Overview · 3 min read
R&D credit for startups
The research credit rewards spending on developing new or improved products, software and processes. Early-stage companies with little income tax can apply part of it against payroll taxes instead, which turns it into cash.
- Who it fits
- Software and hardware startups paying people to build new products.
- Figures
- 2026 tax year
The key rule
Qualified small businesses (under $5 million in gross receipts and no receipts more than five years back) can apply up to $500,000 a year of the credit against payroll taxes.
How it works
Work generally qualifies when it passes four tests:
- It aims to create or improve a product, process or software.
- It involves technical uncertainty about how to do it.
- It uses a process of experimentation, such as testing designs or approaches.
- It relies on engineering, computer science or physical sciences.
5 steps
Identify qualifying work
Engineers, product and data people building something technically uncertain. Wages, contractor costs (generally 65%) and cloud computing used in development can count.
Document as you go
Project lists, tickets and time estimates by person make the study much easier.
Claim on the return
The credit is calculated on Form 6765, and the payroll election is made on a timely filed original return.
Use the payroll offset
After filing, the credit is applied on your quarterly payroll returns starting the next quarter.
Deduct the research costs
Starting with 2025, domestic research costs can again be deducted right away rather than spread over five years. Smaller companies may be able to apply this to 2022 to 2024 as well.
Example
A seed-stage startup
Your company has $1.2 million of revenue and pays $900,000 of engineering wages, about 70% of it on qualifying development. The credit might be roughly $50,000 to $70,000. With no income tax to offset, it is applied against the employer's Social Security tax on payroll over the next quarters, which is real cash back.
Common mistakes
- Claims need real documentation. Be cautious of providers who promise a percentage of payroll without asking about your projects.
- Counting routine work, such as bug fixes after release, cosmetic changes or sales support.
- Missing the payroll election, which must be made on an original, timely filed return.
Key dates
- Business filing deadline
- Credit and payroll election made on the return.
- Following quarter
- Payroll offset begins on Form 941.
Questions we hear
Do contractors count?
Generally 65% of what you pay US contractors for qualified research counts, if you keep the rights to the results and bear the financial risk.
Does foreign development count?
No. Only research done in the United States qualifies for the credit, and foreign research costs are still spread over 15 years.
General education for TaxSquad clients, not advice for your situation. Rules and figures change. Talk to us before acting on this guide.