November 25, 2025

By David R. Natan, CPA, MST, CVA

The Research and Development (R&D) tax credit remains a vital component of U.S. tax policy, designed to promote innovation and technological advancement. This dollar-for-dollar federal tax credit, often supplemented by state benefits, supports companies engaging in qualified research activities. Businesses across many different industries can leverage this credit, making it a powerful incentive for fostering growth and driving innovation.

Approach to the Credit Calculation

The R&D tax credit calculation can be fairly complex, encompassing different elections and credit calculations to determine which approach is best for your company. The process entails determining total qualified research expenses primarily from salaries, subcontract work, supplies, and prototypes, and applying these costs to a base amount threshold. Also, very important to the process is determining which projects qualify within your company. Developing a narrative relative to the qualifying project and tracking your costs by qualified project become very important to the process.

Qualified Research for Purposes of the R&D Tax Credit Defined

Under Section 41 of the Internal Revenue Code (IRC), activities must meet the following criteria to qualify for the R&D tax credit:

  1. Technological in Nature: Activities must rely on principles of engineering, physical or biological sciences, or computer science. Research rooted in social, literary, or historical sciences is not eligible.
  2. Permitted Purpose: Efforts should aim to develop or improve a product, process, function, performance, reliability, or quality. Examples include enhancing manufacturing processes or improving product reliability.
  3. Elimination of Uncertainty: The research must address uncertainties related to product development, feasibility, or design suitability.
  4. Process of Experimentation: Activities should involve testing hypotheses, analyzing results, and refining methods to resolve technical uncertainties.

Eligible Expenses for R&D Credit Calculation

The following expenses may qualify as QREs:

  • Wages: Salaries for employees directly performing, supporting, or supervising qualified research activities.
  • Supplies and Prototypes: Tangible property consumed during qualified research, excluding depreciable items.
  • Contract Research: 65% of payments to third-party contractors performing qualified research within the U.S.

Examples of Qualified Activities

  • Developing new or improved products, processes, software, or formulas
  • Creating prototypes or models
  • Creating environmentally favorable design and creating more efficient ‘green’ processes
  • Enhancing software technologies
  • Improving manufacturing processes or implementing automation
  • Developing tools, jigs, molds, and dies
  • Streamlining internal processes to boost efficiency
  • Developing a new client portal that entails a customized client experience
  • Building or enhancing e-commerce platforms for scalability and efficiency
  • New technology experimentation and evaluation, utilizing algorithms and AI to improve processes and products
  • Mobile app innovation, creating native apps with advanced features
  • Developing checkout and payment security
  • Packaging improvements to reduce breakage, improve temperature control or improve sustainability
  • Testing cloud-based inventory platforms for scalability
  • Customizing warehouse management and inventory systems for error reduction, automated fulfillment, etc.

Supporting Documentation: Building a Robust Case

To substantiate the credit, businesses must maintain comprehensive documentation, such as:

  • Time tracking records, meeting minutes, and issue logs
  • Narratives of research endeavors and objectives
  • Email communications detailing challenges and solutions
  • Technical reports, test results, and patent applications
  • Diagrams, drawings, and project specifications
  • Invoices for supplies and third-party services tied to R&D activities

Court cases such as U.S. v. McFerrin and Union Carbide Corp. v. Commissioner highlight the importance of credible documentation. Even without contemporaneous records, credible testimony and supporting evidence can substantiate claims.

Other Key R&D Credit Provisions and Opportunities:

  1. Offsetting Alternative Minimum Tax (AMT): Eligible small businesses with annual gross receipts averaging $50 million or less over the prior three years can apply the R&D credit against AMT liabilities.
  2. Payroll Tax Offset: Startups with less than $5 million in gross receipts and no gross receipts prior to 2020 can offset up to $250,000 annually against payroll taxes for up to five years. This is particularly valuable for C Corporations that are generating carryover losses.
  3. State-Level Benefits: Many states now mirror or build off of the federal R&D credit provisions, enhancing the overall financial advantage. Massachusetts offers a state-specific R&D Tax Credit calculated in several different ways. The core Massachusetts calculation drives off 50% of the base amount of qualified research expenses. The credit is limited to a portion of the corporate excise tax but allows carryover for up to 15 years (indefinitely for some disallowed credits). Businesses conducting research within Massachusetts can significantly reduce tax liabilities by leveraging this credit.

2025 Changes Under “The One Big Beautiful Bill Act” (OBBBA)

OBBBA removes the requirement to capitalize and amortize domestic related R&D that was in effect for tax years 2022, 2023 and 2024, ultimately reviving full-expensing of your domestic R&D costs effective January 1, 2025.

Key Provisions and Action Points:

  1. Optional Capitalization and Retroactive/Prospective Relief for Small Businesses
    Taxpayers may still elect to capitalize and amortize domestic R&D over 60 months (domestic R&D). Small Businesses (average gross receipts under $31 Million) can amend returns for 2022 through 2024 to apply immediate expensing and claim refunds. Alternatively, all US businesses, no matter what their size, can accelerate the remaining unamortized domestic R&D costs from 2022 thru 2024 and expense accordingly in 2025 or spread the expensing over 2025–2026.
  2. Domestic vs. Foreign R&D Distinction and Tracking
    It is important that businesses ensure their cost allocation systems clearly separate U.S.-based activities from foreign ones. Keep in mind that foreign-related R&D is still subject to 15-year amortization (unchanged from TCJA).

Further Compliance Reporting in 2026

In 2026, there will be mandated Form 6765 reporting requirement changes, particularly with Section G of the form. Businesses should plan to track QREs by business component and report more detailed wage categorization (direct, supervisory and support roles). Furthermore, each component will require narrative documentation covering uncertainty involved, experimentation details, and objectives.

Maximizing the Credit’s Impact

The R&D tax credit has become increasingly accessible and impactful, thanks to permanent extensions under the PATH Act and enhanced state-level incentives. Newburg CPA can help you navigate the complexities and maximize the credit opportunities available. Our team will work with you to ensure you have appropriate internal documentation to support maximizing the credits.

Contact Us for More Insight

The Newburg CPA team can help you maximize your R&D tax credit opportunities and navigate the ever-changing compliance requirements. Please contact your resource at Newburg CPA or email info@newburg.com for more information.