R&D Tax Credit: Federal Research and Development Tax Treatment

It’s a good idea to consult a tax specialist to ensure you take full advantage of the credit and calculate it correctly. Complete the form below, and the team member best suited to help you will be in touch soon. Section A is the regular method, while Section B is an alternative simplified method. The best way to determine which section you should file is to use them both to estimate how much credit you’re entitled to and then file the section that gives you the largest amount of credit. It isn’t required to fill out Section A and Section B. You only need to fill out one of them, as they’re just different methods of calculating how much credit you’re entitled to receive. The folks at Barnes Dennig work diligently to understand our business thereby enabling them to provide valuable advice beyond the nuts-and-bolts of accounting.

Changes on the horizon

Work with a professional firm knowledgeable in the R&D tax credit to get advice and make sure you aren’t failing to claim eligible expenses. Not all expenses relating to research and experimentation costs will qualify for the R&E tax credit. Some examples of expenses that don’t qualify for the R&E tax credit include certain depreciable assets such as buildings and equipment, non-wage benefits for personnel, and overhead expenses. The point of the R&E tax credit is to incentivize innovation for businesses by making their research and experimentation costs less of a burden. The R&E credit is one of many tax extenders, which are federal tax provisions that were originally set to expire in December of 2013.

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• Notably, the court did not address the special rule in Sec. 41(d)(2)(C) that requires production processes to be treated as a separate business component from the business component being produced.
• The Fifth Circuit’s decision in Grigsby, 86 F.4th 602 (5th Cir. 2023), emphasizes the need for taxpayers to clearly define business components when preparing and documenting their Sec. 41 credit.
• As a loss-making company, you could potentially claim back a more significant percentage of your R&D expenditure than those that make a profit.
• You aren’t required to use the entirety of your R&E tax credit for the current tax year.
• Navigating the intricacies, complexities, and technical jargon in our tax system can be a challenge even for the most seasoned accountant, let alone someone trying to file their taxes on their own accord.

Startups with little to no income tax liability can use the credit to offset up to $500,000 of payroll taxes annually, providing significant cash-flow benefits. In addition to the R&D tax credit, the ability to fully recover the cost of R&D expenses is an important aspect of the tax code for firms engaging in innovation. Under current law, firms can choose to fully deduct R&D costs from their taxable income in the year in which they are incurred. In this paper, we examine the federal tax treatment of R&D investment, with a focus on the R&D tax credit and cost recovery for R&D expenses. We review the evidence for the R&D tax credit’s effectiveness and the credit’s complexity, while recommending ways to improve the credit if it is retained in the tax code.

Representative projects included infrastructure improvements such as flood control structures and site preparation for industrial plants. After initially approving the credit and issuing the refund, the IRS determined that the refund was erroneous because the claimed activities did not align with the requirements for qualified research under Sec. 41. While many large businesses take advantage of this credit, smaller businesses often forego extensive tax savings because they aren’t aware they qualify.

The Research and Experimentation (R&D) Tax Credit is one of the most generous yet underutilized tax incentives available to U.S. businesses. Each year, the federal government allocates billions of dollars—upwards of $12 billion annually in R&D credits, with no annual limit—to fuel innovation and technological advancement across industries. Since its permanent extension in 2015, the R&D tax credit has offered a stable and predictable source of financial support for companies engaged in research, ensuring that the benefits of multi-year investments remain secure. R&E tax credits in excess of $9 billion are claimed annually at the federal level alone. Businesses taking full advantage of these credits can recapture up to 20% of increased R&D expenditures. In years where the statute of limitations is open, there are often further opportunities to claim credits and obtain significant cash refunds or offset other defined withholdings.

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With the right approach and resources, your business can confidently claim this credit and reinvest the savings into growth and innovation. Don’t leave valuable dollars on the table, embrace the R&D tax credit for what it is—a vital strategic asset in this Innovation Era. After doing all this meticulous documentation, it would be a shame not to optimize the value of your investment. Chances are, there are also state R&D tax credits available where you operate (four out of five states have them), and most adhere closely to the federal guidelines. Activities excluded from the R&D tax credit include routine data collection, market research, reverse engineering without substantial innovation, cosmetic improvements, and research in social sciences, arts, or humanities. Research conducted outside the U.S., quality control testing, internal-use software (unless meeting specific criteria), and adaptations of existing products without significant improvement are also ineligible.

• Information on this web site does NOT constitute professional accounting, tax or legal advice and should not be interpreted as such.
• The reader accepts the information as is and assumes all responsibility for the use of such information.
• Table 7 shows an example of the established firm taking the regular R&D credit in 2021.
• First introduced in 1981 as part of the Economic Recovery Tax Act, the R&D tax credit has evolved significantly over four decades, shaped by the push and pull of competing economic and political forces.

These activities must aim to discover technological information and develop or improve business components, such as products, processes, software, techniques, or inventions. A recent circuit court case, Grigsby,1 emphasizes the need for taxpayers to clearly define business components when preparing and documenting their Sec. 41 research tax credit. The Fifth Circuit determined that the taxpayer failed the business–component requirement and cited that failure as one of two reasons for disallowing the research credit. It offers a dollar-for-dollar reduction in tax liability, lowering the company’s effective tax rate and improving its financial health. When accounting for increased economic growth, canceling R&D amortization costs about $108 billion from 2022 to 2031.

Supplies used in the research process, like materials for prototypes or chemicals for testing, also qualify. Payments to U.S.-based third-party contractors contributing expertise to the project are eligible as well. The R&D credit landscape continues to evolve, with new legislation under consideration at both federal and state levels. The American Innovation and R&D Competitiveness Act of 2025 represents a bold move to restore the immediate deductibility of R&E expenditures, providing a much-needed boost to U.S. businesses and the economy.

Recent developments

The more they can deduct, the lower their taxable income, and the less they owe in taxes. If your business lacks tax liability, you first must carry the credits back one year (if there was tax liability). The extended time frame was put into effect by 2015’s Protecting Americans from Tax Hikes (PATH) Act. The Research and Development tax credit is also known as the Research and Experimentation (R&E) tax credit. These two terms refer to the federal benefit outlined in Section 41 of the Internal Revenue Code.

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Explore eligibility and steps to claim tax credits for research activities, including qualifying costs and coordination with other credits. The IRS contended that each of the taxpayer’s projects failed the business–component test under Secs. 41(d)(1)(B)(ii) and (d)(2)(B) because the taxpayer was inconsistent in its description of the business component to which each project related. Still, the court concluded that the taxpayer’s wheat hybrids project did not meet the business–component test because the taxpayer failed to establish what business component it sought to develop with this project. During this project, the taxpayer performed testing on new varieties of wheat that it collected from breeders, and the court found that the taxpayer was simply determining what was available from wheat breeders and growers rather than developing a new or improved product or process.

All of the activities must include research and experimentation tax credit a process of experimentation including testing, modeling, simulating, systematic trial and error. We find that canceling R&D amortization would reduce federal revenue by about $131.3 billion from 2022 to 2031 on a conventional basis. About 75 percent of the cost is experienced over the first four years of the budget window, before reaching a steady-state cost of about $5 billion to $6 billion per year in the last half of the budget window. Many studies examine the degree to which the R&D credit increases R&D spending, but there is less evidence regarding the effect the R&D credit has on innovation. Since around 1980, private sector R&D investment as a share of Gross Domestic Product (GDP) has grown consistently, while public sector R&D has declined—more than two-thirds of all U.S.

If the new R&E rules were having an adverse effect on their capacity to finance research, we would have expected to see the opposite. Changing the R&E tax deduction to permanently allow corporations to write off their research expenses all at once would cost roughly $200 billion over 10 years. The backlash for R&D section 174 is widespread, with businesses facing problems, confusion, and high costs under the new law. A bipartisan group of members of Congress have recognized this as a problem and have introduced legislation to repeal amortization. That’s why we have created this in-depth, detailed guide on the Research and Experimentation Tax Credit.

However, if low-tech industries increase their R&D more than high-tech ones do, that suggests the additional innovations are marginal improvements and have smaller spillover benefits. The R&D tax credit was first established in 1981, in the Economic Recovery Tax Act (ERTA). Effective tax administration entails ensuring taxpayers understand what is required to support the claim for the research and experimentation (R&E) credit.