How Businesses Can Leverage R&D Tax Credits to Reduce Tax Liability in 2025

Research and development are critical for business growth and for national security, as businesses invest in innovation and keep the United States competitive in a global economy.

Recognizing this, the federal government offers tax incentives to businesses that invest in R&D. If your company invests in improvements in processes, products or software, you have an opportunity to reduce your tax liability every year. There is still time to claim the credit for the 2024 tax year.

How Can the R&D Tax Credit Benefit My Business?

Contrary to popular misconceptions, the R&D tax credit is not limited to large businesses or lab coat science. Any legitimate efforts to improve operations may qualify for the credit. It is a dollar-for-dollar credit and can be applied retroactively. And there is no limit on the amount that can be claimed.

For businesses whose federal R&D credit is greater than their tax liability, any unused credit can be carried back one year or carried forward for up to 20 years. Most states provide a state credit, boosting the potential benefit of the credit to 10-20% of qualified spending. In 2022, businesses in a wide range of industries claimed an estimated $18 billion in R&D credits.

The R&D tax credit may be claimed by startups that have not yet produced profits or even revenue to offset up to $500,000 of their federal payroll tax liabilities.

What are the Rules of Eligibility for the R&D Tax Credit?

Eligibility for the R&D tax credit is broad. Your organization may qualify for one or more of the following activities:

Improving existing products

Investing resources into the creation of new or improved products

Developing processes, prototypes or software

Employing designers, engineers, or scientists and their direct supervisors

Hiring outside consultants to assist innovation

To qualify, businesses must pass a four-part test of Qualified Research Activities:

The purpose of the research is to create a new or improved business component, resulting in a new or improved function, performance, reliability, or quality.
The research process must follow scientific principles. It must conduct simulation, modelling or systematic trial and error, and evaluate other alternatives to achieve desired results.
Experimentation must rely on the hard sciences: engineering, physics, chemistry, biology, or computer science.
Because theory and practice often don’t align, research must attempt to eliminate uncertainty about the results.

It is not necessary to achieve a scientific breakthrough or invent something new, just improve internal operations, products or services.

What are Qualified Research Expenses?

Wages and salaries – paid to employees who perform or directly supervise or support qualified activities described above.

The cost of supplies – This includes increased utility costs but not capital costs or general administrative supplies.

Increased computer costs – specifically the rent or lease of computers or online services used in qualified research activities.

The cost of outside contractors – if the results of the research are owned by the applying business. The amount of these costs are limited and the rules complex.

Small companies, and those with small research and development budgets, even those without formal R&D departments, may still qualify for the credit and benefit from applying. Unlike some other tax mitigation strategies, qualifying for the R&D tax credit does not entail daunting amounts of administrative time.

What Documentation is Required for the R&D Tax Credit?

Businesses applying for the R&D tax credit must document all their costs – wages and salaries, equipment and computer purchases and leases and contractor costs. If applying retroactively for prior years, this information must be gathered for those years as well. Support for the R&D claim must also be provided, including project lists and notes, lab results, and anything else relevant. The onus is on the applying entity to demonstrate that it has met the four-part test for qualified research activities.

This is merely a summary of the R&D tax credit provisions. The actual law is extremely complex and invites scrutiny from the IRS. In addition, recent changes have created some uncertainty about some of its elements. It is critical the businesses applying for the credit either educate themselves thoroughly on the law or partner with a professional tax consultant like National Tax Group, which has helped hundreds of businesses claim millions of dollars in credits.

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