activities Qualify for the Credit? 

The R&D credit isn’t just for scientific research. Generally, to qualify for the credit, a research activity must: 

• Relate to the development or improvement of a “business component,” such as a product, process, technique or software program. 
• Strive to eliminate uncertainty over how (and whether) 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 — that is, it must rely on “hard science,” such as engineering, computer science, physics, chemistry or biology. 

To claim the credit, you must bear the financial risk associated with the research and enjoy substantial rights to the results. Otherwise, it will be considered “funded research,” which is ineligible for the credit. 

These criteria are broad enough to encompass a wide range of business activities. Examples include developing new products, improving processes (including business or financial processes that involve computer technology) and developing software for internal use. 

Finally, only domestic research costs qualify for the federal research credit. Foreign research expenses are excluded and must instead be capitalized and amortized over 15 years. 

Can the Credit Generate a Refund? 

The credit is nonrefundable — meaning it can’t be used to generate a loss. However, businesses don’t necessarily lose the benefit if they can’t use it immediately. Unused credits may be carried back one year or forward up to 20 years. Limits on general business credits also prevent companies from using tax credits to erase their tax liability entirely. 

What Do Startups and Small Businesses Need to Know About the Credit? 

Startups may elect to offset research credits against up to $500,000 in employer-paid payroll taxes. For this purpose, “startups” are generally businesses in operation for less than five years with less than $5 million in gross receipts. 

In addition, sole proprietors and owners of small pass-through entities (including S corporations, partnerships and most limited liability companies) can use the credit to reduce their alternative minimum tax liability. For this purpose, “small businesses” are generally those with average gross receipts of no more than $50 million for the three preceding tax years. 

Can Businesses Claim the Credit for Deductible Research and Experimental Costs? 

Research-related expenses may qualify for two tax breaks. The first is the research credit; the second is the deduction for research and experimental (R&E) costs. Businesses can immediately deduct domestic R&E expenditures paid or incurred in tax years beginning after Dec. 31, 2024. However, you can’t claim both breaks for the same expenses. 

In general, the expenses that qualify for the research credit are narrower than those that qualify for the R&E deduction. If you claim the research credit, you must reduce the amount otherwise deductible (or capitalized) for R&E expenditures by the amount of the credit. However, under the One Big Beautiful Bill Act, the amount deducted or charged to a capital account for R&E costs is reduced by the full amount of the research credit, as opposed to being subject to a more complex calculation in effect under prior law. 

Explore Your Eligibility 

If your business invests in developing or improving products, processes or software, our tax credit specialists can help you assess eligibility, quantify potential benefits and ensure your research-related tax breaks are properly supported. Contact us for more information.