Businesses investing in research and development (R&D) may qualify for a valuable federal tax credit. While the rules can be complex, the potential savings are significant. Below are answers to common questions about this credit and how it may benefit your company.
What’s the Value of the Research Credit?
The federal R&D credit rewards companies that increase qualified research activities. Typically, it equals 20% of qualified research expenditures (QREs) above a base amount tied to past spending. QREs may include wages, supplies, and certain contract research costs.
Although the credit is nonrefundable, unused credits can be carried back one year or forward up to 20 years. Start‑ups may apply up to $500,000 of credits against payroll taxes, while small pass‑through entities can use the credit to reduce alternative minimum tax liability.
Which Costs Qualify?
Eligible research isn’t limited to laboratory science. To qualify, activities must:
- Improve or develop a business component (product, process, software, or technique)
- Address uncertainty about feasibility or methodology
- Involve experimentation, such as modeling or trial and error
- Be technological in nature, relying on engineering, computer science, physics, chemistry, or biology
The company must bear the financial risk and retain substantial rights to the results. Examples include developing new products, improving processes, or creating internal‑use software. Only domestic research costs qualify; foreign expenses must be capitalized and amortized over 15 years.
Can Businesses Claim Both the Credit and the Deduction?
Research expenses may qualify for two tax benefits: the R&D credit and the deduction for research and experimental (R&E) costs. Businesses can deduct domestic R&E expenditures beginning in tax years after December 31, 2024. However, the same expenses cannot be used for both benefits.
Generally, qualifying expenses for the credit are narrower than those for the deduction. If the credit is claimed, the deductible R&E amount must be reduced by the credit. Recent legislation simplified this adjustment, making compliance easier.
Next Steps
Many companies overlook the R&D credit due to its complexity, but the savings can be substantial. States may also offer additional incentives. If your business invests in innovation, consult a tax professional to evaluate eligibility, calculate benefits, and ensure proper documentation.