Turning Innovation into Tax Savings with the R&D Tax Credit

The research and development tax credit — commonly called the R&D tax credit — is a federal tax incentive for businesses that perform qualified research activities. Many states also offer R&D tax incentives, though state rules and carryforward periods vary. The credit is designed to reward organizations that develop or improve products, processes, software, formulas, inventions, or technologies.

R&D does not have to mean work performed in a laboratory or research department. Many everyday activities may qualify when a business is working to improve functionality, performance, reliability, quality, speed, safety, scalability, or efficiency.

The biggest question is not whether innovation is happening — it is whether the organization can clearly identify, calculate, and document the qualifying work.

Here’s how to determine your eligibility.

Qualifying Organizations for the R&D Tax Credit

Businesses across many industries may qualify for the R&D tax credit if they are developing or improving products, processes, software, or technologies and can support those activities under the applicable rules. R&D tax incentives are not limited to technical companies or organizations investing heavily in formal R&D departments.

Industries that commonly evaluate R&D tax credit opportunities include:

• Manufacturing and distribution
• Software and technology
• Agriculture
• Life sciences
• Food and beverage
• Aerospace and defense
• Healthcare and medical technology
• Engineering

Defining “Research and Development”

A business does not need to invent something entirely new to qualify. Improvements to existing products, processes, or software may also be eligible if the work meets the rules for qualified research — for example, improving product reliability, deploying new technology, changing production processes, or improving client-facing software performance.

Examples of activities that may qualify include:

• Developing new or improved products
• Improving manufacturing processes for speed, efficiency, safety, or quality
• Designing tools, jigs, molds, dies, or fixtures
• Developing or improving software applications
• Testing alternative materials or production methods
• Creating prototypes or models
• Developing packaging designs that reduce waste or improve product protection
• Designing and testing alternatives for automated equipment or production systems

Not every improvement effort qualifies. Activities that are routine, cosmetic, duplicative, or purely based on style, preference, market research, or business judgment may not satisfy the requirements. This is why documentation and technical review are essential before claiming the credit.

Calculating Eligible Expenses

The R&D tax credit is generally calculated based on qualified research expenses tied to qualifying activities. Potential expenses may include:

• Employee wages related to qualified research
• Supplies used in qualified research
• Certain contract research expenses
• Certain computing or cloud costs used for qualified research

Staff salaries, raw materials, third-party contractors, and computing costs may be claimed as part of the credit, but businesses should consult a qualified tax advisor to confirm whether an activity or expense falls within the definition of research and development.

Because the rules are technical, the expense analysis should not happen in isolation. The strongest R&D tax credit claims connect expenses directly to qualifying projects, technical uncertainties, experimentation, and business components.

Four-Part Test for Qualified Activities

To qualify for the R&D tax credit, activities must satisfy each component of a four-part test.

1. Permitted Purpose

The project must be the development of a new or improved business component, such as a product, process, software application, technique, formula, or invention. The improvement should relate to function, performance, reliability, or quality.

Examples:

• Automating processes to increase effectiveness, efficiency, or safety
• Software developments designed to improve function, performance, reliability, quality, speed, security, scalability
• Design of tools, jigs, molds, fixtures, and dies

2. Eliminate Uncertainty

The work must be intended to resolve technical uncertainty. This uncertainty may relate to whether the desired result can be achieved, how it should be achieved, or what design is appropriate.

Examples:

• Uncertainties regarding optimal design or methodology
• Uncertainties regarding which programming language to use in software development
• Optimal building design given unique geological site constraints
• Developing appropriate packaging designs to reduce packaging waste or protect a product

3. Process of Experimentation

Substantially all of the qualified research activities must involve a process of experimentation. This may include modeling, simulation, testing, trial and error, systematic evaluation of alternatives, or iterative design.

Examples:

• Experimenting with alternative solutions to resolve technical uncertainties
• Developing applications to be functional on and compatible for iOS or Android OS
• Proceeding through multiple iterations of CAD designs to change unique design components
• Testing alternative machinery or machinery features to improve automated packing or processing systems

4. Technological in Nature

The project must discover information that fundamentally relies on principles of the hard sciences.

Examples:

• Physical or biological sciences
• Computer science
• Mechanical or electrical engineering

Recent Legislative Changes Impacting R&D Incentives

The enactment of new tax legislation has introduced significant changes to R&D expensing, including:

• Immediate Expensing of R&D Costs: Companies can now immediately deduct eligible R&D expenses or elect to amortize them for tax years beginning after December 31, 2024. However, foreign R&D expenses are not eligible for immediate expensing.
• Recapture of Previously Capitalized R&D Costs: Companies have the ability to deduct previously capitalized R&D costs on their 2025 and 2026 tax returns if they didn’t meet the criteria and deadline to amend their tax returns to reclaim those costs.

This change creates new planning opportunities, but it also increases the need for careful modeling. The treatment of domestic research and experimental expenditures may affect other areas of tax planning, including taxable income, deductions, credits, and broader business tax attributes.

For businesses investing in innovation, the planning question is no longer simply, “Do we have R&D?” The stronger question is: How should we document, calculate, and model R&D activity to improve tax outcomes while maintaining a defensible position?

Strategic Considerations Going Forward

Organizations are under pressure to improve margins, modernize operations, and invest in technology without losing sight of cash flow. The R&D tax credit can help offset the cost of innovation, but the benefit depends on the quality of the underlying analysis and documentation. Businesses should take a proactive approach throughout the year rather than reconstructing support after the fact.

To make the most of the available incentives:

• Document everything. Keep detailed records of qualifying R&D activities, expenses, and personnel.
• Evaluate prior tax years. You may be able to amend returns to claim credits or benefit from deductions under new rules.
• Work with a qualified tax advisor. Guidance from specialists helps ensure compliance and maximize savings.
• Not sure if you qualify? Take our R&D Tax Credit Assessment to see if your development efforts qualify for incentives.

Whether you're building new applications, streamlining operations, or investing in AI, your development work may qualify for significant tax savings. The key is knowing where to look — and how to claim these benefits. Eide Bailly can help.