Key Takeaway
The US federal R&D tax credit cuts tax liability dollar for dollar with no cap. Startups under $5M in revenue can apply up to $500K against payroll taxes instead of waiting for profit. More than 30 states add their own credits, with rates and refundability that vary a lot.
The US R&D tax credit reduces what you owe dollar for dollar, and there’s no federal cap on it. Most companies that qualify either don’t claim it or claim a fraction of what they could.
This article covers who qualifies, which costs count, how the two calculation methods differ, how pre-revenue startups get cash from it, and what each state adds on top.
What is the US R&D tax credit?
A federal incentive under IRC Section 41 that reduces your tax liability in proportion to what you spend on qualified research.
Dollar for dollar matters. A deduction reduces taxable income, so it’s worth your marginal rate. A credit reduces the tax itself, so it’s worth face value.
One wrinkle worth knowing: the Tax Cuts and Jobs Act of 2017 required R&D expenses to be amortized under Section 174 rather than expensed immediately, over five years domestically and 15 years for foreign research. The One Big Beautiful Bill Act later reinstated immediate expensing for domestic research under Section 174A. Foreign research still amortizes over 15 years, which is a real reason to keep R&D onshore.
Who qualifies?
The four-part test
All four have to be true. The IRS applies them per project, not per company.
- Permitted purpose. The work improves a product, process, software, technique or formula.
- Elimination of uncertainty. You didn’t know at the outset whether it would work, or how.
- Process of experimentation. You evaluated alternatives through testing, modelling or simulation.
- Technological in nature. The work relies on engineering, computer science or hard sciences.
The second and third are where claims fail. Building something difficult isn’t enough if the outcome was predictable, and trying one approach isn’t experimentation.
Which industries qualify?
Software, including applications, cybersecurity and AI. Manufacturing, covering production methods, material testing and throughput work. Biotech and life sciences. Engineering and architecture. Aerospace and automotive.
The list is indicative, not exhaustive. Industry doesn’t determine eligibility; the nature of the work does.
Which costs qualify?
Four categories, and wages dominate for most companies.
- Employee wages. Salaries for engineers, developers and technical staff doing, supervising or directly supporting the research.
- Contractor expenses. 65% of what you pay third parties performing qualified research on your behalf.
- Materials and supplies. Anything consumed in prototyping, testing and experimentation.
- Cloud and server costs. Compute used for development, simulation and data testing.
That 65% contractor haircut catches people out. Budget for it when you’re deciding whether to hire or outsource research work.
How much is the credit worth?
Two calculation methods. You pick the one your records support.
Regular Research Credit (RRC): 20% of qualified research expenses above a base amount calculated from gross receipts and historical R&D spending. Worth more, needs years of data.
Alternative Simplified Credit (ASC): 14% of qualified expenses exceeding 50% of your three-year average. With no three-year history, it’s 6% of total qualified expenses.
Most young companies use ASC because they can’t compute the base amount for RRC. Keep records anyway. RRC usually wins once you have the history.
The startup payroll offset
If you have under $5 million in gross receipts and less than five years of revenue history, you can apply up to $500,000 a year against employer payroll taxes instead of income tax.
This is the provision that makes the credit useful before profitability. We cover the mechanics in R&D payroll tax credits for startups.
What do the states add?
More than 30 states run their own credit. Rates, caps, refundability and carryforward vary widely, and the refundable ones matter most if you’re pre-profit.
| State | Rate | Notes |
|---|---|---|
| Arizona | 24% up to $2.5M QREs, 15% above | 75% refundable for small businesses |
| California | 15% over base, 24% university research | Non-refundable, indefinite carryforward |
| Connecticut | 6% small business, 1-6% tiered for larger | 65% refund for qualifying small firms |
| Delaware | 10% of QRE increase, 20-100% small business | Fully refundable |
| Florida | 10% of increased R&D | $9M annual cap, short application window |
| Illinois | 6.5% over base | Non-refundable, 5-year carryforward |
| Indiana | 15% on first $1M increase, 10% above | Sales tax exemption on R&D equipment |
| Louisiana | 30% under 50 employees, 10% at 50-99, 5% at 100+ | Transferable SBIR/SBTT credits |
| Maine | 5% over base, 7.5% basic research | 15-year carryforward |
| Maryland | 10% over base | $12M cap, $3.5M reserved for small business, through June 30 2027 |
| Massachusetts | Capped at $25,000 excise plus 75% of remainder | 15-year carryforward |
| Minnesota | 10% of first $2M, 4% above | 15-year carryforward |
| Missouri | 15% of QRE increase, 20% with university research | 10-year carryforward |
| Nebraska | 15% of federal credit, 35% university research | Refundable |
| New Hampshire | 10% of QRE increase | $7M annual cap, 5-year carryforward |
| New Jersey | 10% of eligible expenses | 7-15 year carryforward |
| New Mexico | 5% of QREs, 10% rural | Extra 5% for payroll increases |
| New York | 15% at 10+ employees, 20% under 10 | Up to $500,000/yr refundable for 3 years |
| North Dakota | 25% of first $100,000, 8% above | 15-year carryforward, transferable for small business |
| Ohio | 7% of net excess QREs | 7-year carryforward, offsets Commercial Activity Tax |
| Pennsylvania | 10% standard, 20% small business | $55M annual cap, 15-year carryforward |
| Rhode Island | 22.5% of first $111,111, 16.9% above | 7-year carryforward |
| South Carolina | 5% of in-state QREs | 50% liability cap, 10-year carryforward |
| Texas | Franchise tax credit or sales tax exemption | Choose one per tax year |
| Utah | 5% over base, 5% basic research, 7.5% current-year | |
| Vermont | 27% of federal credit | 10-year carryforward |
| Virginia | Minor: 15% of first $300,000, refundable | Major: 10% non-refundable |
| Wisconsin | 5.75% of QREs, 2.875% with no prior QREs | Up to 25% refundable, 25-year carryforward |
Colorado, Georgia, Hawaii, Idaho, Iowa, Kansas, Kentucky and Arkansas also offer credits. Rates and windows change, so confirm current figures with the state before you file.
How do you claim it?
Step 1. Identify the qualifying work. Run each project through the four-part test and write down how it meets each part. Do this while the work is happening, not in April.
Step 2. Gather documentation. Payroll records showing who worked on what, supply and contractor payments, and technical records: reports, prototypes, test results, design iterations.
Step 3. File Form 6765. Attach it to your income tax return, using either RRC or ASC.
Step 4. Elect the payroll offset if you qualify. Under $5M in gross receipts and under five years of revenue history. Miss this election and the credit waits until you’re profitable.
How do you get the most out of it?
Track expenses as the work happens. Reconstructed records lose credits at the margin, because the borderline work is exactly what nobody remembers.
Claim state credits alongside the federal one. Companies routinely file federal and forget their state entirely.
Keep documentation organized against IRS expectations, not your own filing habits. And automate the capture, because the manual version is where accuracy goes.
Chrono Platform tracks qualified activity from the tools your engineers already use, organizes the expenses, and produces reports aligned to IRS requirements, including the payroll offset for startups.
Frequently Asked Questions
What is the four-part test?
Your research needs a permitted purpose (improving a product, process or software), must eliminate technical uncertainty, must use a process of experimentation testing alternatives, and must be technological in nature. All four have to hold, per project.
Can startups claim before they’re profitable?
Yes. Under $5 million in gross receipts and fewer than five years of revenue history lets you apply up to $500,000 a year against employer payroll taxes. The credit starts applying the quarter after you file.
Which states offer the best R&D credits?
Arizona (24%, 75% refundable for small business), Louisiana (up to 30% for companies under 50 employees), Delaware (fully refundable), and California (15-24% with indefinite carryforward) are among the most generous. Refundability usually matters more than headline rate if you’re pre-profit.
Is there a cap on the federal credit?
No. The federal credit has no strict limit; it scales with qualified expenses. The $500,000 cap applies only to the payroll tax offset for qualifying small businesses. State caps are separate and listed above.
Filing in Canada too? SR&ED is more generous for small companies: 35% refundable on the first $3 million. See the SR&ED tax credit explained.