United States: Three Biggest Surprises Of The R&D Tax Credit

Last Updated: July 10 2019
Article by Eisner Amper

Many businesses overlook this lucrative perk

The R&D tax credit is available to many more businesses than is commonly realized. It's not just technology companies that may qualify. Emerging and established businesses across diverse industries can also take advantage of this lucrative dollar-for-dollar benefit.

Now is a particularly good time to revisit the tax credit, which was enacted in 1981, then extended more than a dozen times until the Protecting Americans from Tax Hikes Act of 2015 made it a permanent feature of the code. Recent tax changes preserved its status, with no sunset provisions.

States such as New York and New Jersey offer similar tax incentives. This bipartisan federal and state support should give businesses the incentive to explore the tax credit, which can carry forward 20 years.

Here are the three biggest surprises about the R&D tax credit, and the businesses that qualify.

1. Process Improvement Counts

Businesses often assume that only new product development qualifies for the R&D tax credit. However, expenditures to improve internal processes also count if the activity is U.S.-based. If contractors are used, for example, they must be located stateside, as must any internal R&D team.

The R&D activity must also pass a four-part test. One essential principle of the credit is a process of experimentation, which means any effort must undertake an iterative process of trial and error. Similarly, there must be technical uncertainty, and the activity must rely on the hard sciences. Finally, it must aim to improve a business component in the areas of increased performance, reliability, quality, or function. A business component is a product, process, invention, software, or formula.

2. The Credit Applies Across Industries

The financial services sector often overlooks the R&D credit. However, with software, artificial intelligence, and analytics crucial to their operations, many firms require innovative technology development to stay competitive. This activity provides ample opportunity for potentially claiming the credit.

Although the purchase of a software license is an eligible expense, relatively new internal-use software regulations provide taxpayers the opportunity to claim software development expenses and avoid the more strenuous threshold of innovation.

With strong emphasis on process improvement, manufacturing companies are also a prime candidate for the credit. For example, a bread company may invest to lower the amount of energy used on heat, produce more bread per hour, and reduce workforce through automation. These are all areas of research and development that would fall under the tax credit.

3. Startups Also Qualify

Because the first few years of a business typically don't produce any taxable income, many startups assume they must turn a profit before qualifying for the R&D tax credit.

However, the PATH Act of 2015 made it possible for certain startup companies to claim a special R&D payroll tax credit. If qualified, the business can offset employer FICA taxes with the R&D credit for a savings up to $250,000 annually.

The company must be considered a qualified small business (QSB) to claim this special credit. A QSB must have $5 million or less in gross receipts in the year the credit is claimed, and no gross receipts in a period of five years before the filing. For example, with a tax filing for 2018, a QSB can have gross receipts from 2014 through 2018, but none prior to 2014. Offsetting FICA liabilities through the credit is a lesser-known area of tax law, so it's important to speak to the right tax professional.

Next Steps for Qualifying Businesses

Historically, specific areas of the R&D tax credit were considered a "tier one" audit issue for the IRS. Although the IRS abandoned the tiered issues in 2012, a high degree of IRS scrutiny continues. Businesses should thus familiarize themselves with the basics to stay in compliance and understand it's the taxpayer's burden to substantiate an R&D tax credit claimed.

There are three eligible costs aggregated to compute the R&D tax credit. At a minimum, it's important to understand what constitutes qualified research expenditures that the credit applies to. Employee salaries can be deducted up to the percentage of time spent on R&D activity. If 20% of an employee's time is devoted to R&D, for example, that's the percentage of W-2 wages eligible for the credit.

Supplies also qualify where they are dedicated to R&D. Specialized lab equipment can be claimed, for example, but general office supplies cannot. Depreciable assets also do not qualify. Finally, costs for stateside contractors can be deducted up to 65%, on an accrual basis.

Substantiation is the item most challenged by the IRS, so it's important to get these details right. Businesses should also maintain contemporaneous documentation of all R&D efforts. Results, failures, successes, designs, and meetings should all be tracked in real time. Supporting narrative should include discussion points, objectives, and courses of action. Backdating these details won't work come audit time.

To mitigate risks, business should consider a professional R&D study. The right tax professional will also have the technical expertise to review a company tax return and determine if a business qualifies for the credit. Many businesses may be pleasantly surprised.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions