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The federal research credit (Internal Revenue Code section 41) rewards spending on developing a new or improved product, process, software or technique, which the tax rules call a business component. It is not limited to labs or tech companies. The question is never the industry; it is what the work was actually trying to do. A manufacturer improving how a part performs, an engineering firm working through a design problem it did not know how to solve, and a software company building a new feature can each fit, while routine production, cosmetic changes and copying an existing design do not. The credit is also not a deduction. It reduces tax directly, and it comes with its own rules, forms and records.
To count as qualified research, the work has to pass four tests, and the IRS applies them to each business component separately. First, it must be domestic research that qualifies as a research expenditure under section 174A. Second, its purpose must be discovering information that is technological in nature, meaning it relies on the physical or biological sciences, engineering or computer science. Third, it must be aimed at developing a new or improved business component, better in function, performance, reliability or quality, not just in style or looks. Fourth, substantially all of the activities must be elements of a process of experimentation: forming ideas, testing alternatives and refining based on the results.
The credit is built on qualified research expenses, or QREs. The IRS instructions for Form 6765 list wages for people engaged in the actual conduct of qualified research, supplies used in it, rent for computers located off the taxpayer's premises, and 65% of what the taxpayer pays outside contractors for qualified research. The statute also reaches people who directly supervise or directly support the research, which is one reason records matter. Costs outside these categories, such as general overhead, are not QREs.
The statute lists kinds of work that do not count even when they look like research. These include research done after commercial production begins, adapting an existing product to a particular customer's need, duplicating an existing business component, surveys and market research, software developed mainly for the company's own internal use (with exceptions), research done outside the United States, research in the social sciences, arts or humanities, and research funded by another party. Work aimed only at style, taste or cosmetic design falls out too.
There are two main methods. The regular credit is 20% of qualified research expenses above a base amount. The alternative simplified credit, or ASC, is 14% of qualified expenses above half of the average of the prior three years, or 6% of qualified expenses if the taxpayer had none in one of those three years. Once the ASC is elected it applies to the current year and all later years, and on an amended return it can be elected only if no research credit was claimed for that year. A taxpayer can also elect a reduced credit (15.8% on the regular method, or 79% of the ASC amount), and that election has to be made on the original, timely filed return. It cannot be made or changed on an amended return.
A qualified small business can apply the credit against its employer payroll tax instead of income tax. The IRS says it first reduces the employer share of Social Security tax, and any remaining credit reduces the employer share of Medicare tax. Under the IRS instructions, that means a corporation (including an S corporation) or partnership with gross receipts under $5 million for the year and no gross receipts in any year before the five-year period ending with the current year. The most it can apply is $500,000 per year, it cannot make the election for a year if it made it for five or more preceding years, and the election must be made by the due date of the original return, including extensions. This option matters for a company with little or no income tax to offset.
Two changes matter for the conversation. First, a 2025 federal tax law added section 174A, which allows an immediate deduction for domestic research and experimental expenditures paid or incurred in tax years beginning after December 31, 2024. Foreign research continues to be capitalized and amortized. Second, Form 6765 gained Section G, which reports research costs by business component. According to the IRS instructions (December 2025), Section G is optional for tax years beginning before 2026 and required for tax years beginning after 2025, with exceptions: it is not required for a qualified small business claiming the reduced payroll tax credit, or for a filer with qualified expenses of $1.5 million or less and average gross receipts of $50 million or less who reports a credit on an original return. For those who must complete it, the instructions say to report "a minimum of 80% of total QREs or a maximum of 50 business components."
The IRS's audit guide for research credit claims says support should be contemporaneous and available for inspection, that a taxpayer must be able to support 100% of the credit claimed unless a valid statistical sample is used, that arbitrary and unsupported allocations should not be accepted, and that project-based accounting links costs to business components. The guide is dated May 2008, so treat it as a statement of examiner expectations, not as current procedure. A good first conversation asks what the client tried to build or improve, what they were unsure how to do, how they tested alternatives, who worked on it and what records exist. It stops short of quoting a dollar figure, because the amount depends on facts and documentation the rep has not seen yet.
The research credit comes down to three things: whether the work meets the four-part test, whether the costs fall in the right categories, and whether the records can show it. Forms, elections and recent law changes all matter, but the first conversation is about what the client actually did. The 2025 changes push the paperwork toward business-component detail, which makes clear, accurate questions at the start more valuable, not less. A team member who can explain this plainly, and who knows when to stop short of a number, is useful both to clients and to the specialists who take the work from there.
In your own words: a client says their team "built a new feature all year." Which of the four tests would you ask about first, which exclusion might apply, and why would you not give them a dollar figure on the first call?
Reading a good explanation feels like understanding it. Usually it isn't the same thing — and you don't find out which one you've got until someone asks you to explain it back.