How to Claim the R&D Tax Credit for 2025

As a successful software development company, you spent $500,000 last year developing a new cloud-based platform. Your team worked for months solving technical challenges—building custom algorithms, testing different architectures, troubleshooting performance issues, and iterating through multiple prototypes. You assumed this was normal product development, not something that qualified for special tax treatment.

Then your accountant asks: "Did you claim the research and development tax credit for this development work?" You had no idea your activities were qualified. The credit could have saved you $65,000-100,000 in federal taxes. This credit isn't just for pharmaceutical companies and tech giants conducting cutting-edge research. It's available to any business that develops new or improved products, processes, software, formulas, or techniques involving technical uncertainty.

According to IRS data, only 24,000 businesses claim the R&D credit annually, yet estimates suggest over 360,000 businesses engage in qualifying activities. Studies indicate that businesses audited on R&D credits lose an average of 30-40% of claimed credits due to inadequate documentation, particularly failure to document the process of experimentation and technical uncertainty.

This guide shows you exactly how to determine if your activities qualify for the research and development tax credit in 2025, how to calculate the credit amount using Form 6765, and precisely what documentation you need to survive IRS examination.

What is the Research and Development Tax Credit?

The research and development tax credit (also called the R&D credit or Section 41 credit) is a federal tax incentive that rewards businesses for investing in innovation and technological advancement. The credit reduces your tax liability dollar-for-dollar based on qualified research expenses (QREs) you incur developing new or improved products, processes, software, formulas, or techniques.

Credit Value and Types

The R&D credit comes in two calculation methods, and you choose whichever provides the larger benefit.

Regular Research Credit (RRC): 20% of current year qualified research expenses exceeding a base amount (calculated from prior years' spending patterns). This method typically provides larger credits for companies with consistently increasing R&D spending.

Alternative Simplified Credit (ASC): 14% of current year qualified research expenses exceeding 50% of the average QREs from the prior three years. This simplified method benefits companies with fluctuating R&D spending or newer companies without extensive history.

For startups and small businesses, the research and development tax credit offers additional benefits through the payroll tax credit offset option, allowing eligible companies to apply up to $500,000 of their R&D credit against payroll taxes rather than income taxes.

Who Can Claim the Research and Development Tax Credit?

The research and development tax credit is available to businesses of all sizes and industries—not just traditional research labs or tech companies.

Businesses commonly eligible:

• Software development companies creating new applications, platforms, or systems
• Manufacturing companies improving production processes or developing new products
• Engineering firms designing new structures, systems, or technologies
• Food and beverage companies developing new recipes, formulas, or processing methods
• Architectural firms using new design techniques or technologies
• Agricultural businesses developing new growing methods or crop varieties
• Automotive and aerospace companies developing components or systems
• Pharmaceutical and biotechnology companies (traditional R&D activities)

The key is not your industry but whether your activities involve resolving technical uncertainty through a process of experimentation to develop something new or improved.

What Activities Qualify for the R&D Credit?

The IRS uses a four-part test to determine if activities qualify as research. All four requirements must be met for expenses to qualify as QREs.

The Four-Part Test

1. Permitted Purpose Test

Your research must be undertaken to develop or improve a business component's function, performance, reliability, or quality. A "business component" is any product, process, software, technique, formula, or invention intended for sale, lease, license, or use in your trade or business.

Qualifies: Developing software with faster processing speeds, creating a manufacturing process that reduces defects, designing a more durable product material.

Doesn't qualify: Research for style, taste, or cosmetic changes; market research; routine data collection; research after commercial production begins.

2. Technical Uncertainty Test

At the beginning of your activities, the information available must be insufficient to determine how to develop or improve the business component, or the appropriate design method must be uncertain.

Qualifies: Uncertainty about the capability of achieving desired function, uncertainty about the appropriate design or methodology, need to develop new algorithms or processes because existing solutions don't work.

Doesn't qualify: Activities where the solution is readily available in published literature, common knowledge in the industry, or can be achieved by hiring someone with the necessary expertise without experimentation.

3. Process of Experimentation Test

Substantially all research activities must constitute a process of experimentation to resolve technical uncertainty. This means you must evaluate alternatives through modeling, simulation, systematic trial and error, or other methods.

Qualifies: Building multiple prototypes and testing each, running simulations to compare design approaches, conducting iterative testing to optimize performance, systematic troubleshooting of technical problems.

Doesn't qualify: Customer surveys or focus groups, routine quality control, efficiency studies that don't involve technical uncertainty.

4. Technological in Nature Test

The process of experimentation must rely on principles of physical or biological sciences, engineering, or computer science. The process must be technological, not just the end result.

Qualifies: Applying engineering principles to solve structural problems, using computer science algorithms to optimize performance, applying physics principles to material selection.

Doesn't qualify: Business process improvements not involving hard sciences, management technique developments, social science research.

Common Qualifying Activities by Industry

Understanding how the four-part test applies in your specific industry helps identify qualifying activities.

Software Development:

• Developing new algorithms or data structures
• Creating new functionality or features involving technical uncertainty
• Improving software performance, scalability, or security
• Integrating complex systems or APIs requiring experimentation
• Developing new testing frameworks or methodologies
• Resolving compatibility issues across platforms

Manufacturing:

• Developing new manufacturing processes or techniques
• Improving production efficiency through technical innovation
• Developing or improving product designs requiring testing
• Creating new materials or material combinations
• Automating processes involving technical challenges
• Reducing defect rates through process experimentation

Engineering and Architecture:

• Designing structures with new materials or methods
• Developing innovative structural systems
• Creating energy-efficient designs requiring modeling
• Solving complex site-specific engineering challenges
• Developing new construction techniques or processes

Food and Beverage:

• Developing new recipes or formulations
• Improving shelf life or stability through experimentation
• Creating new processing methods or techniques
• Developing new packaging that maintains product integrity
• Scaling recipes from small to large production

Activities That DON'T Qualify

Certain activities explicitly do not qualify for the research and development tax credit, even if they support qualifying research.

Excluded activities:

• Research after commercial production begins (post-production improvements generally don't qualify)
• Adaptation of existing business components to particular customer requirements (customization isn't qualifying research)
• Duplication of existing products or processes (reverse engineering doesn't qualify)
• Surveys, studies, research related to management functions
• Research conducted outside the United States
• Research funded by another party (government grants, customer-funded research)
• Research in social sciences, arts, or humanities

The distinction between qualifying development and excluded activities can be subtle. The key is whether you're solving technical uncertainty through experimentation or simply applying known techniques.

What Expenses Qualify as QREs?

Not all expenses related to qualifying research activities count toward the credit calculation. Only four specific categories of costs qualify as Qualified Research Expenses (QREs).

1. Wages

Wages paid to employees who directly performed or directly supervised qualifying research activities, or who directly supported the research (clerical support for research projects).

What qualifies:

• Salaries of engineers, scientists, developers, designers engaged in qualifying activities
• Salaries of supervisors who directly oversee qualifying research
• Wages paid to technicians conducting experiments or building prototypes
• Time spent by these employees on qualifying activities (not their entire salary unless 100% qualifying work)

What doesn't qualify:

• Executive or management salaries (unless directly performing research)
• Sales and marketing staff
• Administrative support not directly supporting specific research projects
• Time spent on non-qualifying activities

Calculation: You must allocate wages based on time spent on qualifying activities. If an engineer spends 60% of their time on qualifying development work, 60% of their wages are QREs. Time tracking or reasonable estimates based on project records are essential documentation.

2. Supplies

Tangible property used and consumed in the research process, other than land, improvements to land, or property subject to depreciation.

What qualifies:

• Materials and components used in prototypes
• Testing materials consumed during experiments
• Chemicals, reagents, or biological materials used in research
• Raw materials used in developing new products or processes
• Consumable tools and supplies

What doesn't qualify:

• Equipment with useful life exceeding one year (these are depreciable, not supplies)
• Materials used in production after research is complete
• Office supplies not specific to research projects
• Property subject to depreciation or amortization

3. Computer Rental or Lease Costs

Costs to rent or lease computers used in qualifying research. This category is narrow and rarely applies today since most businesses own computers rather than rent them.

What qualifies:

• Cloud computing costs for research activities (servers, processing power, storage)
• Short-term rental of specialized computing equipment
• Time-based costs for computer usage in research

What doesn't qualify:

• Purchased computers (depreciation expense, not rental)
• Software subscriptions (not rental of computers themselves)
• General IT infrastructure not specifically used for research

4. Contract Research Expenses

65% of amounts paid to third parties for qualified research they perform on your behalf. Only 65% qualify because the contractor is claiming wages for their own employees.

What qualifies:

• Payments to third-party contractors, consultants, or research firms to perform qualifying research
• Outsourced development work involving qualifying activities
• Payments to universities or research institutions for research

What doesn't qualify:

• Amounts paid to related parties (5% or more common ownership)
• Research performed outside the United States
• Payments for research where you don't retain substantial rights to results

How Do I Calculate the R&D Credit Amount?

The credit calculation involves multiple steps and requires using Form 6765 (Credit for Increasing Research Activities). You calculate both the Regular Research Credit and Alternative Simplified Credit, then choose whichever is larger.

Alternative Simplified Credit (ASC) Calculation

Most businesses use the ASC method because it's simpler and doesn't require detailed historical calculations going back decades.

ASC formula:
Credit=14%×(Current Year QREs−(50%×Average QREs from prior 3 years)

Step-by-step ASC calculation:

1. Determine current year QREs (total of all four categories: wages, supplies, computer rental, contract research)
2. Calculate average annual QREs from prior three years
3. Multiply that average by 50%
4. Subtract result from current year QREs to get "excess QREs"
5. Multiply excess QREs by 14%

Regular Research Credit (RRC) Calculation

The RRC is more complex, requiring calculation of a "base amount" from historical spending over multiple years. The formula provides a 20% credit rate instead of 14%, potentially yielding larger credits for companies with consistently increasing R&D spending.

RRC formula:
Credit=20%×(Current Year QREs−Base Amount)

The base amount calculation involves your fixed-base percentage (based on QREs from years 1984-1988 relative to gross receipts) multiplied by your average gross receipts from the prior four years. For most companies, this calculation is complex and requires extensive historical data.

Because of the complexity and the favorable results often produced by ASC, most small business tax credits consultants recommend using ASC unless detailed historical analysis shows RRC would be substantially better.

Payroll Tax Credit Election for Startups

Qualified small businesses can elect to apply up to $500,000 of their R&D credit against payroll taxes instead of income taxes. This is particularly valuable for startups without taxable income but with payroll tax liability.

Eligibility for payroll tax credit election:

• Gross receipts less than $5 million in the current tax year
• No gross receipts for any tax year before the five-year period ending with the current year (business is less than 5 years old from first revenues)
• Election can be made for up to 5 years

The payroll tax credit allows pre-revenue or low-profit startups to monetize their R&D credit immediately rather than carrying it forward until they have sufficient income tax liability.

How Do I Claim the R&D Credit on My Tax Return?

Claiming the research and development tax credit requires completing Form 6765 and attaching it to your business tax return. The form calculates your credit amount and documents your election method.

Completing Form 6765

Form 6765 consists of three sections corresponding to the two credit calculation methods and special elections.

Section A - Regular Credit:

Complete this section only if calculating the Regular Research Credit method. This section requires:

• Current year QREs by category (wages, supplies, computer rental, contract research)
• Fixed-base percentage calculation or election
• Base amount calculation using historical gross receipts
• Credit calculation: 20% of current QREs exceeding base amount

Most businesses skip Section A unless they've determined RRC provides a better result than ASC.

Section B - Alternative Simplified Credit:

This section calculates the ASC method. You'll report:

• Current year QREs by category
• Prior three years' QREs (one line for each year)
• Calculation of average prior QREs and 50% base amount
• Credit calculation: 14% of excess QREs

Complete this section if using ASC (most common choice).

Section C - Qualified Small Business Payroll Tax Election:

Complete this section only if making the payroll tax credit election for startups. This section documents:

• Confirmation you meet eligibility requirements (under $5M gross receipts, less than 5 years old)
• Amount of credit you're electing to apply against payroll taxes (up to $500,000)
• Tax year for which election applies

Attaching Form 6765 to Your Tax Return

After completing Form 6765, you attach it to your business tax return:

• C Corporations (Form 1120): Attach Form 6765 to Form 1120. The credit amount flows to Form 3800 (General Business Credit), then to Form 1120, Schedule J.
• S Corporations (Form 1120-S): Attach Form 6765 to Form 1120-S. The credit passes through to shareholders on Schedule K-1, Line 13 (credits).
• Partnerships (Form 1065): Attach Form 6765 to Form 1065. The credit passes through to partners on Schedule K-1, Line 15 (credits).
• Sole Proprietorships (Schedule C): Attach Form 6765 to Form 1040. The credit flows through Form 3800 to Schedule 3, Line 6.

Reducing Deductions for QREs

An important rule reduces your deduction for research expenses by the amount of credit claimed, or you can elect a reduced credit to avoid reducing deductions.

Two options:

Option 1 (default): Claim full credit but reduce your expense deduction by the credit amount. If you claim a $50,000 credit, reduce your wage/supply deductions by $50,000.

Option 2: Elect a reduced credit (credit × approximately 87%) and take full expense deductions.

Most businesses choose Option 1 (full credit, reduced deduction) because the dollar-for-dollar tax reduction from the credit exceeds the tax value of the deduction.

What Documentation Do I Need to Support My R&D Credit Claim?

IRS examinations of R&D credits are common, and inadequate documentation is the primary reason credits are reduced or disallowed. Contemporaneous documentation created during the research process is essential. The IRS expects documentation proving all four parts of the qualifying research test for each project and detailed support for all QRE amounts claimed.

1. Project Documentation

For each qualifying project, document:

• Project objectives and goals (what you were trying to develop or improve)
• Technical uncertainty faced at project outset (what was unknown)
• Alternative approaches considered and evaluated (process of experimentation)
• Design documents, specifications, technical drawings
• Meeting notes discussing technical challenges and solutions
• Test plans and testing results
• Iteration records showing modifications and improvements
• Final outcomes and results

2. Technical Uncertainty Documentation

The hardest element to prove is technical uncertainty. Documentation should show:

• Specific technical questions you needed to answer
• Why the solution wasn't readily available or known
• Literature searches showing no existing solution
• Expert consultation notes
• Descriptions of why existing methods were inadequate

Without clear documentation of what was uncertain and why, the IRS commonly disallows credits during examination.

3. Process of Experimentation Documentation

Prove that you evaluated alternatives systematically:

• Prototypes built and tested (photos, test data, results)
• Simulations or models created and compared
• A/B testing results comparing approaches
• Performance metrics measured during testing
• Decision logs explaining why certain approaches were selected or rejected

4. Wage Documentation

For wage QREs claimed on Form 6765, maintain:

• Time tracking records showing hours spent on qualifying activities by employee
• Project assignments and descriptions of qualifying work performed
• Job descriptions showing employees' technical roles
• Payroll records connecting wages to specific employees
• Allocation methodologies if using estimates rather than actual time tracking

The IRS expects reasonable basis for wage allocations. Contemporary time tracking is strongest evidence; estimates based on project records are acceptable if reasonable and documented.

5. Supply Documentation

For supply QREs:

• Purchase receipts showing supplies purchased
• Project records connecting supplies to specific qualifying projects
• Inventory records showing supplies consumed (not held for resale)
• Descriptions of how supplies were used in experimentation

6. Contract Research Documentation

For contract research expenses:

• Contracts with third-party research providers
• Invoices showing amounts paid and services performed
• Documentation proving you retained substantial rights to research results
• Evidence that research was performed in the United States
• Confirmation that contractor is not a related party

Creating a Documentation System

The best time to create documentation is contemporaneously—during the research process, not when preparing Form 6765.

Best practices:

• Implement project tracking systems documenting objectives, uncertainties, and experiments
• Require technical staff to maintain project logs or journals
• Hold regular meetings discussing technical challenges and document discussions
• Save all design iterations, test results, and prototypes
• Implement time tracking for employees engaged in development work
• Create written project close-out reports summarizing uncertainties faced and solutions developed
• Maintain centralized repository of all R&D documentation (digital folder by project)

Many businesses use project management software, version control systems (GitHub), issue tracking systems (Jira), or engineering notebooks to create contemporaneous records automatically during the development process.

Can I Amend Prior Years to Claim Missed R&D Credits?

Yes, you can file amended returns to claim research and development tax credit for prior years if you missed claiming it originally.

You can amend returns to claim the R&D credit within three years of the original return filing date (or two years from when you paid the tax, whichever is later).

For 2022 returns filed April 15, 2023: You can amend until April 15, 2026.

For 2023 returns filed April 15, 2024: You can amend until April 15, 2027.

Amending Returns for R&D Credits

To claim missed research and development tax credit from prior years:

1. Conduct R&D study for each prior year, identifying qualifying activities and calculating QREs
2. Complete Form 6765 for each prior year being amended
3. File Form 1120-X (corporations), Form 1040-X (individuals), or appropriate amended return
4. Attach completed Form 6765 showing credit calculation
5. Include detailed explanation of credit claim in amendment explanation section

The IRS processes amended returns claiming R&D credits slowly—often 6-12 months or longer. Be prepared for potential examination, especially for large credits claimed on amendments.

How NSKT Global Can Help Maximize Your R&D Credit

NSKT Global specializes in research and development tax credit studies for businesses across all industries, ensuring you claim maximum small business tax credits while building documentation that withstands IRS examination. We provide comprehensive R&D credit studies by interviewing technical staff to identify all qualifying activities, applying the four-part test to each project rigorously, identifying all qualifying wage, supply, and contract research expenses and preparing complete Form 6765 with detailed supporting calculations.

We handle prior year amendments by conducting R&D studies for prior open years (typically 3 years), gathering and organizing available contemporaneous documentation from prior years. We assist qualified small businesses with payroll tax credit elections by determining eligibility for startup payroll tax credit elections, calculating optimal credit amounts to apply against payroll taxes (up to $500,000). We help completing Section C documenting the election, coordinating with payroll processors to claim the credit against quarterly payroll tax deposits, and ensuring compliance with all eligibility requirements.

Whether you're claiming the research and development tax credit for the first time or have claimed it for years, our expertise ensures you capture every dollar of available small business tax credits while maintaining documentation that survives the most rigorous IRS examination.