Research and Development Expenses: Expensing, Section 41 Credit

Businesses can recover the cost of research and development through two separate federal tax benefits, and the rules for both apply in 2026: a full deduction for domestic R&D expenses in the year they are incurred under Section 174A, and a Section 41 credit that directly reduces the tax owed on top of that deduction. Understanding research and development expenses, deductions, and credits comes down to three questions: does the work qualify, how are the dollars written off, and how much of a credit sits on top.

What Counts as Qualified Research

Before any spending can support a deduction or a credit, the underlying activity has to clear a four-part test, applied separately to each product, process, software project, or component.¹

The work must aim to create or improve the function, performance, reliability, or quality of a product, process, software, technique, formula, or invention intended for commercial use. Cosmetic changes don’t count.
At the start of the project, there must be genuine uncertainty about whether the result can be achieved, how to achieve it, or what the right design looks like.
The team must systematically evaluate alternatives through modeling, simulation, prototyping, or trial and error.
The experimentation must rely on principles of physical science, biological science, engineering, or computer science. Social sciences, arts, and humanities are out.

Activities the Statute Excludes

Some work looks technical but falls outside the definition of qualified research by statute.² Testing and refinement after a product enters commercial production do not qualify. Adapting an existing product to one customer’s specifications is customization, not research. Reverse engineering is out. So are surveys, market and efficiency studies, management techniques, routine quality control, and advertising work. Research performed outside the United States, Puerto Rico, or U.S. possessions cannot generate the credit, though it may still be deductible under different amortization rules. Research funded by another party through a grant or contract cannot be claimed by the party performing the work.

Which Expenses Qualify

Once an activity passes the four-part test, the spending on that activity falls into a few recognized buckets.

Employee Wages

Wages are usually the largest bucket. For credit purposes, “wages” means the taxable compensation in Box 1 of an employee’s W-2, including salary, bonuses, and stock option exercises, but not nontaxable fringe benefits.³ Only the portion of an employee’s time spent directly performing, supervising, or supporting qualified research counts, which puts a premium on accurate time tracking.

Supplies

Materials consumed during research qualify as supplies, provided they are not depreciable property. Prototype components, chemicals used in testing, and raw materials destroyed in experiments all count. General utility costs like routine lighting do not, but extraordinary energy costs tied to specific research equipment can qualify if the business can document the link.⁴

Contract Research

When a business hires outside contractors to perform qualified research, only 65% of the amount paid counts as a qualifying expense.² Cloud computing and computer rental costs used in the course of research also fall within qualifying expenses.

Software Development

Under Section 174, any amount paid to develop software must be treated as a research expenditure, whether the software is for internal use or for sale.⁵ Qualifying activities include planning and requirements documentation, architecture design, modeling, writing and converting source code, and testing through the point the software is placed in service (for internal tools) or reaches technological feasibility (for commercial products). Upgrades that add new functionality or meaningfully improve speed or efficiency also qualify. Employee training, post-launch bug fixes and routine maintenance, data conversion, and installation do not. The line falls at the moment the software goes live or reaches commercial readiness; costs after that are operational.

One caveat for the credit: software built primarily for the company’s own use must clear an additional high threshold of innovation test under Section 41, which is where many internal-tool credit claims fail. Customer-facing software developed for sale has a cleaner path.

Deducting R&D Expenses in 2026

The rules for writing off research costs shifted sharply in recent years, and where the work happens now determines everything.

Domestic Research: Full Immediate Expensing

The 2017 Tax Cuts and Jobs Act had required businesses to capitalize and amortize research costs over five years for domestic work and fifteen for foreign work starting in 2022. In mid-2025, Congress reversed that requirement for domestic research. New Section 174A, enacted as part of the One Big Beautiful Bill Act (P.L. 119-21), permanently restores immediate expensing for domestic research expenditures in tax years beginning after December 31, 2024. For any 2026 tax year, U.S.-based research spending is fully deductible in the year incurred.

Foreign Research: 15-Year Amortization

Research performed outside the United States still must be capitalized and amortized over fifteen years, starting at the midpoint of the tax year the expense is incurred.⁶ If a project involving foreign research is abandoned or the related property is disposed of before the fifteen-year period ends, the remaining deduction cannot be accelerated; amortization continues on the original schedule.

Catch-Up for 2022 Through 2024

Businesses that were forced to capitalize domestic research during the 2022 through 2024 tax years can recover the remaining unamortized balance under the 2025 legislation. The full catch-up deduction can be taken in the first tax year beginning after December 31, 2024, or spread evenly over 2025 and 2026. For companies that capitalized significant amounts during those three years, this is a one-time item worth modeling carefully before filing.

The Section 41 Credit

The deduction reduces taxable income; the credit reduces tax owed dollar for dollar. They stack, but they have to be coordinated on the return.

Two Calculation Methods

The regular credit equals 20% of the amount by which current-year qualified research expenses exceed a historically derived base amount, which can never be less than 50% of current-year expenses.² The fixed-base percentage relies on data going back to 1984, which makes this method impractical for most newer businesses.

Most businesses use the Alternative Simplified Credit instead: 14% of the amount by which current-year qualified research expenses exceed 50% of the average of the prior three years. If any of those three prior years had no qualifying expenses, the rate drops to 6% of current-year expenses. The ASC election applies to the current year and forward, and it cannot be revoked without IRS consent.

The Section 280C Reduced Credit Election

Here is a trap that catches first-time claimants. By default, claiming the R&D credit requires reducing the Section 174 deduction by the amount of the credit, so the same dollars cannot generate both benefits at full strength. The alternative is to elect a reduced credit under Section 280C: the credit is cut by the corporate tax rate (currently 21%), and the full research deduction stays intact.⁷ For most businesses, the reduced credit combined with a full deduction produces a better net result. The election is made on Form 6765 and is irrevocable for that tax year.⁸

Payroll Tax Credit for Startups

Early-stage companies without enough income tax liability to use the credit can apply it against payroll taxes instead. A qualified small business must have gross receipts under $5 million for the current year and no gross receipts for any tax year before the five-year period ending with the current year.² Sole proprietors and partnerships can qualify under the same thresholds.

The maximum payroll tax credit is $500,000 per year. It first offsets the employer’s share of Social Security tax (up to $250,000 per quarter), then any remainder reduces the employer’s share of Medicare tax, with any leftover carrying to the next quarter.⁹ The election is made on Form 6765 with the income tax return, and the credit is then claimed on payroll tax filings using Form 8974.¹⁰

Sequence matters. Form 8974 cannot be filed until after the income tax return containing the Form 6765 election is filed, and the credit first becomes available on the quarterly payroll return for the quarter that begins after that income tax filing. Miss that order and the credit slides an extra quarter.

Documentation

R&D claims live or die on documentation. The IRS will not accept a general assertion that spending was research-related; contemporaneous records have to link dollars to specific technical work.

Project-level records should describe the technical uncertainty at the outset, the alternatives considered, the experiments run, and the results. “Improved our software platform” is not enough. The records need to show what specific technical problem was unsolved and how the team tried to solve it.

Payroll records must tie individual employees to specific projects and show the percentage of time spent on qualifying work versus other duties. Supply invoices should be linked to the project that consumed them. Contracts with outside researchers should describe the scope of qualified work and the financial terms. Organizing files by project rather than by expense category makes those links far easier to demonstrate under audit. Companies that wait until filing season to reconstruct their research history routinely leave money on the table because they cannot substantiate expenses they actually incurred.

Which Forms to File

Several forms carry the pieces of the R&D picture onto the return.

Form 6765 calculates and claims the research credit, including the choice between the regular and simplified methods, the Section 280C reduced credit election, and the small business payroll tax credit election.¹¹
Form 4562 reports amortization of foreign research expenditures subject to the 15-year period. Domestic research deducted immediately under Section 174A does not require this form.¹²
Form 8974 attaches to the quarterly or annual payroll tax return (Form 941, 943, or 944) to claim the small business payroll tax credit.¹⁰

These forms travel with the primary business return: Form 1120 for corporations, Form 1065 for partnerships, or the applicable return for other entity types.¹³ Filing follows the standard deadline for the entity type, generally the fifteenth day of the third or fourth month after the tax year ends. Keep the underlying calculations, time-tracking records, and project documentation for at least three years after filing, and longer where practical, because R&D credits are a common audit target.

State Credits

Most states offer their own research credit on top of the federal one. Rates commonly run from roughly 6.5% to 15% of qualifying expenses, and states differ on whether they follow the federal definition of qualified research, on which expenses they include, and on whether the credit is refundable or transferable. Businesses conducting research in multiple states should evaluate each program on its own terms rather than assuming the federal treatment carries over.

1
Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities – Qualified Research Activities
2
Office of the Law Revision Counsel. 26 USC 41 – Credit for Increasing Research Activities
3
Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities – Qualified Research Expenses
4
eCFR. 26 CFR 1.41-2 – Qualified Research Expenses
5
Internal Revenue Service. Notice 2023-63 – Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
6
Office of the Law Revision Counsel. 26 USC 174 – Amortization of Research and Experimental Expenditures
7
Office of the Law Revision Counsel. 26 USC 280C – Certain Expenses for Which Credits Are Allowable
8
Internal Revenue Service. Instructions for Form 6765 – Credit for Increasing Research Activities
9
Internal Revenue Service. Qualified Small Business Payroll Tax Credit for Increasing Research Activities
10
Internal Revenue Service. Instructions for Form 8974
11
Internal Revenue Service. About Form 6765 – Credit for Increasing Research Activities
12
Internal Revenue Service. Instructions for Form 4562
13
Internal Revenue Service. Instructions for Form 1120