Credit for Increasing Research Activities: Who Qualifies and How to Claim
Explore eligibility and steps to claim tax credits for research activities, including qualifying costs and coordination with other credits.
The tax credit for increasing research activities is an incentive aimed at driving innovation and development across industries. By providing financial benefits, it encourages businesses to invest in new technologies and processes that enhance economic growth and competitiveness.
Understanding eligibility criteria and the claiming process is critical for businesses seeking to utilize this opportunity.
Who Qualifies for the Credit
Eligibility under IRC Section 41 requires businesses to engage in qualified research activities (QRAs) within the U.S. These activities must aim to discover technological information and develop or improve business components, such as products, processes, software, techniques, or inventions.
The four-part test for eligibility requires that the activity: eliminates uncertainty in developing or improving a product or process, relies on principles of science or engineering, involves experimentation, and seeks to enhance function, performance, reliability, or quality.
Small businesses and startups benefit significantly. The PATH Act of 2015 allows them to apply the credit against alternative minimum tax (AMT) or payroll tax liabilities, which is especially useful for startups investing in R&D but not yet profitable.
Activities That May Count
QRAs must be innovative and advance scientific or technological knowledge. For example, in the pharmaceutical industry, developing new drug formulas or production processes often qualifies due to the experimentation involved. In software, creating algorithms or platforms through trial and error may count. Manufacturing activities like designing machinery or improving production lines can also qualify if they involve systematic evaluations.
Costs That May Qualify
Eligible expenses include wages for employees directly involved in research, such as engineers and scientists, as well as those supervising or supporting these efforts. Supplies used in the research process, like materials for prototypes or chemicals for testing, also qualify. Payments to U.S.-based third-party contractors contributing expertise to the project are eligible as well.
Calculating the Amount
The tax credit can be calculated using the Regular Research Credit or the Alternative Simplified Credit (ASC). The Regular Research Credit allows claiming 20% of qualified research expenses (QREs) exceeding a base amount, determined by a fixed-base percentage and average annual gross receipts from the prior four years. The ASC offers a 14% credit on QREs exceeding 50% of the average QREs from the previous three years, with a 6% credit available for companies without sufficient history.
Coordination with Other Tax Credits
Businesses must coordinate the research credit with other tax incentives to optimize their strategy. Expenses qualifying for multiple credits cannot be double-counted. For example, wages claimed under the Work Opportunity Tax Credit (WOTC) must be excluded from QREs for the research credit. Similarly, costs claimed under energy-related credits, like the Section 48 Investment Tax Credit (ITC), must also be excluded. At the state level, research credits often supplement the federal credit but have distinct rules.
Filing Steps
Claiming the research tax credit requires completing Form 6765, “Credit for Increasing Research Activities,” and attaching it to the federal income tax return. This form breaks down QREs, including wages, supplies, and contract research costs. Small businesses offsetting payroll taxes under the PATH Act must also submit Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities,” with their quarterly payroll tax return. Accurate documentation is essential, as the IRS may request evidence to support the claim. Consulting a tax advisor with expertise in research credits can ensure compliance and maximize the credit.