An Explanation
R&D Tax Credit: How Businesses Can Reduce Their Tax Liability
Introduction
The R&D tax credit has been one of the most valuable tax breaks available to American companies for decades. Established in 1981 to increase investment in U.S.-based innovation, it now provides billions of dollars in tax savings annually to companies across the country — and businesses that claim it still benefit from the normal tax deduction for their R&D expenses on top of the credit.
Despite its size, the credit is widely underused. Many small companies don't realize it applies to them — they assume it's reserved for large corporations with formal research departments. Others assume it's limited to technology and manufacturing, when in reality companies across a wide range of industries qualify. That gap between who's eligible and who claims it is exactly where Firestone comes in.
The federal credit generally amounts to 5–10% of R&D expenses, and many states offer an additional 3–15%. It can be claimed for the current year and for up to three years in the past, and can reduce payroll taxes for certain pre-revenue startups.
How the R&D Tax Credit works
1. Qualified research activities
To be eligible, a company must spend money attempting to create a new or improved product, software, production process, technique, or design (including building systems or structural designs).
2. Qualified expenses
Four categories of spend can be included in the credit calculation:
Wages paid to U.S. employees involved in design, prototyping, testing, etc.
Payments to U.S. contractors or vendors providing R&D services
Materials used during these activities
Payments for cloud-based development environments or cloud-computing development resources
3. Documentation
Claiming the credit starts with gathering R&D expense records that support the qualifying activities. The credit is calculated and claimed on the company's tax return, and supporting documentation is compiled to back the claim if it's ever reviewed.
How much could the R&D tax credit save you?
R&D Tax Credit Calculator
Does your company qualify?
Your company may qualify if you:
Develop new or improved products, software, or processes
Improve or automate a production or manufacturing process
Design custom tools, molds, fixtures, or parts
Test prototypes or new materials
Solve technical challenges in engineering, design, or production
Build or refine internal software, apps, or data systems
Not sure if your work counts? A short conversation with Firestone is usually enough to tell.
Industries that Benefit
There is no requirement that companies be part of specific industries to claim the R&D tax credit. It is available to any company regardless of industry that performs qualified activities. The following industries and activities are likely to be eligible.
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Software & Technology
Development of software, apps, data handling, memory optimization, processing engines, algorithms, APIs, database technologies, firmware, robotics, new technologies, automated systems, robotics, etc.
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Manufacturing
Design of new or improved products, custom products, tools, molds, jigs, fixtures, etc. Development or optimization of CNC programs and equipment operations and toolpaths. Developing new manufacturing processes or capabilities; improving existing manufacturing lines or processes.
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Precision Machining
Design of new or improved parts, custom parts, fixtures, jigs. Development or optimization of CNC programs and equipment operations and toolpaths. Development of new machining capabilities or improved processes.
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Engineering
Creating HVAC, mechanical, structural, civil, environmental or other designs. Product development, 3D modeling, testing, etc.
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Electronics Design & Production
Design of printed circuit boards and integrated circuits, developing circuit board production process (pick & place, through hole, etc.), first article runs, development of mechanical and case components for electronics, etc.
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Foundries & Molding
Design of molds, dies, stamps, and tools, developing part-specific molding processes, material application development, injection time analysis, gate seal analysis, cavity balance study, first article test runs, etc.
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Architectural
Developing energy-efficient features, schematic designs, technical building systems design, building envelope design, etc.
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Construction
Building systems design, structural engineering, site engineering, structural and miscellaneous steel detailing and fabrication, design-build projects, etc.
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Life Sciences
Formulations development, pharmaceuticals development, development of seed varieties, coatings, treatments, etc.
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Food & Beverage
Formulation and recipe development, nutrition profile development, shelf-life and stability testing, production process development, etc.
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Retail & Distribution
Developing sales, inventory, or supply-chain applications, processing automation, etc.
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Financial
Development of client portals, quote-generation engines, servicing and delivery applications, and more in the insurance, banking, investing, and other financial areas.
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Service Providers
Development of client portals, quote-generation engines, servicing and delivery applications, and more in the insurance, banking, investing, and other financial areas.
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Miscellaneous
Regardless of industry, any company that has invested into custom software, had mobile applications developed, invested in automation, etc.
R&D Tax Credit Basics Questions
How much is the R&D credit worth?
The federal R&D tax credit is one of the most lucrative tax incentives out there. It is a dollar-for-dollar offset against income taxes, generally ranging between 5% and 10% of eligible R&D expenses. Many states offer R&D tax credits of varying sizes — businesses in certain states can receive tax credits totaling 20% of their R&D expenses.
Try our free calculator →
What is the purpose of the R&D tax credit?
The R&D credit was created to incentivize companies to invest money into the development of new and improved products. The government realizes that new products lead to increased tax revenues and that an incentive like this helps keep high-paying technical jobs in the U.S., resulting in U.S. companies and the U.S. economy as a whole remaining competitive both domestically and internationally.
Is the R&D tax credit new?
No. The R&D tax credit has been around since 1981. Since then, it has been expanded many times, and in 2015 the Protecting Americans from Tax Hikes (PATH) Act made the credit permanent. The R&D tax credit is currently more popular and heavily used than ever, as more companies in a wide array of industries are investing in new technology.
Can the R&D tax credit also reduce state income taxes?
Yes, many states offer their own R&D tax credits for R&D expenses incurred within that state. The value of state R&D tax credits varies widely, but it generally ranges between 3% and 15% of state-specific eligible R&D expenses.
Qualification Questions
Must companies be in a specific industry to benefit?
No—companies in a wide range of industries are eligible. This credit is not only for technology companies or manufacturers!
Is the R&D tax credit only for large companies?
No! Companies of any size are eligible, from sole proprietorships with no employees to Fortune 50 companies with more than 100,000 employees. Unfortunately, while most eligible large companies already claim the R&D tax credit, many eligible small companies fail to take advantage of this valuable tax benefit.
Can companies that don't develop new products take advantage of this credit?
Quite possibly! In today’s business environment, more companies than ever before are eligible. Any company that invests in new or improved production processes, computer software, techniques, designs, formulas, or products can take advantage of the R&D tax credit. Examples of non-obvious companies that can qualify are:
An HVAC company that designs and engineers the HVAC systems they install
A bank that invests in developing custom loan origination or servicing software
A contract manufacturer that develops the process to fabricate a customer’s parts, even if the customer itself handles designing the parts
Many businesses underestimate their qualifying activities. Firestone can help evaluate whether your projects and expenses may qualify.
Must companies generate profit and income taxes to take advantage of the credit?
Not necessarily. The credit isn't refundable and generally can't reduce income taxes below $0, but unused credits carry forward up to 20 years. Startups in their first five years, with under $5 million in current-year revenue, can offset up to $250,000 of FICA payroll taxes with the credit regardless of profitability.
Industry Questions
Does my industry qualify?
See Industries That Benefit →
Documentation Questions
What types of expenses are eligible?
Wages of U.S. employees involved in design, development, testing, or other research activities
Payments to U.S. vendors involved in these activities
Materials used during these activities
Payments to lease cloud-based software development environments
Must companies have specific documentation "proving" R&D to claim the credit?
No. There is no specific record-keeping requirement, and many court cases have confirmed that R&D credits can be supported by testimony that reasonably demonstrates a factual basis for claiming the R&D tax credit.
Must companies implement special systems or accounting procedures to claim the credit?
No. Firestone works with companies to develop support for any R&D tax credits claimed without implementing expensive systems or time-consuming new procedures. We focus on leveraging existing records and data to maximize efficiency and minimize intrusion.
What forms do I have to file to obtain the R&D tax credit?
The R&D tax credit must be claimed on a company’s income tax return. The tax credit can be claimed on original tax returns, and up to three years’ of previously filed tax returns can be amended to claim the R&D tax credit! Any R&D credits claimed reduce the amount of income taxes due.
Can companies calculate and claim this credit on their own?
The R&D tax credit is one of the most complex and ambiguous items in the tax law. Enlisting experts who understand this law and how to apply it to your business is crucial to calculating and claiming a valid tax credit. Additionally, companies that claim the credit on their own often fail to include all eligible expenses and end up with smaller credits than they deserve.
CPA Questions
Does Firestone compete with my accounting firm?
No. Firestone doesn't provide tax preparation, assurance, or accounting services, so there's no overlap with what you already do. We identify opportunities, complete the technical documentation, and help clients maximize available incentives, while you as their primary CPA stays the trusted advisor on record. We don't compete for your core business.
What's the process for referring a client to Firestone?
LINK: Learn About Our CPA Partnership Program →
How Firestone Helps
Identify opportunities: an initial conversation to surface likely-qualifying activities
Analyze activities: a closer look at what the business is doing, against the qualifying criteria
Calculate the credit: determining the federal and state credit amount based on qualified expenses
Prepare documentation: compiling records that support the claim, so it's ready if reviewed
After one short introductory conversation, Firestone will have a good idea of whether your business could benefit. If eligible, Firestone is committed to helping you claim the maximum amount you deserve.
View the full step-by-step process →
Working With Your CPA
Many eligible companies overlook the R&D tax credit because qualifying activities happen throughout the business, not just in a formal research department. Firestone works alongside CPAs to identify opportunities, complete technical documentation, and help clients maximize the credits available to them.
That partnership is real, not just a talking point: Zach Boyd, CPA and founder of Boyd CPA, has partnered with Firestone since 2017, referring clients for both R&D tax credit and cost segregation work. "Many CPAs are looking for ways to offer more strategic value to their clients," Zach says. "Partnering with Firestone is one of the best ways to do that, and Rance has never once tried to pull a client away from my practice."
See how one referral led to $60,000 in tax savings →
Partnering with Firestone means you can:
Offer specialized R&D tax credit and cost segregation services without building that expertise in-house
Avoid losing complex clients to larger firms
Deepen your value to clients without adding to your workload
Focus on tax prep while Firestone handles the technical study