Key Takeaways
- The R&D tax credit can help organizations save money by turning innovation and improvement efforts into tax savings.
- Eligibility for the credit is not limited to technical industries; many everyday business operations may qualify.
- Both federal and state incentives are available for companies that design, develop, or improve products, processes, or technologies in the U.S.
Organizations seeking to improve products and processes or develop new ones can benefit from the R&D tax credit. R&D tax incentives are not just for technical companies or those investing heavily in R&D activities. Many day-to-day company operations potentially qualify for the R&D tax incentive. Here’s how to determine your eligibility.
What is the R&D Tax Credit?
The research and development tax credit is an incentive for companies that design, develop, and improve business components, as defined by the Internal Revenue Code (IRC). Business components can include products, processes, techniques, software, and inventions that result in new or improved reliability, functionality, quality, or performance.
Along with the federal R&D tax credit, many states also offer R&D tax incentives.
What activities make you eligible for the R&D Tax Credit?
If you fall under any of the following four categories, you may be able to claim the R&D tax credit:
- Your R&D activity is conducted on U.S. soil
- You’re developing or designing innovative products or processes
- You’re investing in improving products and processes
- You’re assessing or implementing new alternatives or developments within the design and development process
What is the 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 product, process, or software.
Examples:
- Automating processes to increase effectiveness, efficiency, or safety
- Software developments designed to improve function, performance, reliability, quality, speed, security, scalability
- Designing building additions or new structures
- Design of tools, jigs, molds, fixtures, and dies
2. Eliminate Uncertainty
The project must involve the discovery of information to eliminate uncertainty concerning capability, methodology, or appropriateness of design.
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 the development activities undergone during a project constitute a process of experimentation.
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 or utilizing Building Information Modeling (BIM) systems to change unique design components
- Evaluating 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 structural engineering
R&D Tax Credit Examples:
- You identify improvements to current products to add new functionality or improve reliability in the field.
- You deploy new technology or make changes to your production processes to boost productivity and speed.
- You develop new software or improve performance of client-facing technology.
Applicable expenses that can be claimed for the credit include staff salaries, raw materials, third-party contractors, and computing costs in the R&D tax credit; however, it’s always wise to consult an accountant to ensure that an activity or expense falls under the definition of research and development.
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 will have the ability to recapture previously capitalized domestic R&D costs by amending its tax return(s) (available to certain small businesses) or accelerating the deductibility of unamortized R&D expenses in its first taxable year beginning after December 31, 2024.
- Restoration of 100% Bonus Depreciation: Qualified assets are eligible for 100% bonus depreciation.
How Does Section 174 Affect the R&D Tax Credit?
Section 174 affects the way organizations account for R&D expenditures. Prior to 2022, Section 174 allowed taxpayers to deduct R&E expenditures fully. These include direct research expenses, like wages and supplies, and indirect research expenses, like overhead and administrative costs related to research activities.
- Dive Deeper: The Impact of Changes to Section 174
Strategic Considerations Going Forward
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 immediate 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 them.
Let’s talk about how you can perform better, protect what you’ve built, and prosper through innovation.
Frequently Asked Questions
How far back can you claim R&D tax credits?
You must carry the credit back one year before you can carry forward. Once you have applied the credit carry back, the only limitation on these credits is a 20-year R&D credit carryforward period. There is no maximum ceiling on how much you could claim via this tax credit. Some international enterprises may claim millions per year via this tax credit.
If you believe you were eligible for this tax credit and failed to claim it, you can amend your business’s tax returns for three years.
What do I need to know about claiming the R&D tax credit?
Claiming the R&D tax credit happens through filing IRS Form 6765. To prepare for claiming this credit, tell your CPA ahead of time.
Your accountant will go through your expenses to determine which ones qualify. Keeping supporting documentation throughout the year will streamline this process. It’s a complex process, so don’t wait until tax season arrives before deciding whether you will claim this credit.
What happens to credits in the carryback or carryover year?
The R&D tax credit is initially applied to offset taxable income in the year the credit is generated. If this is excess credit after the credit is applied in the tax year the credit was generated, the credit will first carry back once year to offset any available taxable income present. It will then forward for up to 20 years.
Credits can be constantly accumulated since there are no maximum limits, but you need to make sure you claim the credit every year. Remember, you can only amend your tax returns for up to three years, so if you were eligible for an R&D tax credit four years ago, you will more likely than not be able to use it now, depending on your tax situation.
Is there a limit on the R&D credit carryforward period?
The federal carryforward period is 20 years; however, state carryforward periods largely depends on where you are based. Many states simply mirror the 20-year period mandated by the Federal government. Other states may have shorter periods or unlimited periods.
The State of California, for example, is an outlier in that it allows businesses to carry forward their tax credits until they’re completely exhausted.
If you have any questions on carryforward regulations, talk to a professional with knowledge of how your state’s rules work regarding the R&D tax credit.
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