Research & Development Tax Credits

RESEARCH & DEVELOPMENT TAX CREDIT

The Research and Development (R&D) tax credit is a Federal tax incentive that rewards taxpayers for increasing investment in U.S.-based research activities. This credit was first introduced by Congress in 1981 and made permanent on 2015. The One Big Beautiful Bill Act (OBBBA) restores same-year deductions for U.S. research costs from tax years starting after December 31, 2024, but keeps 15-year amortization for foreign research. New IRC §174A allows an optional 60-month write-off and treats immediate expensing as an automatic accounting-method change with no §481(a) adjustment needed.

The R&D tax credit is available to businesses that design, develop, or improve products, processes, techniques, formulas, or software. Correctly calculating and properly documenting the R&D tax credit is critical because it can greatly lower taxes and increase cash flow.

QUALIFICATIONS

The R&D tax credit is available to taxpayers who incur incremental expenses for Qualified Research Activities (QRAs) conducted within the U.S. While primarily a wage-based credit, the credit is comprised of the following Qualified Research Expenses (QREs):

• Internal wages paid to employees for qualified services; this includes those individuals directly performing the science as well as those individuals directly supporting and supervising these individuals.
• Supplies used and consumed in the R&D process.
• Contract research expenses (when someone other than an employee of the taxpayer performs a QRA on behalf of the taxpayer, regardless of the success of the research).
• Basic research payments made to qualified educational institutions and various scientific research organizations.

Research activities must meet the four part qualification test.

• Activities must rely on a hard science, such as engineering, computer science, biological science or physical science.
• Activities must relate to the development of new or improved functionality, performance, reliability or quality features of a structure or component of a structure, including product or process designs that a firm develops for its clients.
• Technological uncertainty must exist at the outset of the activities. Uncertainty exists if the information available at the outset of the project doesn’t establish the capability or methodology for developing or improving the business component, or the appropriate design of the business component.
• Experimentation must be conducted to eliminate the technological uncertainty. This includes assessing a design through modeling or computational analysis and experimenting with a material’s durability or longevity.

BENEFITS

The R&D tax credit is primarily a wage-based federal credit, which is worth approximately 7.9% of qualified R&D activities. Thus, a taxpayer with $1M of qualified wages could receive a $65,000 benefit. Many states also offer R&D tax credit that can greatly enhance the value of the study. Further, the credit can often be claimed for prior tax years. Many states also offer the R&D credit which can further increase your credits.

The types of businesses that can benefit from an R&D study is far more expansive than what most people expect. Many of these industries have claimed the credit: Aerospace & Defense,
Electronics, Architecture & Engineering, Food Science, Agriculture, Manufacturing, Automotive,
Pharmaceuticals, Biotechnology & Bioengineering, Software Development, Chemicals, Telecommunications, and many more.

When the R&D credit was made permanent, it was expanded to allow a larger number of taxpayers that have been unable to take advantage of the credit previously.

• Small businesses can now take the R&D tax credit against their alternative minimum tax (AMT). The previous AMT restriction prevented qualified companies from utilizing the research credit, but new changes removed that hurdle for any qualified company with less than $50 million in gross receipts.
• Startup businesses with gross receipts of less than $5 million can now take the R&D tax credit against their payroll taxes (essentially making it a refundable credit for up to five years).
• Retroactive application: Qualified small businesses (under $31 million gross receipts) can apply these changes retroactively for 2022-2024, pending IRS guidance.

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