The Research and Development (R&D) Tax Credit remains a valuable tool for businesses investing in innovation. While it’s not a new incentive, recent changes, especially the One Big Beautiful Bill Act (OBBBA) and updates to IRS Form 6765 make claiming the credit more complex, yet potentially more rewarding. These adjustments allow for full expense deductions and require more detailed project information to substantiate claims.
Here’s a streamlined overview of the key changes and how to prepare for them in 2025.
How to Qualify for the R&D Tax Credit
To qualify for the R&D tax credit, businesses must meet a four-part test:
- Permitted Purpose: Developing new or improved products, processes, or software.
- Eliminating Technical Uncertainty: Addressing unknowns in capability, methodology, or design.
- Process of Experimentation: Engaging in iterative testing or experimentation.
- Technological Nature: Involving fields like engineering, computer science, or chemistry.
Additionally, the research must be conducted in the U.S., and companies must bear the financial risk of the project.
Eligible Costs
Eligible expenses include wages, supplies, contract research, and cloud computing services. However, certain costs like those in social sciences or post-commercial production, are excluded.
The Financial Benefit
The R&D tax credit typically offers a 10% to 12% benefit of qualified research expenses. Unlike tax deductions that only reduce taxable income, the credit directly reduces your tax liability dollar-for-dollar.
Key Benefits for Startups
Since 2016, startups with under $5 million in revenue have been able to apply up to $250,000 of R&D credits to offset Social Security payroll taxes. Starting in 2023, this limit increased to $500,000, and now, credits can offset both Social Security and Medicare taxes. This change provides a significant cash flow boost for early-stage businesses.
Major Changes: IRS Form 6765 Updates
In December 2024, the IRS proposed changes to Form 6765, which claims the R&D tax credit. The new form will require businesses to provide more detailed project data, including:
- A list of qualifying projects and expenses.
- Descriptions of technical uncertainties addressed and alternatives considered.
These updates will be optional for 2025 filings but required for 2026, so businesses should start tracking their R&D projects and expenses now to ensure compliance.
Documentation Best Practices
With increased scrutiny, maintaining proper documentation is crucial. Key practices include:
- Track technical uncertainties and experimentation processes.
- Document employee time and allocate it to specific R&D projects.
These steps are critical for both compliance and defending your claim during an audit.
State-Level R&D Tax Credit Developments
Several states are enhancing their R&D tax credit programs:
- Michigan: Introduced a new credit with a $200,000 bonus for collaborations with universities.
- Missouri: Launched a credit targeting minority-owned, women-led, and startup businesses.
- Texas: Replaced its R&D equipment sales tax exemption with a performance-based franchise tax credit.
- Connecticut: As of mid-2025, Connecticut expanded its R&D (and R&E) tax credit program. Under the new law, single-member LLCs may qualify (if they meet certain criteria), and for small biotech companies the refundability of unused credits was increased to 90%.
- Iowa: In June 2025 Iowa replaced its long-standing Research Activities Credit with a more targeted R&D Tax Credit program, effective for tax years beginning January 1, 2026. The new program narrows eligibility to specific industries (advanced manufacturing, bioscience, technology/innovation, etc.), introduces a credit rate up to 3.5% of qualifying in-state research expenditures, and limits the overall annual credit pool to $40 million.
- Minnesota: Recently modified its R&D credit to make it partially refundable: 19.2% for 2025, with a planned increase to 25% for tax years 2026–2027.
These state-level incentives can provide additional support for innovation.
Section 174: New Relief for R&D Expenses
The Tax Cuts and Jobs Act (TCJA) had required businesses to capitalize and amortize R&D expenses, but OBBBA introduces Section 174A, which restores the ability to fully expense domestic R&D costs starting in 2025. This change offers flexibility, allowing businesses to either deduct expenses immediately or amortize them over 5 years. Foreign R&D expenses will still be subject to 15-year amortization.
Small businesses with average gross receipts under $31 million from 2022-2024 can apply the new rules retroactively, potentially unlocking refunds for prior years.
How Align Tax Consulting Can Help
Align’s dedicated R&D team helps businesses maximize their R&D tax credit opportunities. Whether you need guidance on new form requirements or assistance with documenting your R&D activities, we can provide expert support tailored to your needs.
Contact us to learn how we can help you navigate the latest changes and optimize your R&D tax credit claims.
