The R&D credit was introduced in 1981 to increase technical jobs in America by encouraging businesses to invest in research and innovation. The R&D credit may be claimed by taxpaying businesses that develop, design, or improve products, processes, formulas, or software.

US employee wages, supplies, contractors, and cloud hosting costs could potentially qualify for the R&D credit.

The primary benefit of the R&D Credit is a direct reduction in your federal and potentially state income tax liability. It’s a dollar-for-dollar credit, meaning it directly reduces the amount of taxes owed. If the credit amount exceeds your tax liability in a given year, or if you weren’t profitable enough to utilize the full credit, you can carry the remaining credit back one year and forward up to 20 years. Certain startups that do not have any federal income tax liability may be eligible to use the credit to offset up to $500k in employer FICA payroll taxes.

Absolutely! Startups and small businesses can see significant advantages from the R&D Credit. Notably, there’s a provision that allows qualifying startups to offset employer FICA payroll taxes with the R&D credit, up to $500,000.
To be eligible, the company must:

• Have less than $5 million in gross receipts for the credit year
• Have no more than five years of gross receipts

While the following highlights industries that potentially qualify for the R&D credit, it’s not an exhaustive list. Remember, the key is overcoming technical challenges in your industry.

• Technology & Software Development
• Industrial Manufacturing
• Life Sciences & Pharmaceuticals
• Financial Services
• Food & Beverage
• Energy Organizations
• Architecture
• Engineering

The IRS uses a four-prong test to determine if an activity qualifies for the R&D Credit. These prongs focus on the presence of innovation and experimentation in the process. An activity qualifies if it meets all four criteria:

Four-Part Test for Qualifying Activities

1. Permitted Purpose: The activity performed must relate to a new or improved product, process, software, invention, or formula (business component) in terms of:
   1. Function
   2. Performance
   3. Reliability
   4. Quality
2. Technological in Nature: The activity must rely on principles of:
   1. Physical science
   2. Biological science
   3. Engineering
   4. Computer science
3. Elimination of Uncertainty: The activity must be intended to discover information to eliminate technical uncertainty concerning the capability, method, or design for developing or improving a business component.
4. Process of Experimentation: The activity must be substantially related to identifying uncertainties in product, process, or design development, evaluating alternatives to eliminate those uncertainties, and testing or modeling to refine or achieve the desired outcome.