R&D tax credit
The R&D tax credit rewards companies for qualifying research and development work with a dollar-for-dollar reduction in tax owed, generally landing between 6% and 14% of qualified research expenses. An estimated $60 billion of the $92 billion available went unclaimed in 2019, mostly because companies doing real qualifying work don't realize they qualify.
The R&D tax credit, officially the Credit for Increasing Research Activities, is a federal tax credit (and in most states, a state-level one too) that rewards companies for spending on qualifying research and development. Unlike a deduction, which only reduces taxable income, a credit reduces the tax bill itself, dollar for dollar.
It's been part of the tax code since 1981, but it's still one of the most underused incentives available to growing companies. The biggest misconception is that it's only for companies with a formal lab or an "R&D department." In practice, the credit reaches into virtually every industry where a team is building, improving, or experimenting: software, manufacturing, healthcare, financial services, food and beverage, construction, and more.
An estimated $60 billion of the $92 billion in available R&D tax credits went unclaimed in a single recent year. That's not because companies aren't doing qualifying work. It's because most of them don't realize they are.
Two reasons come up over and over. First, "R&D" sounds like lab coats and microscopes, so a founder running a five-person engineering team building a new product doesn't think to check whether the work qualifies, even though the four-part test is about the nature of the work, not the size or formality of the team doing it. Second, many companies assume the credit is worthless to them because they aren't profitable yet, without realizing the payroll tax offset exists specifically for that situation. Both gaps are easy to close once someone actually runs the numbers against the real test, rather than against the assumption.
The credit reaches further than most business owners expect. A general contractor developing a new framing technique, a wealth management firm building its own portfolio-rebalancing engine, or a craft brewery experimenting with fermentation can all have qualifying activities, the same as a software team shipping a new feature. The IRS uses a four-part test. Work has to clear all four to count as qualified research:
Building new features, improving architecture, or developing internal tools — including code that gets built and later discarded.
Designing components, developing new fabrication techniques, or experimenting with materials and tooling.
Solving a technical problem where the right approach, or whether it was achievable at all, wasn't known going in.
Testing alternatives through prototyping, modeling, or systematic trial and error before landing on a final design.
Once an activity clears the four-part test, the costs tied to it become eligible. The main categories:
Sales, marketing, and routine maintenance don't qualify. The expenses only count if they're actually connected to work that passes the four-part test above.
For companies using the Alternative Simplified Credit, the most common calculation method, the credit generally lands between 6% and 14% of qualified research expenses, depending on how many prior years of R&D spend the company has to base the calculation on: 6% the first year claiming, moving toward 14% with more history.
A team of 8 engineers averaging $125,000 in salary, spending about 37.5% of their time on qualifying R&D, has roughly $375,000 in qualified research expenses — putting the estimated credit range between $22,500 and $52,500. The exact number depends on headcount, salary, and how much of the team's time is actually spent on qualifying work.
The credit is available federally and, separately, in most states, though state rates and rules vary and have to be calculated on their own. A company operating in a state with its own R&D credit can potentially claim both, which is part of why the total value is worth modeling properly rather than estimating off the federal range alone.
For profitable companies, the credit offsets income tax with no cap. But the real unlock for startups is the payroll tax offset. Since the 2015 PATH Act, a qualified small business, generally under $5 million in current-year gross receipts and no more than five years of gross receipts history, can apply up to $500,000 per year of the credit against the employer portion of Social Security and Medicare taxes instead of income tax.
That matters because most early-stage companies don't owe income tax yet, so a credit that can only offset income tax is worth nothing to them on paper. The payroll tax election turns it into real, usable cash: the credit reduces the actual payroll tax bill starting on the next quarterly filing after the return is processed, not a deferred asset sitting unused on the balance sheet. The election is claimed on Form 6765 and applied via Form 8974, which attaches to the quarterly Form 941 payroll filing.
Separately from the credit itself, Section 174 governs when R&D costs can be deducted at all. From 2022 through 2024, the tax code required companies to capitalize and amortize R&D expenses over five years (fifteen for foreign research) instead of deducting them the year the money was spent. Full same-year expensing was restored starting in 2025, and companies that amortized costs during that window can often recover the unamortized balance, or claim the R&D credit itself retroactively, on an amended return, for whichever tax years are still inside their filing window.
These are two separate mechanisms that interact: Section 174 decides when a deduction happens, the R&D credit is a separate dollar-for-dollar reduction in tax owed, and a company can be affected by both at once. If your business capitalized R&D costs during 2022–2024 and hasn't revisited the math since the rules changed, that's worth a real look before the amendment window closes.
Claiming the credit means filing Form 6765 (Credit for Increasing Research Activities) with the federal income tax return, alongside documentation showing which activities and expenses actually cleared the four-part test. That documentation is what holds up if the IRS ever asks — reconstructed narratives written after the fact don't carry the same weight as records built while the work was happening.
For a company electing the payroll tax offset, the process has one more step: once the credit is approved, it's applied via Form 8974, which attaches to the quarterly Form 941 payroll filing. None of this requires the company to already have a formal R&D process in place. It requires being able to show, with real detail, what the team actually built and why the outcome wasn't a given going in.
We identify what actually qualifies, build the technical documentation that holds up if the IRS ever asks, and file it, whether that's alongside your existing CPA or start to finish.
A real review of your engineering, product, and technical work against the four-part test, not a generic checklist.
Documentation tied to real projects and real people, prepared while the work is fresh, not reconstructed later.
Form 6765, the payroll tax election if it applies, and the correspondence that comes after, handled, not left on your desk.
The R&D tax credit is a federal (and often state-level) tax credit that rewards companies for qualifying research and development spending, engineering and product work that meets the IRS's four-part test, with a dollar-for-dollar reduction in tax owed rather than just a deduction.
A company identifies its qualified research expenses, primarily wages for employees doing hands-on technical work, then calculates a credit against those expenses using one of two IRS-approved methods. Most companies use the Alternative Simplified Credit, which generally lands between 6% and 14% of qualified research expenses. The credit reduces federal income tax owed dollar for dollar, and a pre-revenue or early-revenue company can apply up to $500,000 of it against payroll tax instead, since most early startups don't yet owe income tax.
Under the Alternative Simplified Credit, the calculation starts with qualified research expenses, mostly wages, multiplied by the percentage of time employees spend on qualifying R&D work. That figure is then multiplied by a rate between 6% and 14%, depending on how many prior years of R&D spend the company has to base the calculation on: 6% for a company claiming the credit for the first time, moving toward 14% with more years of R&D spending history.
Qualifying expenses are mostly wages paid to employees doing hands-on technical work: engineering, software development, product design, and testing, along with a portion of supply costs and contract research. The work has to meet the IRS's four-part test: it has to be technological in nature, aimed at eliminating uncertainty, involve a process of experimentation, and intended to develop a new or improved product or process. Sales, marketing, and routine maintenance don't qualify.
There's no fixed dollar amount. It depends entirely on how much a company spends on qualifying research, generally landing between 6% and 14% of qualified research expenses under the Alternative Simplified Credit. A team of 8 engineers averaging $125,000 in salary, spending about 37.5% of their time on qualifying R&D, has roughly $375,000 in qualified research expenses, putting the estimated credit between about $22,500 and $52,500.
Any company doing qualifying research can claim it, not just companies with a formal R&D department or lab. The four-part test is about the nature of the work, not the org chart or company size, so a five-person engineering team building a new product can qualify the same as a large, established research operation. Pre-revenue and early-revenue startups often qualify too, and can apply the credit against payroll tax instead of income tax.
Add your revenue and website for a full review, reviewed by a CPA who ran EY's West Coast R&D Tax Credit practice for 13 years.