R&D Tax Credit 2026: 7 Proven Steps for Small Businesses

The R&D tax credit is one of the most valuable and most underused tax breaks available to US small businesses in 2026. Plenty of owners assume it only covers lab coats and patents. In practice, a software team fixing performance problems or a machine shop redesigning a fixture may qualify.

The rules also changed a lot recently. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, brought back immediate expensing of domestic research costs under new Section 174A. That makes the credit and the deduction work together again, instead of pulling against each other the way they did from 2022 through 2024.

This guide explains the four-part test, which costs count, how to calculate the credit using the Alternative Simplified Credit (ASC), how startups can use it against payroll taxes, and how to document your claim for the new Form 6765 Section G. We finish with worked examples for a software company and a manufacturer.

Table of Contents

• What Is the R&D Tax Credit?
• The Four-Part Test for the R&D Tax Credit
• Qualified Research Expenses: What Counts
• ASC vs Regular Method
• The Payroll Tax Offset for Startups
• Section 174A and Section 280C Interplay
• Documentation That Holds Up
• Form 6765 and Section G
• R&D Tax Credit Examples by Industry
• Common R&D Tax Credit Mistakes
• FAQ
• Conclusion

What Is the R&D Tax Credit?

The R&D tax credit, formally the credit for increasing research activities under Internal Revenue Code Section 41, rewards businesses that spend money developing or improving products, processes, software, formulas, or techniques. It is a credit, not a deduction, so it reduces your tax bill dollar for dollar.

A $10,000 deduction for a corporation at the flat 21% rate saves $2,100 of tax. A $10,000 R&D tax credit saves $10,000.

Who can claim it?

C corporations, S corporations, partnerships, LLCs, and sole proprietors can all generate the credit. For pass-through entities, the credit flows to the owners’ individual returns. If you are unsure how your entity is taxed, our explainer on what an LLC means for taxes is a good starting point.

You do not need to be profitable to benefit. Unused credits can generally be carried forward to future years, and qualified small businesses can use part of the credit against payroll taxes even with zero income tax liability.

Why 2026 is a good year to look at it

Between 2022 and 2024, research costs had to be capitalized and amortized over several years instead of deducted right away. Many small businesses faced higher taxable income just because they did research. OBBBA fixed the domestic side through Section 174A, so claiming the R&D tax credit no longer comes with that painful side effect for domestic work.

The IRS has published an overview of the law changes on its One Big Beautiful Bill provisions page, which is worth bookmarking.

The Four-Part Test for the R&D Tax Credit

Every activity you claim must pass all four parts of the Section 41 test. The test is applied to each “business component,” meaning a product, process, computer software, technique, formula, or invention you hold for sale, lease, license, or use in your business.

1. Permitted purpose (Section 174 test)

The research must aim to create a new or improved business component, specifically improving its function, performance, reliability, or quality. Changes that are purely cosmetic, style-driven, or about marketing do not count.

For example, redesigning an app’s color scheme fails this test. Rebuilding the app’s sync engine so it handles offline data without corruption can pass.

2. Technological in nature

The work must rely on principles of the hard sciences: engineering, physics, chemistry, biology, or computer science. Research grounded in economics, psychology, or market surveys does not qualify for the R&D tax credit.

You do not have to discover a new scientific principle; applying existing principles in a new way is enough.

3. Elimination of uncertainty

At the start of the project, you must have faced uncertainty about the capability to develop the component, the method for developing it, or the appropriate design. If the answer was known or obvious from the outset, the activity likely fails.

A good habit is to write a short problem statement at kickoff that describes what you did not know. That note becomes powerful evidence later.

4. Process of experimentation

Substantially all of the activities must involve evaluating one or more alternatives to resolve the uncertainty. That can include modeling, simulation, prototyping, systematic trial and error, or testing competing designs.

Think of it as the scientific method applied to business problems. Keep records of every iteration, including failures, because they support your R&D tax credit claim.

Activities that are excluded

• Research after commercial production begins (routine quality control, for example).
• Adapting an existing product for a particular customer without technical uncertainty.
• Duplicating or reverse-engineering an existing product.
• Surveys, studies, efficiency surveys, and management functions.
• Research conducted outside the United States.
• Research funded by a customer, grant, or another party where you do not retain substantial rights or bear the financial risk.
• Social sciences, arts, and humanities research.

The funded-research exclusion trips up many consulting and contract firms. If your contract pays you regardless of whether the work succeeds, the client may be the one bearing risk, and your R&D tax credit claim for that project may fail.

Qualified Research Expenses: What Counts

Once you know which activities qualify, you need to measure the qualified research expenses (QREs) tied to them. QREs are the foundation of every R&D tax credit calculation, so getting them right matters more than anything else.

The main categories of QREs

QRE category	What it includes	Common examples
Wages	Taxable W-2 wages for employees who perform, directly supervise, or directly support qualified research	Engineers, developers, lab technicians, first-line supervisors, testers
Supplies	Tangible property used and consumed in the research	Prototype materials, raw materials for test runs, lab consumables
Contract research	A portion of amounts paid to US third parties performing qualified research on your behalf	Outside engineering firms, testing labs, contract developers
Computer use	Amounts paid for the right to use computers in qualified research	Certain cloud hosting and computing costs used for development and testing environments

Wages: usually the biggest piece

For most small businesses, wages make up the bulk of QREs. You include the portion of each employee’s taxable wages that relates to qualified activities. An engineer who spends most of the year on qualifying projects may be included largely in full; a CTO who splits time between strategy and hands-on architecture may be included only in part.

Owner compensation can count too, but only if it is W-2 wages. S corporation owner-employees must already take reasonable compensation, and the qualifying share of that salary can become a QRE. Distributions do not count, and neither does a sole proprietor’s draw.

What does not count as a QRE

• Overhead such as rent, utilities, and general administrative costs.
• Depreciable equipment and property (these go through depreciation instead; see our guide to straight line depreciation).
• Benefits and payroll taxes, which are not treated as wages for this purpose.
• Payments to foreign contractors or for work performed outside the US.
• Costs funded by grants or customers when you do not bear the risk.

A clean chart of accounts makes QRE tracking far easier. If your books lump everything into “salaries” and “contractors,” consider restructuring with the help of our accounting services team before the year closes.

ASC vs Regular Method: Calculating Your R&D Tax Credit

There are two ways to compute the R&D tax credit: the regular research credit and the Alternative Simplified Credit (ASC). The method you choose can change the size of your credit and the amount of paperwork required.

How the ASC works

Under the ASC, your credit equals 14% of current-year QREs that exceed 50% of your average QREs for the prior three tax years. If you had no QREs in any one of those three prior years, the credit is simply 6% of current-year QREs.

The steps look like this:

1. Add up QREs for each of the three prior tax years.
2. Divide by three to get the average.
3. Multiply the average by 50% to get the base.
4. Subtract the base from current-year QREs.
5. Multiply the excess by 14%.

How the regular method works

The regular credit compares current QREs to a base amount built from a historical “fixed-base percentage” and your average gross receipts. Older companies may need data from decades ago, and startups use special start-up rules that adjust over time.

The regular method can produce a larger R&D tax credit for some companies with well-documented history. For most small businesses, gathering that historical data is impractical, so the ASC is the default.

ASC vs regular at a glance

Feature	Alternative Simplified Credit (ASC)	Regular method
Rate	14% of QREs above 50% of the prior 3-year average	Based on QREs above a historical base amount
No prior QREs	6% of current-year QREs	Start-up company rules apply
Data needed	Three prior years of QREs	Historical QREs and gross receipts
Complexity	Lower	Higher
Best for	Most small and mid-sized businesses	Companies with strong historical records and a favorable base

Worked ASC example

Suppose Brightline Analytics, a small software company, reports these QREs:

Year	QREs
2023	$400,000
2024	$500,000
2025	$600,000
2026 (current year)	$800,000

The prior three-year average is $500,000. Half of that is $250,000. Current QREs of $800,000 minus $250,000 equals $550,000 of excess QREs. Multiply by 14% and Brightline’s 2026 R&D tax credit is $77,000 (before any Section 280C adjustment, covered below).

Worked 6% example

Now take Keystone Fabrication, a young manufacturer that had no QREs in 2023 because it had not yet started development. Its 2026 QREs are $300,000. Because one of the three prior years had zero QREs, the ASC rate is 6% of current QREs, giving a credit of $18,000.

The 6% rule looks less generous, but this R&D tax credit still turns $300,000 of development spending into $18,000 of tax savings.

The Payroll Tax Offset for Startups

Early-stage companies often have losses, so an income tax credit may sit unused for years. Congress addressed that with the payroll tax election, which lets a qualified small business (QSB) use the R&D tax credit against payroll taxes instead.

Who is a qualified small business?

For this purpose, a QSB generally has less than $5 million in gross receipts for the current tax year and no gross receipts for any tax year before the five-tax-year period ending with the current year. In plain terms: under $5 million in receipts and no more than 5 years of receipts.

A QSB can elect to apply up to $500,000 per year of its R&D tax credit against the employer’s share of payroll taxes. The election is made on Form 6765 filed with a timely return, including extensions.

How the payroll offset actually works

1. Calculate the credit for the year on Form 6765.
2. Elect the payroll tax portion (up to $500,000) on the form.
3. File the income tax return.
4. Starting with the first calendar quarter that begins after you file the return, claim the credit on your quarterly Form 941 using Form 8974.
5. Any credit not used in that quarter carries to the next quarter.

Timing matters. A calendar-year startup that files its 2026 return in March 2027 can start using its R&D tax credit in the second quarter of 2027; extending pushes the benefit back.

Payroll offset example

Brightline Analytics from the earlier example has $3 million of 2026 gross receipts and has had receipts for four years, so it is a QSB. It is still reinvesting everything and has no income tax liability.

Brightline elects to apply its full $77,000 R&D tax credit against payroll taxes, offsetting employer payroll taxes on Form 941 starting the quarter after it files. That cash stays in the business, which is often worth more to a startup than a carryforward.

Payroll offset planning ties closely to cash flow forecasting. If you want help modeling the quarters, our Virtual CFO service builds this into the monthly forecast.

Section 174A and Section 280C: How the R&D Tax Credit and Deduction Interact

The credit and the deduction for research costs are separate provisions that affect each other. Understanding how they fit together helps you avoid double-counting and pick the best election.

Section 174A: immediate expensing is back

Under OBBBA, domestic research and experimental expenditures are immediately deductible again for tax years beginning after December 31, 2024. Foreign research still must be amortized over 15 years.

Small businesses with average gross receipts of $31 million or less could elect retroactive treatment back to 2022 by amending returns. That election window generally closed around July 2026. If you missed it, talk to an advisor about remaining options.

Taxpayers can also elect to deduct remaining unamortized 2022–2024 domestic research costs over 2025, or spread them over 2025 and 2026. That catch-up deduction can create meaningful savings in the current year.

Section 280C: no double benefit

Section 280C prevents you from getting a full deduction and a full credit on the same dollars. With Section 174A restored, you generally have two choices:

• Reduce the deduction: Take the full R&D tax credit and reduce your Section 174A deduction by the amount of the credit.
• Elect the reduced credit: Keep the full deduction and elect a smaller credit, reduced by the maximum corporate tax rate (21%) for corporations. The election is made on a timely filed original return.

280C example for a C corporation

Brightline is a C corporation with a $77,000 credit and $800,000 of Section 174A domestic research deductions.

Option A, reduce the deduction: Brightline claims the full $77,000 credit and deducts $723,000 ($800,000 minus $77,000). The lost $77,000 of deduction costs $16,170 of tax at 21%, so the net benefit of the credit is $60,830.

Option B, reduced credit election: Brightline keeps the full $800,000 deduction and claims $77,000 × (1 − 0.21) = $60,830 of credit.

For a profitable corporation, both paths often land in the same place. The choice matters more with losses, carryforwards, payroll offsets, or state differences. For pass-throughs, the owner’s bracket drives the R&D tax credit analysis, so model both options.

Documentation That Holds Up

The IRS has been clear that credit claims need support. A spreadsheet of wages multiplied by a guessed percentage will not survive an exam. Good documentation connects each dollar of QREs to a specific qualified activity.

What to keep

• Project records: problem statements, technical specs, design documents, and the uncertainty you faced at the start.
• Experimentation evidence: test plans, prototypes, lab notebooks, simulation results, code commits, bug tickets, and sprint notes.
• Time tracking: hours by employee by project, ideally captured as work happens, not reconstructed a year later.
• Payroll records: W-2 wages for each employee included in QREs.
• Supply invoices: tied to specific projects and tests.
• Contracts: for contract research, showing who bears the risk and who keeps the rights.
• Nexus documentation: a clear link between each activity, the business component, and the costs claimed.

Build it into existing workflows

The best R&D tax credit records come from tools you already use. Developers can tag tickets by project, and engineers can log hours in the job-costing system. Contemporaneous records beat after-the-fact interviews and make Section G far less painful.

Form 6765 and Section G: Reporting Your R&D Tax Credit

You claim the R&D tax credit on IRS Form 6765, Credit for Increasing Research Activities. The IRS redesigned the form, and the biggest change is Section G, which asks for information by business component.

What the redesigned form includes

• Sections for the regular credit and the ASC calculations.
• A section for the qualified small business payroll tax election.
• Questions about the taxpayer’s research activities, such as the number of business components and officer wages included.
• Section G, which collects business component details.

What Section G asks for

Section G asks you to identify business components and report information about each one, such as the type of component, the information you sought to discover, and the QREs broken down by wages, supplies, and contract research. In effect, it turns your documentation into a reportable schedule.

The IRS phased Section G in gradually, allowing optional reporting at first and providing exceptions for certain smaller filers and qualified small businesses making the payroll election. Because these rules have evolved, check the current Form 6765 page on irs.gov and its instructions for the year you are filing.

Refund claims need extra detail

If you claim the credit on an amended return, the IRS requires specific information: the business components, research activities, the individuals who performed them, and the information they sought to discover. Incomplete refund claims are routinely rejected before anyone looks at the merits.

Even if Section G is optional for your filing, preparing the information as though it were required is smart. It shows the IRS you have a disciplined process and protects the R&D tax credit if you are examined.

R&D Tax Credit Examples by Industry

The credit is industry-neutral, but it looks different depending on what you build. Here are two common scenarios.

Software and SaaS companies

Software companies are strong R&D tax credit candidates because development is inherently iterative. Qualifying activities often include:

• Designing new algorithms or data architectures.
• Building integrations where the method or design was uncertain.
• Improving performance, scalability, or security in ways that required experimentation.
• Developing machine-learning models and evaluating alternative approaches.

Activities that usually do not qualify include routine bug fixes after release, cosmetic UI changes, data entry, and configuring off-the-shelf software without technical uncertainty. Internal-use software (such as back-office systems) faces a stricter “high threshold of innovation” test.

Software example: Brightline Analytics has four developers earning a combined $560,000 in W-2 wages, a QA engineer earning $90,000, and a CTO earning $200,000. Time tracking shows developers spent 90% of their time on qualifying work, the QA engineer 80%, and the CTO 40%.

Role	W-2 wages	Qualified %	Wage QREs
Developers (4)	$560,000	90%	$504,000
QA engineer	$90,000	80%	$72,000
CTO	$200,000	40%	$80,000
Cloud computing for dev/test	—	—	$64,000
Contract research (qualifying portion)	—	—	$80,000
Total QREs			$800,000

With $800,000 of QREs and the prior-year history shown earlier, the ASC credit is $77,000. Because Brightline is a QSB, it can use the full amount against payroll taxes.

Manufacturing companies

Manufacturers often do qualifying work without calling it research. Engineers design new products, tweak tooling, and solve production problems every day. Typical qualifying activities include:

• Designing new or improved products, parts, or assemblies.
• Developing new manufacturing processes or improving yield and tolerances.
• Designing custom jigs, fixtures, molds, and tooling.
• Testing new materials or coatings.
• Building and testing prototypes and first articles.

Routine quality control and standard production runs do not qualify.

Manufacturing example: Keystone Fabrication is an S corporation that began development in 2024. It had no QREs in 2023. In 2026, it has $220,000 of qualifying engineer and technician wages (including the qualifying share of the owner’s reasonable compensation), $60,000 of prototype materials, and $20,000 of qualifying outside testing costs.

Total QREs are $300,000. Because Keystone had no QREs in one of the three prior years, its ASC credit is 6% × $300,000 = $18,000. The credit passes through to the owner’s individual return.

Keystone is young, but its gross receipts exceed $5 million, so it cannot use the payroll election. Instead, the owner applies the credit against individual income tax, subject to the general business credit limits. In 2027, once Keystone has three years of QREs, it will move to the 14% ASC calculation.

Other industries that often qualify

• Life sciences and biotech (see our guide on fractional CFO support for biotech startups).
• Engineering and architecture firms, subject to the funded-research rules.
• Food and beverage producers developing new recipes, formulations, or shelf-life improvements.

Common R&D Tax Credit Mistakes

Small errors can shrink your R&D tax credit or invite IRS scrutiny. Watch for these.

1. Assuming you do not qualify

Many owners never claim the R&D tax credit because they think it is only for big tech or pharmaceutical companies. If your team solves technical problems through testing and iteration, run the four-part test before ruling it out.

2. Claiming whole departments

Including every engineer at 100% without time records is a red flag. Use realistic percentages supported by project-level tracking.

3. Ignoring the funded-research exclusion

Fixed-price contracts where you bear the risk of failure may qualify. Time-and-materials contracts where the client pays regardless often do not. Review contract terms before including those costs.

4. Including non-qualifying costs

Rent, utilities, benefits, depreciable equipment, and foreign contractor payments are not QREs. Including them weakens the whole R&D tax credit claim.

5. Missing the payroll election

A QSB must make the payroll tax election on a timely filed return. Filing late or forgetting to check the box can leave cash on the table for a year or more.

6. Overlooking Section 280C

Forgetting to reduce the Section 174A deduction, or failing to make the reduced credit election on an original return, can create an overstatement or a missed planning opportunity.

7. Weak documentation for Section G and refund claims

Reconstructing a year of research from memory rarely works. Track activities as they happen and map costs to business components all year.

8. Forgetting state credits

Many states offer their own research credits with different rules. Your federal R&D tax credit work often supports a state claim with little extra effort.

For a broader list of opportunities beyond the research credit, see our guide on how to save federal tax.

R&D Tax Credit FAQ

Can a company with no profit claim the R&D tax credit?

Yes. Unused credits can generally be carried forward to future years. A qualified small business with under $5 million in gross receipts and no more than 5 years of receipts can also apply up to $500,000 per year against payroll taxes.

What is the ASC rate for 2026?

The ASC equals 14% of current-year QREs above 50% of the average QREs for the prior three years. If you had no QREs in any of those three prior years, the credit is 6% of current-year QREs.

Does the R&D tax credit reduce my Section 174A deduction?

Under Section 280C, you generally either reduce your Section 174A deduction by the credit amount or elect a reduced credit. For corporations, the reduced credit is the full credit reduced by the 21% corporate rate.

Can I claim the credit for prior years?

You can often claim missed credits on amended returns for open tax years. Refund claims must include detailed information about business components, research activities, and personnel, so preparation matters.

Do contractors’ costs count as QREs?

Only a portion of payments to US contractors performing qualified research on your behalf counts, and only if you bear the financial risk and retain substantial rights to the results. Payments for foreign research do not qualify.

Is Form 6765 Section G mandatory?

The IRS phased in Section G, with optional reporting for early years and exceptions for some smaller filers and qualified small businesses. Check the current Form 6765 instructions for the year you are filing, and keep component-level records either way.

Can an S corporation or LLC owner benefit?

Yes. The credit flows through to owners of S corporations, partnerships, and multi-member LLCs. Qualifying W-2 wages paid to S corporation owner-employees can count as QREs, but distributions cannot.

How long should I keep R&D records?

Keep records as long as the return can be examined, and longer if you carry an R&D tax credit forward, because the IRS can review the year the credit arose when you use it later.

Conclusion

The R&D tax credit is a powerful tool for US small businesses that build, test, and improve things. In 2026, with domestic research costs immediately deductible again under Section 174A, the credit is more attractive than it has been in years.

The steps are straightforward: confirm your activities pass the four-part test, measure QREs carefully, choose the ASC unless the regular method clearly wins, consider the payroll election if you are a startup, handle Section 280C, and keep documentation that supports Form 6765 Section G.

Done well, the R&D tax credit rewards innovation you are already doing.

This article is general information and is not tax or legal advice. Tax rules are complex and depend on your specific facts, so consult a qualified CPA or tax advisor before acting. Figures and rules are current as of September 2026.