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A Guide to the Federal R&D Tax Credit for Technology Companies (2026)

 

The federal research credit under Internal Revenue Code Section 41 is general business credit based primarily on qualified research expenses, or QREs. The regular credit generally equals 20% of current-year QREs that exceed the applicable base amount, with separate rules governing basic-research payments and certain energy-research consortium payments.

The credit is not available simply because a company operates in the technology sector, employs engineers, develops software, or uses artificial intelligence. Eligibility turns on the activities actually performed, the business components involved, the related expenses, and the records maintained to support the claim.

For pass-through entities, the credit is allocated under special rules. An individual owner's usable credit may be limited to the tax attributable to income allocable or apportionable to the relevant trade or business, subject to permitted carryforward treatment.

Qualified Research

The Four-Part Framework

For 2026, research generally qualifies only if:

• The related expenditures are treated as domestic research or experimental expenditures under Section 174A;
• The research seeks information that is technological in nature;
• The information is intended to be useful in developing a new or improved business component; and
• Substantially all of the activities constitute elements of a process of experimentation relating to a qualified purpose.

A qualified purpose concerns a new or improved function, performance, reliability, or quality. Research directed primarily at style, taste, cosmetic design, or seasonal design does not qualify, and these requirements are applied separately to each business component.

"Technological in nature" means the experimentation fundamentally relies on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may rely on existing technologies and established scientific principles; there is no requirement to develop technology that is new to the world, to exceed the common knowledge of skilled professionals, to obtain a patent, or to achieve a successful result. A patent other than a design patent is conclusive evidence of technological information, though a patent is not required to substantiate a claim.

Uncertainty and Experimentation

Uncertainty exists when, at the outset of the research, the available information does not establish the capability or method for developing or improving the business component, or the appropriate design of that component.

A process of experimentation generally requires:

• Identifying the technical uncertainty;
• Identifying one or more alternatives intended to resolve that uncertainty; and
• Evaluating those alternatives through modeling, simulation, systematic trial and error, testing, or another comparable evaluative process.

The process should generally be capable of evaluating more than one alternative. A taxpayer need not test every conceivable alternative, but simply selecting an existing product or adopting a predetermined solution ordinarily does not rise to the level of experimentation.

The regulations treat the "substantially all" requirement as satisfied when at least 80% of the research activities for a business component—measured by cost or another consistently applied, reasonable basis—constitute elements of a qualified process of experimentation. The remaining activities must still satisfy the other statutory requirements and cannot themselves be excluded activities. This is a business-component test, not a general 80% employee-time or wage test, and the distinction matters considerably in practice.

Business Components and the Shrinking-Back Rule

A business component is a product, process, computer software program, technique, formula, or invention held for sale, lease, or license, or used by the taxpayer in its trade or business. A commercial production process may itself be treated as a business component separate from the product it produces.

Where a broad project does not satisfy the requirements as a whole, the shrinking-back rule permits analysis of the most significant qualifying subset—a module, feature, subsystem, algorithm, interface, or other discrete technical process. This analysis continues until a qualifying subset is identified or the most basic element fails the requirements. The shrinking-back rule exists to preserve otherwise qualifying activities within a larger project; it is not itself a basis for excluding them.

Common Exclusions

The credit generally does not apply to:

• Research conducted outside the United States, Puerto Rico, or another U.S. possession;
• Research conducted after a business component is ready for commercial sale or use;
• Customer-specific adaptation of an existing business component;
• Duplication of an existing business component from inspection, plans, blueprints, specifications, or publicly available information;
• Efficiency surveys and management studies;
• Market research, testing, advertising, or promotions;
• Routine data collection;
• Routine or ordinary quality-control testing or inspection;
• Certain internal-use software;
• Research in the social sciences, arts, or humanities; and
• Research funded by another person or governmental entity, to the extent of that funding.

Research directed at a separate new or improved component may still qualify even where the taxpayer already commercially produces an existing version. Likewise, a production-process project may qualify where the process itself satisfies the requirements and has not yet reached commercial readiness. A project may qualify even if the taxpayer does not ultimately succeed in developing the intended component or technology—though that principle does not relax the other requirements or excuse routine, post-production, funded, foreign, or otherwise disqualified activities.

Software, AI, and Qualified Research Expenses

Software and Artificial Intelligence

Software development is evaluated under the same research-credit framework applied to other activities. Potentially qualifying work may include designing and testing alternative algorithms, resolving scalability or reliability uncertainty, developing specialized interfaces, testing alternative data-processing methods, or improving measurable performance through structured experimentation.

The use of artificial intelligence, machine learning, automated coding tools, or existing software does not, by itself, satisfy the requirements. An AI-related project must still identify technical uncertainty, evaluate genuine alternatives, rely fundamentally on qualifying scientific or engineering principles, and seek information useful in developing or improving a business component.

Routine implementation, configuration of standard software, straightforward data migration, ordinary maintenance, and selection among commercially available products generally do not establish a qualifying process of experimentation. Debugging performed during development is not automatically excluded, but the specific work must independently satisfy the research requirements; debugging that occurs after a component is ready for commercial use is generally treated as post-production activity.

Internal-Use Software

Software developed primarily for internal general and administrative functions—financial management, accounting, tax, human resources, legal, or support services—must satisfy both the ordinary research requirements and a high-threshold-of-innovation test.

The taxpayer must generally establish that:

• The software would produce a substantial and economically significant reduction in cost, improvement in speed, or other measurable improvement if successful;
• Development involved significant economic risk, including substantial resource commitments and substantial technical uncertainty regarding recovery of those resources within a reasonable period; and
• Commercially available software could not be used for the intended purpose without modifications that would themselves satisfy the innovation and economic-risk requirements.

Software developed for commercial sale, lease, license, or marketing to third parties is generally not internal-use software, nor is software developed to enable third parties to initiate functions or review data on the taxpayer's system, subject to the facts and circumstances and the relationship between the users and the taxpayer.

Dual-Function Software

Software used both for internal administrative functions and for third-party interaction is presumed to be developed primarily for internal use.

Where the taxpayer can separately identify a third-party subset that only enables third-party interaction, that subset is not treated as internal-use software. Any remaining dual-function subset remains subject to the internal-use rules.

After identifying any third-party subset, the taxpayer may apply a regulatory safe harbor to the remaining dual-function software if:

• The related research qualifies without applying the internal-use-software exclusion; and
• Third-party use is reasonably anticipated to constitute at least 10% of the software's use.

Where these conditions are met, the taxpayer may include 25% of the otherwise qualified research expenses attributable to the remaining dual-function software or subset. An objective and reasonable industry method—such as processing time, data transfer, or user-interface screens—should be used to estimate third-party use.

Employee Wages

In-house research expenses include wages for qualified services, meaning services consisting of:

• Conducting qualified research;
• Directly supervising qualified research; or
• Directly supporting qualified research.

The statute does not establish a general numeric percentage of an employee's working time that must be devoted to research. Where substantially all of an individual's services for the taxpayer during the year are qualified services, all of that individual's services for the year may be treated as qualified services. The 80% rule concerns research activities within a business component—it is not a general employee-wage threshold, and the two should not be conflated.

Job titles, departments, credentials, and seniority do not determine eligibility; the actual services performed, and their connection to qualified research, control the analysis. Wages already used to calculate the work opportunity credit cannot also be treated as qualified research wages.

Supplies

Supplies are tangible property used in qualified research, excluding land, improvements to land, and property subject to depreciation. For technology companies, qualifying supplies may include nondepreciable materials used in prototypes, experimental devices, testing fixtures, engineering models, and other experimental work. Depreciable equipment does not qualify as a supply for this purpose.

Computer and Cloud Costs

Amounts paid for the right to use computers in conducting qualified research may qualify under the applicable rules. The Form 6765 instructions describe the relevant computer rental or lease expense as involving computers located off the taxpayer's premises, where the taxpayer is neither the operator nor the primary user.

Cloud hosting, storage, software-as-a-service subscriptions, and general-purpose computing charges do not qualify simply because they support a technology project. A charge should be considered only where it represents a qualifying right to use computers, the computers are used in conducting qualified research, and the expense can reasonably be connected to eligible activities. Mixed-use charges should be allocated on a reasonable basis, with production and nonqualifying use excluded.

Contract Research

Contract-research expenses generally equal 65% of amounts paid to a nonemployee for qualified research. The applicable percentage rises to 75% for qualifying payments to a qualified research consortium—generally a qualifying tax-exempt organization organized and operated primarily to conduct scientific research that is not a private foundation.

A 100% percentage may apply to payments for qualified energy research performed by an eligible small business, an institution of higher education, or a Federal laboratory. The research must still satisfy the ordinary qualification requirements; the special 100% rule does not apply merely because the contractor falls within one of these categories.

Prepaid contract-research amounts are taken into account during the period in which the qualified research is conducted. Where research is performed partly inside and partly outside eligible U.S. locations, only the portion attributable to research performed in the United States, Puerto Rico, or another U.S. possession may be included, subject to the applicable 65% or 75% limitation.

Sections 174A, 174, and 280C

Domestic and Foreign Research Expenses

For amounts paid or incurred in taxable years beginning after December 31, 2024, Section 174A generally permits the current deduction of domestic research or experimental expenditures.

A taxpayer may instead elect to capitalize domestic research or experimental expenditures and amortize them ratably over a period of at least 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures. The election is generally made by the return due date, including extensions; it applies to the current and subsequent taxable years; and it generally may not be changed without IRS consent.

Treatment under Section 174A does not, by itself, make an activity eligible for the research credit—the activity must separately satisfy the research-credit requirements.

Foreign research remains subject to Section 174. Foreign research expenditures generally must be capitalized and amortized ratably over 15 years, beginning at the midpoint of the taxable year in which the expenditures are incurred. Foreign research remains excluded from the research credit even though the related costs may be amortized for income-tax purposes.

Transition Rules

Taxpayers with unamortized domestic research expenditures incurred during taxable years beginning after December 31, 2021, and before January 1, 2025, may generally elect either to deduct the remaining balance in the first taxable year beginning after December 31, 2024, or to recover it ratably over two taxable years beginning with that year. A taxpayer may also elect to continue amortizing the balance under the prior rules.

A special retroactive election was available to an eligible small business for taxable years beginning after December 31, 2021. Eligibility generally required that the taxpayer not be a prohibited tax shelter and that it satisfy the Section 448(c) gross-receipts test for the first taxable year beginning after December 31, 2024. The cited guidance identifies a $31 million gross-receipts threshold for the first 2025 tax year, subject to the applicable aggregation and Section 448 rules. The election required amended returns or the applicable partnership adjustment procedure.

As of August 12, 2026, the one-year period for making that retroactive election has expired. Any taxpayer evaluating a transition position should also consider applicable accounting-method procedures, statute-of-limitations issues, partnership filing rules, and the required coordination with the reduced-credit election.

Coordination With the Reduced-Credit Election

For taxable years beginning after December 31, 2024, a taxpayer that does not elect the reduced research credit must generally reduce domestic research or experimental expenditures otherwise taken as a deduction or charged to a capital account by the gross research credit allowed.

Alternatively, the taxpayer may elect the reduced credit and avoid reducing the related domestic research deduction or capitalized amount. This election is made on the original timely filed return, including extensions; it generally cannot be made or changed on an amended return, and it is irrevocable for the taxable year.

Taxpayers should model both alternatives carefully. The relevant comparison is not a universal percentage reduction but the interaction among the credit amount, the related research deduction or capitalized amount, taxable income, applicable limitations, and other tax attributes—no single rule of thumb should substitute for the applicable computation.

Credit Computation, Payroll Tax, and 2026 Reporting

Regular and Alternative Simplified Methods

Under the regular method, the base amount generally equals the fixed-base percentage multiplied by the taxpayer's average annual gross receipts for the four taxable years preceding the credit year. The base amount cannot be less than 50% of current-year QREs. Gross receipts are reduced by returns and allowances; for a foreign corporation, only effectively connected gross receipts are included.

Under the alternative simplified method, the credit generally equals 14% of current-year QREs exceeding 50% of the taxpayer's average QREs for the three preceding taxable years. If the taxpayer had no QREs in any of those three years, the credit generally equals 6% of current-year QREs. The election generally applies to the current and succeeding taxable years unless revoked under the applicable procedures.

QREs and gross receipts used in prior periods must be determined consistently with the definitions used for the credit year—a point that becomes especially important when a taxpayer adds new categories of expenses, changes its methodology, acquires or disposes of a business, or expands the scope of its research claim.

Qualified Small Business Payroll-Tax Election

A qualified small business generally is a corporation, including an S corporation, or a partnership that:

• Has less than $5 million of gross receipts for the credit year; and
• Had no gross receipts for any taxable year before the five-taxable-year period ending with the credit year.

For an individual or other noncorporate person, the test considers the aggregate gross receipts from all trades or businesses of that person. The $5 million threshold measures Section 448(c) gross receipts for the credit year—not R&D receipts, receipts from a particular business line, or receipts sourced to a particular state. Predecessors, related entities, short taxable years, and applicable aggregation rules must also be considered, and a tax-exempt organization cannot be a qualified small business for this election.

For taxable years beginning after December 31, 2022, the maximum amount that may generally be specified in the payroll-tax election is $500,000. This is an election ceiling, not an automatic or unrestricted refundable credit. The actual payroll-tax credit portion is the least of:

• The amount specified in the election;
• The research credit otherwise determined; and
• For a taxpayer other than a partnership or S corporation, the applicable business-credit carryforward amount.

Partnerships and S corporations make the election at the entity level, generally on or before the due date, including extensions, of the originally filed income-tax return; the election cannot be made on an amended return.

The election generally cannot be made if the taxpayer, or another person treated as a single taxpayer under the aggregation rules, has already made the election for five or more preceding taxable years. Members of a controlled group are treated as a single taxpayer for eligibility and limitation purposes, although each member may make its own election subject to the allocation rules.

The credit is applied through the employment-tax return procedures. For amounts available beginning in 2023, the credit first reduces the employer share of Social Security tax, generally subject to a $250,000 quarterly limitation, with any permitted remaining amount reducing the employer share of Medicare tax. Unused amounts carry forward under the applicable procedures. The election does not offset employee withholding, the employee share of Social Security or Medicare tax, Federal unemployment tax, or any other employment tax liability.

Form 6765 for Tax Years Beginning in 2026

For a tax year beginning after December 31, 2025, Section G of Form 6765 generally must be completed unless one of the specified exceptions applies. The principal exceptions are:

• The taxpayer is a qualified small business under the payroll-tax rules and checked the box to claim a reduced payroll-tax credit; or
• The taxpayer's total QREs, determined at the controlled-group level, are no more than $1.5 million, its average annual gross receipts for the preceding three tax years are no more than $50 million under the applicable Section 448(c) rules, and it is reporting the credit on an original return.

The $1.5 million figure measures total QREs at the controlled-group level; the $50 million figure measures average annual gross receipts for the prior three tax years, not merely current-year receipts or research-related receipts.

Where Section G is required, the taxpayer generally must report business components representing at least 80% of total QREs or, alternatively, no more than the 50 highest-QRE business components, listed in descending order by QRE amount, with remaining components reported in aggregate. The required reporting generally includes:

• The entity's EIN and principal business activity code;
• A business-component name or consistent identifier;
• The component type;
• The software classification, if applicable;
• Wages for employees conducting, directly supervising, and directly supporting qualified research;
• Supplies;
• Computer rental or lease costs; and
• Applicable contract-research expenses.

The Form 6765 reporting requirement does not change the underlying substantive qualification rules. A taxpayer must still apply the four-part test separately to each business component and retain records sufficient to substantiate the claimed activities and expenses.

Taxpayers using statistical sampling under the applicable revenue procedure must still report the required 80%/Top 50 business components, even where those components were not selected in the sample. The statistical sampling plan must be attached, and filing the form does not constitute IRS acceptance of the sample as adequate substantiation.

For an amended return or administrative adjustment request that adds a research credit or increases a previously reported credit, the taxpayer must follow the applicable valid-claim procedures. The amended filing may require business-component information, including information sought to be discovered for the components covered by the claim.

Documentation and Practical Controls

Taxpayers must retain records in sufficiently usable form and detail to substantiate both eligibility and the amount of the credit. No single type of document is mandatory, but the records should be specific enough to connect the technical work to the claimed expenses.

Useful records may include:

• Project charters and technical requirements;
• Architecture and design documents;
• Engineering specifications;
• Sprint plans and development tickets;
• Source-code repositories and commit histories;
• Test plans, benchmarks, and results;
• Model-training and performance records;
• Payroll and time records;
• Contractor agreements and invoices; and
• Records allocating computer or cloud costs to qualified research.

A defensible file should identify:

• The business component;
• The uncertainty existing at the beginning of the research;
• The alternatives considered;
• The experiments or evaluations performed;
• The scientific or engineering principles applied;
• The personnel involved;
• The research location;
• The research period; and
• The method used to calculate the QREs.

Generic descriptions such as "developed software," "worked on platform," or "improved performance" ordinarily do not explain the technical uncertainty, experimentation, or business-component connection with sufficient specificity. Documentation should distinguish experimental development from implementation, maintenance, customer customization, routine quality control, production support, data migration, and configuration of existing tools.

Conclusion

The research credit can provide a significant federal tax benefit to technology companies, but software, cloud, AI, internal-use, foreign-research, funded-research, and customer-specific activities all require careful classification.

The strongest claims:

• Identify discrete business components;
• Document technical uncertainty at the beginning of the project;
• Show alternatives and evaluative testing;
• Apply the 80% standard at the business-component level;
• Avoid treating 80% as an employee-wage rule; and
• Tie wages, supplies, computer costs, and contractor expenses to qualifying activities.

 

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Disclaimer: This guide is for informational purposes only and does not constitute specific legal or tax advice. Tax rules are complex and individual circumstances vary. Please consult a qualified tax professional for your situation.