The Federal R&D Tax Credit for Startups: A Plain-English Guide

What the R&D tax credit is

The federal research and development tax credit, defined in Section 41 of the tax code, rewards companies for spending on qualified research conducted in the United States. It is a dollar-for-dollar credit rather than a deduction, which makes it valuable.

Crucially for startups, the credit is not limited to lab science. Building and improving software, developing new products, and engineering technical solutions can all qualify, which is why many software and technology companies are eligible without realizing it.

The IRS four-part test

To qualify, an activity must pass all four parts of the IRS test. The test is the gate: if an activity meets every part, the associated costs can count toward the credit.

• Permitted purpose: the work aims to create or improve a product, process, software, technique, or formula in function, performance, reliability, or quality.
• Technological in nature: it relies on principles of a hard science such as engineering, computer science, physics, biology, or chemistry.
• Elimination of uncertainty: at the outset you were uncertain about capability, method, or design.
• Process of experimentation: you evaluated alternatives through modeling, simulation, prototyping, or systematic trial and error.

What expenses qualify

Qualified research expenses fall into a few defined buckets. The largest for most startups is wages paid to employees who perform, directly supervise, or directly support qualified research, including a meaningful share of engineering payroll.

Beyond wages, you can include supplies consumed in research, a portion of contract research paid to US-based contractors (generally counted at 65 percent), and certain costs of cloud or rented computing used for research. Foreign contractor work and routine costs like rent and general administrative overhead do not qualify.

• Wages for employees doing, supervising, or supporting research
• Supplies consumed in the research process
• Contract research with US providers, generally at 65 percent
• Cloud and rented computing used for qualified research

The payroll-tax election: up to $500,000 a year

Most early startups owe little or no income tax, so a credit against income tax would sit unused. The payroll-tax election solves this. A qualified small business can elect to apply the credit against its employer payroll taxes instead, turning the credit into real cash even while pre-profit.

A qualified small business is one with less than $5 million in gross receipts in the current year and no gross receipts in any year more than five years before the current year (in practice, under five years of revenue). The maximum applied against payroll tax is $500,000 per year, an amount raised from $250,000 by the Inflation Reduction Act for tax years beginning after December 31, 2022.

The credit first offsets the employer share of Social Security tax (up to $250,000 per quarter) and any remainder offsets the employer share of Medicare tax. The election is made on your income tax return and then claimed on your quarterly payroll filing.

• Eligibility: under $5M current-year gross receipts and under 5 years of revenue
• Cap: up to $500,000 per year against payroll taxes
• Applied first to employer Social Security (up to $250,000 per quarter), then Medicare
• Lets pre-profit companies monetize the credit as cash

Form 6765 and how to claim it

The credit is calculated and claimed on Form 6765, Credit for Increasing Research Activities, filed with your income tax return. The payroll-tax election is made on that same form and must be made on a timely filed return, including extensions, so missing the deadline forfeits the election for that year.

Supporting the claim means documenting which projects and activities met the four-part test and tying qualified expenses to them. Contemporaneous records, such as payroll allocations and project notes, make the credit far easier to defend than reconstructing everything later.

Section 174 and the 2025 OBBBA change

The R&D credit is separate from how you deduct research costs, and the deduction rules just changed. A 2017 law required companies to capitalize and amortize research and experimental costs starting in 2022 rather than deduct them immediately, which raised taxable income for many R&D-heavy startups.

The One Big Beautiful Bill Act, signed July 4, 2025, created Section 174A and restored immediate expensing of domestic research costs for tax years beginning after December 31, 2024. Companies can again fully deduct US-based R&D in the year incurred (with an option to capitalize over at least 60 months if they prefer). Costs for research conducted outside the US still must be amortized over 15 years under Section 174.

The practical takeaway: you can claim the Section 41 credit and, for tax years starting in 2025 and later, again deduct your domestic R&D immediately. The two provisions stack and are worth coordinating with a tax professional.

• Section 174A restores immediate expensing of domestic R&D
• Effective for tax years beginning after December 31, 2024
• Foreign R&D still amortizes over 15 years under Section 174
• The Section 41 credit and the Section 174A deduction are separate and can both apply

How Median handles R&D credits

Median identifies qualifying activity from your books, calculates the credit, and prepares the documentation and Form 6765, then coordinates the payroll-tax election so the credit shows up as cash. Because the books are updated as activity lands rather than in a month-end batch, the wage and expense data behind the claim is accurate from the start.

The R&D credit is offered as an add-on priced on the estimated credit: $5,000 flat under $50,000, and 10 percent of the credit at $50,000 and above, so past that point the cost scales with the value delivered. Tax filing is available as a separate add-on from $1,499 per year.