What Are R&D Tax Credits?

The research and development (R&D) tax credit is a federal tax incentive intended for businesses of all types and sizes to conduct applied R&D within the U.S. that will lead to new, improved, or technologically advanced products, processes, principles, methodologies, or materials. A tax credit can be used to offset income tax liabilities on a dollar-for-dollar basis, thereby lowering your company’s effective tax rate and increasing cash flow. Recently, the criteria for qualifying for R&D tax credits have been redefined and are now more lenient, including a larger group of businesses. In fact, a company may qualify if it has simply invested time, money, and resources toward the advancement and improvement of its products and processes.

The Federal R&D tax credit (Section 41) is a 20% incremental credit on qualified R&D expenses that exceed a base amount or a 14% incremental credit under the alternative simplified credit regime. In addition, many state governments reward taxpayers with income tax credits for increasing R&D spending. In some states, companies may take a credit against their state income or franchise tax equal to a percentage of their qualified R&D expenditures over some base amount (the credit typically can be carried forward or backward for a specified number of years). States generally use the same federal definition of qualified R&D in their tax codes.