Gillon Tax and our professional team have been performing R&D tax credit studies since 1998, generating significant tax savings for companies both large and small. Our R&D process is efficient, cost-effective, and designed to maximize value while maintaining technical rigor and audit defensibility. We work closely with management, engineering, and finance teams to identify qualifying activities and properly document expenditures.

The Research and Experimentation (R&E), commonly referred to as the R&D tax credit, is one of the most valuable tax incentives available to U.S. businesses. Designed to encourage innovation and domestic investment, the credit provides a dollar-for-dollar reduction of federal tax liability for companies that incur qualified research expenditures in the United States.

Despite common misconceptions, the R&D tax credit is not limited to technology or life sciences companies. Businesses across a wide range of industries—including manufacturing, engineering, and industrial services—regularly qualify.

What Is the R&D Tax Credit?

The R&D tax credit is a general business credit calculated as a percentage of a company’s qualified research expenditures (QREs) incurred during a tax year. Unlike deductions, which reduce taxable income, tax credits directly reduce the amount of tax owed, making the R&D credit particularly impactful.

Who Can Claim the R&D Tax Credit?

Any taxpayer that conducts qualified research activities as part of a trade or business in the United States may be eligible to claim the R&D tax credit. While the credit is often associated with high-tech industries, nearly two-thirds of R&D credits generated in the U.S. are attributable to more traditional industries, such as manufacturing and product development.

Companies do not need to invent new products to qualify. Enhancements to existing products, processes, techniques, or software may also meet the requirements.

How Is the R&D Tax Credit Calculated?

The R&D tax credit is an incremental credit equal to up to 20% of a taxpayer’s current-year qualified research expenditures that exceed a base amount. The base amount can be calculated using one of three IRS-approved methodologies, allowing flexibility based on a company’s facts and historical data.

Qualified Research Expenditures (QREs)

Qualified research expenditures generally include:

• Wages for employees engaged in qualified research activities
• Supplies consumed during the research process
• Contract research expenses, subject to applicable limitations
• Basic research payments to qualified organizations

Accurate identification, allocation, and documentation of these costs are critical to sustaining the credit upon examination.

Qualifying Research Activities: The Four-Part Test

To qualify for the R&D tax credit, activities must satisfy the IRS four-part test. All four requirements must be met.

1. Permitted Purpose
   

   The activity must be intended to create new or improve existing functionality, performance, reliability, or quality of a product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or use in its trade or business.

2. Technological in Nature
   The process of experimentation must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. The use of existing technologies and established scientific principles does not disqualify an activity from meeting this requirement.
3. Process of Experimentation
   The taxpayer must engage in a systematic process of trial and error designed to evaluate one or more alternatives. This process must seek to resolve uncertainty related to the capability, method, or appropriate design of the product or process.
4. Elimination of Uncertainty
   At the outset of the research, uncertainty must exist regarding the development or improvement of the product or process. The taxpayer must intend to discover information that would eliminate uncertainty as to the capability, method, or appropriateness of the result.

Benefits from Tax Reform

The Tax Cuts and Jobs Act (“Tax Reform”), enacted on December 22, 2017, significantly enhanced the value of the R&D tax credit for many taxpayers.

Under Tax Reform, net operating loss (NOL) deductions are generally limited to 80% of taxable income, leaving the remaining 20% subject to tax. R&D credits may be used to offset this residual tax liability. In addition, taxpayers subject to certain international taxes—such as GILTI and BEAT—may apply R&D credits against those taxes as well.

Importantly, companies with tax loss carryforwards may perform an R&D study and benefit from previously generated credits without filing amended tax returns, creating a meaningful planning opportunity.

Payroll Tax Offset for Startup Companies

Qualified startup companies with less than $5 million in gross receipts may elect to apply up to $500,000 of R&D credits per year against payroll taxes, rather than income taxes, for up to five years following their first year of gross receipts. This provision allows early-stage companies to monetize R&D credits even before achieving profitability.

State R&D Tax Credits

In addition to the federal R&D tax credit, many states offer valuable credits for conducting research and development activities within their jurisdictions. These credits vary widely by state in terms of eligibility, calculation, and benefit.

A comprehensive R&D credit study should include the identification and calculation of applicable state R&D tax credits, which can significantly enhance the overall benefit.