Does Your Business Qualify for the R&D Tax Credit? A Plain-English Guide

  business may qualify for the federal R&D tax credit if it spends time or money in the United States trying to develop or improve a product, process, software, formula or technique, and that work involves technical uncertainty and a process of testing or experimentation. Qualifying costs usually include wages, supplies and part of contract research expenses. Many small and midsize companies qualify without realizing it.

The name "research and development tax credit" leads many business owners to assume it's only for laboratories, universities or large corporations with engineers in white coats. That assumption can cause companies to miss valuable tax savings. A software startup refining its platform, a manufacturer redesigning a production line, a food brand reformulating a recipe or a contractor developing a new building technique may all be doing work the tax code rewards. r&d tax credit services

Companies that work with experienced R&D tax credit services providers often find qualifying activities they never considered research. This guide explains, without the jargon, what the credit is, who qualifies, what counts and how to approach a claim with confidence.

The Credit in One Paragraph

The federal research credit, found in Section 41 of the Internal Revenue Code, provides a tax credit for businesses that incur qualified research expenses in the United States. Because it is a credit rather than a deduction, it can reduce the tax liability directly rather than simply reducing taxable income.

That distinction matters. A deduction saves a percentage of the amount spent, depending on the applicable tax rate. A credit reduces tax liability by the amount of the credit itself, subject to the applicable rules and limitations.

According to K-38 Consulting, qualifying businesses can claim credits of $250,000 or more depending on their research spending and circumstances.

The Four-Part Test, Translated

The IRS uses a four-part test to determine whether an activity can qualify as research.

1. Permitted Purpose

The work must aim to create or improve the function, performance, reliability or quality of a product or process.

Plain English: You are trying to make something work better.

Example: Making software run faster or developing a product that lasts longer.

2. Elimination of Uncertainty

At the beginning of the project, there must be uncertainty about how to achieve the desired result, whether the result can be achieved or what design should be used.

Plain English: You don't already know exactly how to solve the technical problem.

Example: Testing different materials because you don't know which one will withstand high temperatures.

3. Process of Experimentation

The company must evaluate alternatives through testing, modeling, prototyping, simulation or another systematic process.

Plain English: You try different approaches to determine what works.

Example: Building several prototypes and comparing their performance.

4. Technological in Nature

The research must rely on principles of engineering, computer science, physical science or biological science.

Plain English: The solution involves technical or scientific knowledge.

Example: Coding, chemistry, mechanical engineering or biological testing.

An activity generally needs to satisfy all four parts of the test. Importantly, the company does not necessarily need to invent something that has never existed anywhere in the world. The relevant technical uncertainty can relate to whether your business can achieve a particular result.

Industries That Qualify More Often Than Owners Expect

R&D activities can occur across many different industries.

Software and SaaS

Examples include:

• Building new software features
• Improving platform performance
• Developing new architecture
• Creating complex integrations
• Solving technical scalability problems

Ecommerce

Ecommerce companies may conduct qualifying research when developing:

• Custom software tools
• Recommendation engines
• Mobile applications
• Automated systems
• New products or technical processes

Manufacturing

Manufacturers frequently conduct research when improving:

• Production processes
• Tooling
• Automation
• Product design
• Quality-control processes
• Manufacturing efficiency

Biotech and Life Sciences

Potential activities include:

• Developing compounds
• Testing therapies
• Developing diagnostics
• Improving laboratory methods
• Conducting technical experiments

Hardware and Electronics

Research may involve:

• Device design
• Component development
• Firmware
• Prototyping
• Performance testing

Food, Beverage and CPG

Companies may perform qualifying research when they:

• Reformulate recipes
• Develop new products
• Test ingredients
• Extend shelf life
• Develop new packaging

Construction and Engineering

Potential research activities include:

• Developing new construction methods
• Testing specialized materials
• Improving energy efficiency
• Developing specialized systems
• Solving complex engineering challenges

Healthcare Technology

Examples include:

• Patient platforms
• Medical devices
• Data systems
• Healthcare software
• Technical integration projects

If your team regularly asks, "How do we make this work?" and then tests different answers, the project may deserve a closer review.

What Usually Does Not Count

Understanding exclusions is just as important as understanding qualifying activities.

Activities that generally do not qualify include:

• Research conducted outside the United States
• Work performed after commercial production begins when it consists of routine troubleshooting
• Market research
• Surveys and consumer preference testing
• Cosmetic or style changes that do not affect function
• Routine data collection
• Routine quality-control testing
• Copying or reverse engineering an existing product
• Research funded by another party when the applicable requirements regarding financial risk and rights are not satisfied

Contract and grant arrangements can be particularly important. The terms may affect who bears the financial risk and who retains rights to research results, so these arrangements should be reviewed carefully.

The Costs You Can Count

Qualified research expenses, commonly called QREs, generally fall into several categories.

Wages

Certain taxable wages paid to employees who perform, directly supervise or directly support qualified research may be included.

For many companies, wages represent the largest category. For example, a software developer who spends significant time developing and testing new technical features may have a portion of their compensation associated with qualifying research.

Supplies

Certain materials used and consumed during research may qualify.

Examples include:

• Prototype components
• Laboratory materials
• Testing materials
• Experimental production batches

General office supplies and depreciable equipment are generally treated differently and may not qualify as QREs.

Contract Research

Generally, 65% of qualifying amounts paid for certain contract research performed on behalf of the business may be included, subject to the requirements of the tax rules.

The applicable rules can depend on where the research is performed, who bears the financial risk and who retains rights to the results.

Certain Computing Costs

Depending on the facts and circumstances, certain computing resources used in qualified research may also be relevant.

Because the treatment of specific expenses can vary, companies should review their records and circumstances carefully.

How the Credit Is Calculated

There are two primary calculation approaches.

Regular Research Credit

The regular research credit uses a historical base calculation. This method can become complex, particularly for companies with unusual or incomplete historical records.

Alternative Simplified Credit

The alternative simplified credit, commonly called the ASC, is used by many businesses.

Under the commonly applicable calculation, the credit generally equals 14% of qualified research expenses above 50% of the average qualified research expenses for the previous three tax years. Special rules apply when a company does not have qualified research expenses in certain prior years.

The appropriate method depends on the company's history, expenses and tax circumstances. Accurate records are therefore important when determining the potential credit.

The Payroll Tax Option for Startups

Early-stage companies sometimes assume that an R&D credit is not useful because they do not yet have income tax liability.

The payroll tax election can be particularly relevant to qualifying small businesses.

Generally, a qualified small business that meets the applicable gross-receipts and other requirements may elect to apply up to $500,000 of the credit against certain payroll taxes.

This can make the credit useful for eligible startups before they become profitable.

For startups managing cash carefully, payroll-tax savings can potentially help extend runway without requiring additional equity financing. The election has specific eligibility and filing requirements, so businesses should confirm their status with a qualified tax professional.

Recent Law Changes Worth Knowing

The R&D tax credit exists alongside a separate set of rules concerning the deduction of research and experimental expenditures under Section 174.

For several years, businesses generally had to capitalize and amortize certain research expenses instead of immediately deducting them. Federal legislation enacted in 2025 changed the treatment of certain domestic research and experimental expenditures, including provisions allowing qualifying taxpayers to restore immediate expensing for domestic research expenses and transition rules for prior years.

Because the timing, elections and interactions between the deduction rules and the research credit can be complicated, businesses should review the rules applicable to their specific tax years instead of assuming that one treatment applies universally.

Some states also provide their own research-related tax incentives, potentially creating additional opportunities.

Documentation That Holds Up

Strong documentation is an important part of an R&D tax credit claim.

Useful records may include:

1. Project lists describing research projects and their technical objectives
2. Records of uncertainty, including design documents, specifications and meeting notes
3. Evidence of experimentation, such as test plans, results, prototypes and version histories
4. Time tracking or reasonable allocations showing how employees spent their time
5. Payroll, invoice and contract records connected to research projects
6. Supporting technical materials, including code repositories, laboratory notebooks and engineering tickets

The credit is generally claimed using IRS Form 6765. The form has also evolved to require more detailed information for certain claims.

Creating documentation throughout the year is usually easier than trying to reconstruct several years of research activity after the fact.

Putting the Credit to Work in Your Financial Plan

A tax credit can be more useful when it is incorporated into the company's broader financial planning instead of treated as a once-a-year tax filing exercise.

When management has a reasonable estimate of potential tax savings, those savings can be incorporated into financial forecasts and cash planning.

For example, companies can consider the potential impact when planning:

• Hiring
• Product development
• Research spending
• Capital expenditures
• Fundraising
• Cash reserves
• Future tax obligations

This is why some businesses approach R&D tax planning as part of broader business consulting and financial planning. Research activity can be tracked throughout the year, expected savings can be incorporated into forecasts and the credit can be coordinated with other applicable tax strategies.

Where K-38 Consulting Comes In

K-38 Consulting, a Raleigh, North Carolina-based finance firm founded by Dallas Alford IV, CPA, provides R&D tax credit services to startups and midsize businesses across the United States as part of its broader outsourced CFO practice.

The firm works with companies in technology, ecommerce, biotech, hardware and other industries to identify potentially qualifying activities, calculate qualified research expenses and support claims with documentation.

K-38 Consulting also provides cost segregation services, startup CFO services, controller services and accounting automation.

The firm works with accounting platforms such as QuickBooks and NetSuite and uses web-based forecasting tools to help businesses maintain a current view of financial performance.

The company serves businesses in markets including Raleigh, Charlotte, Atlanta, Tampa, Miami, Austin, New York City, Chicago, Los Angeles, San Francisco and San Jose.

Business owners interested in exploring the credit can discuss their research activities and financial situation with a qualified professional before deciding whether to pursue a claim.

A Five-Minute Eligibility Self-Check

Ask yourself these questions:

1. Did your company develop or improve a product, process, software, formula or technique?
2. Was there uncertainty about how to achieve the desired technical result?
3. Did your team test, prototype, model or compare alternatives?
4. Did the work rely on engineering, computer science or physical or biological sciences?
5. Was the qualifying research performed in the United States?
6. Did your business bear the applicable costs and satisfy the requirements concerning rights to the research?
7. Does your company potentially meet the requirements for the small-business payroll tax election?

If the answers to the first six questions are generally yes, the activities may warrant a more detailed R&D tax credit review.

A yes to the final question may indicate that the payroll tax election is worth investigating as well.

Frequently Asked Questions About the R&D Tax CreditDo I need a patent or a major breakthrough to qualify?

No. A patent or world-changing invention is not generally required. The key issue is whether the activity satisfies the applicable requirements for qualified research, including technical uncertainty and experimentation.

Can I claim the credit if the project failed?

Potentially, yes. A research project does not necessarily need to succeed to qualify. The process of experimentation and the other requirements are what matter.

Can software development qualify for the R&D tax credit?

Yes, certain software development activities can qualify when they satisfy the four-part test and the other applicable requirements.

Can a small business claim the R&D tax credit?

Yes. Small and midsize businesses can qualify if their activities and expenses meet the applicable requirements.

Can startups use the R&D credit before becoming profitable?

Potentially. Eligible qualified small businesses may be able to elect to apply up to $500,000 of the credit against certain payroll taxes, subject to the applicable requirements.

Can I claim the credit for previous years?

In some circumstances, businesses may be able to amend eligible prior-year returns to claim credits that were not previously claimed. Statutory limitations and procedural requirements apply.

Does claiming the R&D credit automatically increase audit risk?

No conclusion should be drawn simply from making a claim. However, every claim should be properly supported. Detailed and contemporaneous documentation can help demonstrate how the company determined that its activities and expenses qualify.

What employee costs can be included?

Certain wages paid to employees who perform, directly supervise or directly support qualified research may qualify. The amount depends on how the employee's work relates to qualifying research.

Can contractor expenses qualify?

Certain contract research expenses can qualify, generally subject to the applicable rules and limitations. The treatment may depend on where the research occurs, financial risk and rights to the research results.

Does research have to be performed in the United States?

For purposes of the federal credit, qualifying research generally must satisfy the applicable U.S. research requirements. Research performed outside the United States generally does not qualify.

Can construction companies qualify?

Potentially. Construction and engineering businesses may have qualifying activities when they develop or improve technical processes, materials, systems or methods and satisfy the four-part test.

Can food and beverage companies qualify?

Potentially. Recipe development, formulation, shelf-life research, packaging development and other technical experimentation may qualify when the applicable requirements are met.

What records should I keep?

Companies should maintain project descriptions, technical documentation, evidence of experimentation, employee time information, payroll records, invoices, contracts and other records that connect expenses to qualifying research.

Is the R&D tax credit the same as an R&D expense deduction?

No. The R&D tax credit is a tax credit calculated under Section 41, while the treatment of research and experimental expenditures under Section 174 concerns the deduction or capitalization of certain research costs. They are related but separate tax provisions.

Are there state R&D tax credits?

Some states provide their own research-related tax incentives. Eligibility, calculation methods and filing requirements vary by state.

Should I use an R&D tax credit specialist?

Businesses can prepare and claim credits themselves, but the rules can be technical. A qualified tax professional or R&D tax credit specialist can help identify potentially qualifying activities, calculate expenses and organize supporting documentation.

Rewarding the Work You're Already Doing

The R&D tax credit is designed to encourage businesses to invest in qualified research and development. Many companies may already perform technical experimentation without thinking of it as "research."

By understanding the four-part test, identifying potentially qualifying wages, supplies and contract research expenses, maintaining strong documentation and considering how tax savings fit into financial planning, businesses can better evaluate whether they have an opportunity to claim the credit.

For companies that are unsure where to start, a structured review of research projects, expenses and documentation can provide a clearer picture of potential eligibility and the steps required to pursue a claim.