Complete guide to the R&D tax credit for small businesses
The research credit helps millions of small businesses reinvest in their operations, hire staff, and fund investigations by offsetting income and payroll tax liabilities.
The credit can provide you with much-needed funding to support your research activities and drive your business growth by covering up to 20% of qualifying research expenses! In this article, we’ll discuss everything you need to know to take advantage of it.
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What is the research tax credit?
The research tax credit, enacted in 1981, provides companies with a federal benefit that allows for dollar-for-dollar cash savings for activities related to developing, designing, or improving products, processes, formulas, or software.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 made the credit permanent and expanded its application to include payroll taxes for qualifying small businesses. The Inflation Reduction Act of 2022 further enhanced these benefits.
What businesses are eligible for research tax credit?
The research tax credit is available to any business engaged in research and development activities.
Contrary to common belief, the credit is not restricted to high-tech or pharmaceutical industries; sectors such as manufacturing, agriculture, software development, and many others may qualify.
Corporations with publicly traded stock can not qualify for the research credit.
What are the qualified research activities and expenses?
Qualified research should aim to discover technological information and develop a new or improved business component.
Most research activities should be part of an experimental process that enhances function, performance, reliability, or quality.
Types of qualifying expenses:
- salaries for employees
- costs of materials and supplies
- expenses for computers and cloud services
- contractor expenses
All qualifying expenses must be directly related to the research. For example, wages paid to a developer working on the research are considered qualifying expenses. However, salaries for employees not directly involved in the research will not be eligible for this credit.
The research credit is not allowed for post-commercial production research, adapting or duplicating existing products, specific internal-use software research, research outside the US and its territories, social sciences, arts, or funded research. You can check the complete list of exclusions on the Internal Revenue Service (IRS) website.
How to calculate the R&D tax credit?
The first step to calculate the research credit is to choose between regular credit and Alternative Simplified Credit (ASC).
Regular credit is 20% of qualifying expenses that exceed a base amount, while ASC is 14% of qualifying expenses over 50% of the average for the prior three years.
If you apply for a regular credit, make sure to calculate the base amount correctly. This calculation can be complex and often requires detailed historical data on research expenditures. Tax professionals can help you choose the method that best suits your business's financial situation and make all the required calculations for you.
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Learn moreForm 6765, credit for increasing research activities
You'll need to use Form 6765 to calculate and claim the research tax credit.
The form consists of four sections:
- Section A calculates the credit based on the regular method.
- Section B calculates the credit using the ASC method.
- Section C summarizes the credit and indicates where it should be reported.
- Section D allows eligible small businesses to apply the credit against payroll taxes.
How to file Form 6765?
You must attach Form 6765 to your business's tax return.
C corps and sole proprietors must file Form 6765 and Form 3800, while pass-through entities report the credit on Schedule K-1.
Form 3800 is used to claim the general business credit (GBC). It is a collection of credits encouraging specific business activities, from research and development to energy efficiency improvements.
When to file Form 6765?
For corporations and sole proprietorships, the deadline to file Form 6765 for the 2024 tax year is April 15, 2025. For partnerships and S corporations, the deadline is March 17, 2025.
To apply the credit against payroll taxes, you must make the election on a timely filed return, including extensions.
How to apply the research tax credit against payroll taxes
Small businesses with gross receipts of less than $5 million for the tax year and no gross receipts for any tax year preceding the five-tax-year period can apply the R&D credit against payroll taxes.
Eligible businesses must complete Section D of Form 6765 and attach Form 8974 to their employment tax return. The credit can be applied to payroll taxes by the first quarter after the tax return when the payroll tax election is filed. Unused credits can be carried forward.
Recent revision of Form 6765 by the IRS
In June 2024, the IRS updated Form 6765 to simplify the reporting process and reduce the taxpayer burden. These changes include making certain sections optional and clarifying reporting requirements. The updated Form 6765 will be mandatory for the tax year 2025.
Learn more about the changes in our blog post IRS unveils revised draft Form 6765 for Research Credit following public feedback.
Get professional help with the R&D tax credit
The research tax credit is quite complex and time-consuming: On average, business owners spend over 17 hours keeping track of records, learning about the tax regulations, preparing and sending the required form to the IRS.
Partner with TFX tax professionals to take care of your business taxes and save time for what matters most for you and your business – your customers, your employees, and your growth.
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Book discovery callDisclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.
Susan Turcotte, a seasoned CPA with over 45 years of accounting experience, holds a Bachelor's in Accounting and a Master's in Taxation from Bryant College. See more
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