Understanding the R&D tax credit for startups

By: Mercury
March 14, 2022

The R&D tax credit is the most significant tax credit that the IRS offers to U.S. companies. Qualifying companies can receive up to $250,000 to offset their payroll taxes—and even more if they have income tax liabilities.

However, startups often end up avoiding the tax credit—the process to claim it is arduous and audits are frequent. Countless companies end up leaving hundreds of thousands of dollars on the table each year.

In this article, Mercury simplifies the R&D tax credit, explains the qualifications that the credit requires, and guides you through the process of claiming it.

Key takeaways

• The R&D tax credit is a significant opportunity to save money on your taxes—it’s worth filing for it, if you qualify.
• The R&D tax credit can be complicated. Maintain clear documentation of your expenses. Research qualifications and exceptions thoroughly.
• If you get audited, don’t worry—audits are more common in the R&D tax credit than with other taxes. Keep your books clean and maintain clarity on why you’ve filed for each expense.
• You don’t need to go at it alone. Work with an experienced tax partner who can help you figure out how to claim the R&D tax credit.

What is the R&D credit?

The R&D credit, also known as the research & experimentation (R&E) credit, was created in 1981 to promote scientific research in the U.S. The tax credit can be claimed for qualified research expenses and can add up to $250,000 to offset payroll taxes, and even more if a company has income tax liabilities.

The R&D credit is one of the most complicated credits to claim and document, as well as one of the most likely credits to get audited.

What changed in 2025? Domestic R&E expensing is back (but foreign rules are still tough)

This article focuses on the §41 R&D tax credit (a credit that can reduce payroll tax or income tax). But starting in tax years beginning after December 31, 2024, Congress changed how many companies can deduct research and experimental (R&E) costs under new §174A.

Here’s the practical takeaway:

• Domestic R&E: Under §174A, taxpayers may generally deduct domestic R&E costs immediately (and can alternatively elect to capitalize and amortize them, with a 60-month minimum).
• Foreign R&E: Foreign R&E generally still must be capitalized and amortized over 15 years.

Why this matters for startups

The §41 credit can reduce tax liability, while §174/§174A affects taxable income through deductions. In 2025, founders need to think about both, together.

How §174/§174A deductions interact with the §41 credit (and §280C(c))

Think of it this way:

• §174 / §174A governs whether R&E costs are deducted now or amortized (affects taxable income).
• §41 is the R&D credit itself (affects tax liability).

If you claim the §41 credit, §280C(c) can require a corresponding reduction to the research deduction (or you can elect a reduced credit on Form 6765 to simplify this interaction).

What can I claim R&D tax credits for?

Companies can claim the R&D credit for qualified research expenses, meaning that an expense needs to:

• Solve for an uncertainty
• Involve a hard science
• Develop something new related to your business
• Involve experimentation

There are many topics that don’t fall under these qualifications for an R&D credit, including:

• Research in the social sciences, arts, or humanities
• Research conducted outside of the U.S.
• Land or land improvements
• Research you’re being paid to do (for example, grants)
• Surveys and marketing research
• Research done after you’ve started commercial production
• Adapting or duplicating existing components
• Software intended for internal use only

If your research qualifies, you can claim anything that falls into the following list:

• W-2 taxable wages. You can claim wages for employees and supervisors carrying out your research.
• A portion of contractor research and expenses. Note: Your company needs to retain substantial rights to the results.
• Research payments. You can claim the cost of basic research payments to reputable educational or scientific research organizations.
• Research supplies. Land and land improvements are explicitly excluded, but computers and cloud servers can qualify.

Qualified Research Expenses (QREs): What counts and how much