R&D Tax Credit (Section 41)

The federal R&D Tax Credit under IRC Section 41 rewards businesses for performing qualified research. Software companies, hardware engineers, biotech, and process-innovation businesses are the largest users.

What qualifies

The IRS uses a four-part test:

1. Permitted purpose: developing a new or improved business component (product, process, technique, formula, software, invention)
2. Technological in nature: relying on engineering, computer science, physical or biological sciences
3. Technical uncertainty: at the start, you didn't know whether it would work or how
4. Process of experimentation: testing or evaluating alternatives

Most modern software development passes all four.

The credit calculation

Two methods:

• Regular Research Credit (RRC): 20% of qualifying research expenditures (QREs) above a base amount
• Alternative Simplified Credit (ASC): 14% of QREs above 50% of the average QREs for the prior 3 years

Most early-stage companies use ASC; it's simpler and works when prior years had no R&D.

Qualified Research Expenses (QREs)

Three buckets:

• Wages for employees engaged in qualified research (engineers, technical staff, technical founders)
• Supplies consumed in research (cloud compute used in experiments, materials)
• Contract research at 65% of US-based contractor costs

Payroll-tax offset (early-stage)

Companies less than 5 years old with under $5M in gross receipts can elect to offset payroll tax with the credit. OBBBA raised the ceiling to $500,000 per year (from $250K). For a bootstrapped or seed-stage company spending $400K on engineering payroll, this can mean $40K+ of cash back into the business this quarter.

Documentation

The IRS wants contemporaneous records. The strongest documentation packs include:

• Sprint logs / project trackers (Linear, Jira, GitHub Projects)
• Git commit history with descriptive messages
• Payroll records mapped to projects
• Architecture decision records or design docs
• Incident postmortems (these prove the experimentation step)