Research & Development Tax Credit


The Credit for Increasing Research Activities (“The R&D Tax Credit”) is a general business tax credit that was implemented to assist businesses that incur qualifying research expenses.
Federal and state R&D tax credits can amount to as much as 20% of the costs incurred in developing new products and manufacturing processes as well as improving existing products and processes.

The R&D tax credit, which was originally introduced by Congress in 1981, was intended to incentivize companies to develop new and improved products and processes. In addition to the federal tax credit, about 40 states provide their own R&D tax credit.

Businesses that utilize the R&D tax credit include all types of manufacturing companies, architectural and engineering firms, software development businesses as well as companies engaged in developing a particular technology to enhance their core business endeavors.

The federal R&D tax credit is a computed proportion of the Qualifying Research Expenses (QREs). The proportion or amount of the credit depends on several factors and is calculated using either the Regular Credit (RC) method or the Alternative Simplified Credit method.

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Qualifying Research Activities

Qualifying Research Activities relate to efforts undertaken to develop new products, enhance existing products, and to develop or improve manufacturing processes. In order to qualify for the R&D tax credit, the qualifying research activities must satisfy the Four Tests ascribed by the Internal Revenue Service. In addition, the company carrying out the work must bear the financial risk.

The Four Tests

The activity was undertaken for the purpose of discovering information that is technological in nature and fundamentally relies on principles of physical or biological sciences, engineering or computer science. The activity was intended to exceed, expand or refine the common knowledge of the skilled professionals in a particular field of science or engineering.

The activity related to the performance, quality or reliability of a product, process, software, technique, formula or invention to be held for sale, lease or license by the company or for carrying out the company’s trade or business.

The activity was undertaken to resolve uncertainty concerning the configuration, performance or methodology of the intended product, process, software, technique, formula or invention. It must be demonstrated the company did not know:

  • if it could achieve the desired result, or
  • how to achieve the desired result, or
  • the appropriate design, process or systematic configuration to achieve the desired result of the product, process, software, technique, formula or invention being developed.

The activity involved a process of experimentation in which more than one hypothesis was evaluated attempting to achieve the desired result. The process of experimentation included the design of an experiment to test and analyze the hypothesis, conducting the experiment, refining or discarding the hypotheses as part of a sequential design process to develop or improve a product, process, software, technique, formula or invention.

It has been found that there are three types of R&D situations in which qualifying research activities occur:

Classic R&D – resulting from a deliberate decision to develop a new or improved product or process.
Contingent R&D – planned to be contingent on receiving an order, where the bid was made knowing that existing technology is insufficient to fill the order without some development effort.
Unplanned R&D – arising from the sudden discovery, part way through filling an order, that existing technology is inadequate and must be advanced by an emergency development effort to complete the order.

Qualifying Research Activities typically include one or more of the following:

  • Development of products or processes using specific know-how that is treated as a trade secret or is patentable.
  • Development of new or improved products in which the state of the art is advanced and that required one or more design iterations to achieve.
  • Development or incorporation of a new technology in order to catch up to a competitor.
  • An attempt to develop a new or improved product or process that was eventually abandoned.
  • Implementation of a new process or improvements to an existing process relating to manufacturing, testing or quality control.
  • Development of new products in which technical uncertainties must be overcome in order to satisfy the requirements of a customer specification or performance requirement.

Qualifying Research Activities are performed by employees who directly conduct, directly supervise or directly support the development effort.

Frequently Asked Questions

Have a question about the research tax credit? Perhaps you’ll find the answer among the commonly asked questions below.

The Research & Development Credit is a business credit that is used to reduce federal income tax. A business taxpayer qualifies for the credit if it paid or incurred qualified research expenses while conducting qualified research activities.
Corporations claim the research credit using IRS Form 6765, Credit for Increasing Research Activities, for the year in which the qualified expenses were paid or incurred. For Sub-S Corporations, LLCs and other types of business entities, the credit is passed-thru to the shareholders on their individual Schedule K1.
No. There’s no maximum the research credit can be.
No. Any Research & Development Credit that is not used to offset the taxpayer’s income tax for the year in which the qualified research expenses were paid or incurred may be carried back to the prior tax year or carried forward for up to twenty years.
No. The credit cannot reduce the alternative minimum tax (AMT); however, the credit can be used to reduce the taxpayer’s regular tax to the AMT. Any research credit that is not used to offset the taxpayer’s income tax may be carried back to the prior tax year or carried forward for up to twenty years.
Yes, as long as the amended return is filed with three years of the original filing date. Note that the 280(C) election regarding the reduced credit cannot be made on an amended return.
Acquisition or dispositions of trades or businesses should be identified and verified (from the base period to the current year) to confirm that they are property reflected in the computation. The taxable year’s qualified research expenses (QREs) and the base period years’ QREs are determined based upon the application of the law in effect for the year in which the credit is being claimed. Consistency between these periods is required per IRC §41(c)(5).
No. In order to prevent a taxpayer from receiving a tax benefit twice regarding its qualified research expenses, the amount of the research credit must be added to income, which thereby reduces the cash benefit associated with the credit by an amount approximately equal to the research credit multiplied by the applicable federal tax rate.
Research activity is considered “qualified research” if it meets all of the four tests as described in Internal Revenue Code (IRC) §41(d)(1). In addition to the four tests, the company carrying out the work must bear the financial risk and must retain the intellectual property rights of the business component.
The following research activities are excluded:
1. Foreign research undertaken outside the United States and its territories.
2. Research conducted in the social sciences, arts, or humanities.
3. Ordinary testing or inspection of materials or products for quality control.
4. Market and consumer research.
5. Research relating to style, taste, cosmetic, or seasonal design.
6. Advertising and promotional expenses.
7. Management studies and efficiency surveys.
8. Computer software for internal use of the taxpayer, unless it meets additional tests.
9. General managerial and administrative duties.
10. Accounting tasks (i.e. bookkeeping, A/R, A/P, payroll).
11. Customer service support;
12. Routine status update meetings.
13. Commercial production.
14. Giving or receiving training.
15. Personnel matters.
16. Budget preparation.
17. Recruiting employees.
18. Charitable fundraising.
19. Attending industry or professional conferences.
20. Attending partnering and alliance activities and meetings.
21. Non-R&D related supervisory functions.
22. Internal business process development.
23. Research to locate and evaluate mineral deposits, including oil and gas.
24. Acquisition and improvement of land and of certain depreciable or depleted property used in research, including the annual depreciation deduction.
25. Research conducted after the beginning of commercial production.
26. Research related to adaptation of an existing business component including the duplication of existing products, processes, software, techniques, formulas or inventions.
27. Research related to duplication of an existing business component from a physical inspection, plans, blueprints, detailed specifications, etc.
28. Funded research, including any research funded by any grant, time and materials contract, or otherwise by another person or governmental entity.
There are two general methods for computing the Research Tax Credit, the Regular Credit (RC) Method and the Alternative Simplified Credit (ASC) Method. Both methodologies are included on IRS Form 6765, Credit for Increasing Research Activities. The taxpayer is permitted to elect either of the two methods when preparing a timely filed return, but since each method has distinct advantages and disadvantages, it is important to understand the two computation methodologies particularly because the elected method cannot be changed on an amended return.
Qualified research expenses (QREs) generally include employee wages, consumed material expenses, and contracted labor costs.

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