R&D Tax Credits Built to Withstand Scrutiny
Thoughtful R&D Credit Support for Business Owners and Their Tax Advisors
1. What is the R&D Tax Credit?
The federal Research & Development (R&D) Tax Credit is a general business tax credit available to companies that incur qualifying research expenses in the U.S. In addition to the federal credit, approximately 40 states offer their own R&D incentives.
The Credit is designed to encourage the development and improvement of products, processes, and technologies.
2. What are the Benefits of the R&D Tax Credit?
The R&D Tax Credit provides a dollar-for-dollar reduction in federal and state tax liability, directly improving cash flow. In many cases, businesses can recapture up to 10 cents for every qualifying dollar spent on eligible research activities. The Credit can be captured retroactively for up to 3 previous tax years.
Qualified Small Businesses may claim a modified version called the Payroll R&D Tax Credit, which permits them to offset payroll tax.
3. How Do You Qualify for the R&D Tax Credit?
R&D Tax Credit eligibility is determined by activity. If a research activity passes all parts of the IRS’ Four-Part Test, it is eligible for the Credit.
Qualifying activities involve creating and improving business components, including products, processes, software, formulas, even recipes. There must be a process of experimentation involved that eliminates some uncertainty, and the activity must be technological in nature.
The product or process does not need to be entirely new to qualify; incremental improvements may still be eligible. Even unsuccessful research efforts can qualify, provided the underlying requirements are met.
4. How Much Can You Save with the R&D Tax Credit?
The R&D Tax Credit grows with you – the more you spend on research, the larger your Credit can become.
You can recoup up to 10 cents of every dollar spent on a qualified activity. This includes money spent on:
- Wages
- Payments to third-party contractors
- Supplies and materials
- Cloud hosting fees
If you spend $500,000 on qualified activities, you can claim a Credit of up to $50,000. Actual savings depend on the quality of documentation and methodology used to support the claim.
What’s Your Industry?
The most common misconception about the R&D Tax Credit is that it only applies to traditional laboratory research. Many business owners assume that if they are not working in a lab, the Credit does not apply to them.
In reality, the R&D Tax Credit is activity-based, not industry-based. It has been successfully claimed by companies across nearly every sector of the economy.
Industries that frequently qualify include:
Eligibility ultimately depends on what your team is doing, not what industry you’re in.
Could You Qualify?
Regardless of industry, businesses often qualify for the R&D Tax Credit if they regularly:
- Create or improve custom designs, processes, equipment or technology
- Test, prototype, or refine custom solutions
- Solve technical problems and evaluate alternatives
If these activities are part of your normal operations, you may be eligible for the R&D Tax Credit.
R&D Tax Credit Case Studies
Real firms. Real numbers. Results supported by IRS-preferred Project Based Methodology.
Custom Plastics Manufacturer: Current Year Success
2024 Wages: $3.29M
2024 Supplies: $558K
Total Spend on Research: $3.84M
Federal Credit: $259K + State Credit: $231K = Total 2024 R&D Tax Credit: $491K
Mechanical Engineering Firm: Retroactive Power
2024 Wages: $4.5M – this is the only spend on research
2024 Federal R&D Tax Credit: $240K
But they qualified in TY 2023, TY 2022, and TY 2021 as well, and claimed another $240K retroactively for each year
Total 2024 R&D Tax Credit = $960K (representing current year benefit along with 3 previous years)
The Capstan Way
R&D Tax Credits can be very powerful -- but they are also heavily scrutinized.
Many claims fail not because the research wasn’t legitimate, but because the Credit methodology or documentation couldn’t withstand review.
That’s where the right approach – and the right partner -- matters.
Not every activity qualifies, and not every dollar should be claimed. We tie qualified activities to qualified expenses, supporting results with detailed interviews, contemporaneous documentation, and technical analysis.
Physical
Report
Including all Raw Data, Tables, Visual Representations
of Data, and Thorough Analysis
Efficient Report Delivery
Most are Completed within 3-6 Months-Half the Industry Average
Defensible
IRS-Preferred, Project-Based
Analysis Methodology
Meticulous
On-Site Data Collection
Ensures all Possible Qualified Expenses are Captured
Transparent
Flat-Fee Structure
No Unexpected Additional Fees
Subject Matter Experts
In Architecture, Engineering, Construction, Software, Manufacturing, and Life Sciences
Multidisciplinary Team
Attorneys, Tax Professionals, & Engineers
$800M+
in Federal and State R&D Tax Credits
2,700 +
R&D Tax Credit Studies Completed
R&D Tax Credits FAQ
What is the Federal Research and Development Tax Credit?
The federal R&D Tax Credit is a general business tax credit for companies that incur R&D expenses in the United States. The tax credit, which was originally introduced in 1981, is intended to incentivize companies to develop new and improved products and processes. In addition to the federal tax credit, about 40 states have their own R&D tax credit initiatives.
What are the Benefits of the Federal R&D Tax Credit?
With a dollar-for-dollar reduction in federal and state tax liability, the R&D Tax Credit provides improved cash flow, offering up to 10 cents in benefit for every qualifying dollar identified in a performed study.
What are the Eligibility Criteria for the R&D Credit?
Since the R&D Tax Credit is activities-based, eligibility is determined by testing the research activities a company performs.
In order to qualify for the R&D Tax Credit, a research activity must pass all four parts of the Four-Part Test:
o Part #1: The research activity must be related to developing a new or improved business component for a “qualified purpose”—i.e. related to new or improved functionality, quality, reliability, or performance.
o Part #2: The research activity must be undertaken for the purpose of eliminating some uncertainty related to appropriate design, method, or capability.
o Part #3: The research activity must involve some Process of Experimentation designed to resolve the uncertainty.
Part #4: The research activity must fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering, or their applications.
What are the Four Pillars of R&D?
The “Four Pillars of R&D” are the criteria that comprise the Four-Part Test. The “Four Pillars” is just another name for the “Four Parts.”
Who Qualifies for the Research and Development Credit?
Anyone who meets the eligibility criteria above qualifies for the R&D Tax Credit.
What are the Types of Expenses that Qualify for the Research and Development Credit?
There are 4 types of expenses that can qualify for the credit:
o Employee Wages
o Supplies and Materials
o Third Party Contractor Costs (Must Reside in US)
o Cloud Hosting Expenses
Based on industry and day-to-day business activities, you may qualify for one or several types of expenses for the credit. You may take all 4 types of expenses if applicable.
How can I Claim the Research and Development Tax Credit?
Businesses can claim the R&D Credit by filing IRS Form 6765, Credit for Increasing Research Activities. Taxpayers must provide “sufficient documentation” to support the amount of QREs they are claiming. The right R&D Tax Credit companies will assist in ensuring that documentation is sufficient.
Keep in mind that the amount of credit available to a taxpayer is limited to the amount of tax liability accrued by the taxpayer in a given tax year. However, the credit can be carried back one year, and then carried forward for 20 years.
Can I Amend Prior Year Returns to Claim the Federal R&D Tax Credit?
Yes. Federal amendment rules apply and permit the amendment of returns to retroactively capture the R&D credit. The standard 3-year window for amending returns also applies to R&D Credit amendments. Your R&D Tax Credit company can work with your tax professional to make this happen.
Are R&D Credits Still Considered a Tier 1 Audit Issue?
No, the R&D Credit is not considered a Tier 1 issue – in fact, the IRS officially eliminated its entire tiering system in 2012. Claiming the R&D Tax Credit does not increase the likelihood of an audit in any way.
That said, it is critical to thoroughly document qualified research activities and costs in the event of IRS scrutiny. There is no specific type of documentation required, but the documentation must be “sufficient” (§ 6001).
An object lesson took place in April of 2019, reminding taxpayers of the consequences of insufficient documentation. In Siemer Milling Company (Siemer Milling) v. Commissioner of Internal Revenue, the Court ruled that Siemer Milling lacked sufficient documentation to support their claimed Credits, and subsequently disallowed over $235,000 in Credits. The Court held that Siemer Milling did not provide sufficient documentation to demonstrate that their business activity had met all parts of the Four-Part Test, particularly Part 3 – Process of Experimentation.
Is it Worth Calculating the R&D Credit if There’s Net Loss and No Tax Due in the Coming Several Years?
It may very well be. Small businesses that are operating in a loss and don’t have tax liability yet may be eligible for the Payroll R&D Tax Credit, a modified version of the Federal R&D Tax Credit.
The Payroll R&D Tax Credit permits “Qualified Small Businesses” to claim up to $500,000 annually for tax years beginning after December 31, 2022, and to use that credit to offset the 6.2% employer portion of the Social Security payroll tax under the Federal Insurance Contributions Act (FICA) as well as the 1.45% employer portion of the Medicare payroll tax liability. (For tax years prior to December 31, 2022, the maximum claim is $250,000 and the credit only applies to the social security tax.)
The Payroll R&D Tax Credit can be taken for up to 5 years, resulting in a potential total credit of $2.5M to apply against payroll taxes.
Your R&D Tax Credit company can help you determine if you are a Qualified Small Business.
I’m in Pennsylvania. Are there PA R&D Credits?
Yes. About 40 states have their own version of the R&D credit. The PA R&D Credit is structured somewhat similarly to the federal version with a few important differences. Your R&D Tax Credit Company can help you claim the federal version of the Research and Development Tax Credit, along with a state version, where possible.
I’m considering several R&D Tax Credit Companies. How Do I Select the Best R&D Tax Credit Company for Me?
Finding the right R&D Tax Credit Company is crucial. Your tax professional may recommend a preferred partner. If not, it’s important to consider a provider’s experience, methodology, and approach to tax consulting. Ask these eight questions to help select the right R&D Tax Credit company.
How much do you charge for a Research and Development Tax Credit Study?
We use a transparent flat-fee system based on project scope – no matter how complicated your project may become, your fee is set at the beginning of the project.
IRS Circular 230 prohibits providers from charging fees contingent on a specific result – if a provider proposes a percentage-based fee, proceed with caution.
I see that Capstan is based in Pennsylvania. Do you only perform PA R&D Credit Studies?
Capstan is headquartered in Dresher, PA, but we perform R&D Tax Credit studies nationwide.
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Additional Information
Back
1. Introduction
The Research and Development (R&D) Tax Credit is a tax incentive offered to companies who create or improve a product or process as part of business activity. The Credit allows businesses to offset their tax liability by claiming their qualifying expenses – many owners save 6-figures or more by cashing in on the innovative work they are already doing.
Firms that engage in innovation and development can benefit from this powerful, dollar-for-dollar Credit, but many companies don’t know it exists, or assume they don’t qualify.
This page will clarify eligibility criteria so businesses can take advantage of this Credit.
LEARN MORE
1. Introduction
The Research and Development (R&D) Tax Credit is a tax incentive offered to companies who create or improve a product or process as part of business activity. The Credit allows businesses to offset their tax liability by claiming their qualifying expenses – many owners save 6-figures or more by cashing in on the innovative work they are already doing.
Firms that engage in innovation and development can benefit from this powerful, dollar-for-dollar Credit, but many companies don’t know it exists, or assume they don’t qualify.
This page will clarify eligibility criteria so businesses can take advantage of this Credit.
2. Understanding Qualifying R&D Activities
The R&D Tax Credit is far more expansive than most people imagine, and many businesses qualify just by performing their day-to-day activities. You/your client may qualify if you engage in some type of technical activity to develop a new or improved product or process. Activities that qualify for the Credit are called “Qualified Research Activities.”
Qualified Research Activity Examples:
Manufacturing
- 3D Modeling
- Custom Tooling and Fabrication
- Material Testing
- Prototyping
- Process Optimization
Software Development
- Feasibility Analysis
- Software Architecture Design and Iterative Revisions
- Programming
- Unit, Integration, Acceptance Testing
Architecture and Engineering
- Design and Optimization of Infrastructure, Electrical Systems, Mechanical Systems, Building Superstructures, etc.
- Material Testing and Performance Analysis
- Creation of plans, schematic designs, elevation drawings
- Evaluation of alternative designs
- CAD or BIM Modeling
Life Sciences
- Creation and optimization of drugs, devices, delivery systems, assays, reagents
- Clinical testing prior to commercialization
- Manufacturing process improvements
- Efficacy, toxicity, and pharmacokinetic testing
Keep in mind, businesses in virtually any industry may take advantage of the R&D Credit. The examples above are a sampling, not an exhaustive list.
To qualify for the R&D Tax Credit, research activities need to meet all four parts of the IRS’ “Four-Part Test:”
- New or Improved BusinessComponent
The activity must be related to developing or improving the functionality, quality, reliability, or performance of a business component, as discussed. - Elimination of Uncertainty
The activity must be undertaken for the purpose of eliminating some uncertainty related to appropriate design, method, or capability. - Process of Experimentation
The activity must involve some kind of experimentation designed to resolve the uncertainty. Examples include: evaluation of alternatives, hypothesis testing, 3D modeling or simulation, etc. - Technological in Nature
The activity must be based on a hard science.
If your activity meets all 4 criteria, it is eligible for the R&D Tax Credit.
3. Can the Credit be Claimed Retroactively? What about Small Businesses?
The R&D Tax Credit may be claimed retroactively. The standard 3-year window for amending returns also applies to R&D Credit amendments.
Small businesses that are operating in a loss and don’t have tax liability yet may be eligible for the Payroll R&D Tax Credit, a modified version of the Federal R&D Tax Credit.
The Payroll R&D Tax Credit permits “Qualified Small Businesses” to claim up to $500,000 annually for tax years beginning after December 31, 2022, and to use that credit to offset the 6.2% employer portion of the Social Security payroll tax under the Federal Insurance Contributions Act (FICA) as well as the 1.45% employer portion of the Medicare payroll tax liability. (For tax years prior to December 31, 2022, the maximum claim is $250,000 and the credit only applies to the social security tax.)
The Payroll R&D Tax Credit can be taken for up to 5 years, resulting in a potential total credit of $2.5M to apply against payroll taxes.
4. Common Misconceptions About the Credit
People often think the following myths are dealbreakers – and that’s not the case.
- We’re not a “scientific” company.
You don’t need to be. Any company in any industry may qualify if they meet the requirements. White coats aren’t mandatory.
- We didn’t invent something new or something huge.
That’s okay. If you’re working on improving some product or process that already exists, that qualifies for the Credit. Don’t overlook small improvements – they may qualify.
- Our research wasn’t successful.
That’s unfortunate. Here’s a silver lining — even if activity was ultimately unsuccessful, it may still qualify for the Credit.
- I don’t want to get audited.
Claiming the R&D Tax Credit doesn’t increase your risk of a potential audit.
5. What Qualifies as R&D Expenses?
Qualified Research Expenses (QREs) are the costs that can be claimed under the R&D Tax Credit. There are four main categories:
- Wages
- Supplies/Materials — Costs paid for tangible items including raw materials, prototypes, reworked products, first article runs, and pilot models
- Contract research — Costs paid to any third-party entities or individuals for services like testing, modeling, laser-cutting, engineering etc.
- Computer rental or cloud computing costs — Costs paid for an off-site cloud-based hosting service to house R&D development efforts
Wages are often the largest QRE in many industries, with the notable exception of manufacturing, which requires hefty supply and material costs.
6. Why Work With an R&D Tax Credit Specialist?
The R&D Tax Credit is quite complex, and taxpayers must work with a qualified professional to ensure a successful claim. Supporting documentation is key, and the right expert will make sure that all necessary documents are provided and organized.
At Capstan, we’ll take a big-picture approach, working to align the R&D Tax Credit with your tax planning and business goals. Plus, the multidisciplinary Capstan team is R&D-dedicated. That exclusive focus means we have the technical and tax knowledge needed to make the most of your opportunities while ensuring compliance.
You can feel confident that your Credit will be leveraged fully and documented thoroughly, ready to withstand scrutiny in the unlikely event of an audit.
7. Conclusion
Only 20% of eligible companies actually claim the R&D Tax Credit. They assume they don’t qualify – but opportunities exist in virtually every industry. They assume it’s too complicated – but it’s easy with the right partner.
Why leave a renewable source of capital on the table? Schedule a complimentary R&D Tax Credit Consultation today.