# What the R&D tax credit is, and who can use it

> A federal credit for qualified research, usually wages: what it is, the three places it can go, and why a tool reseller doesn't get one.

Source: https://lopifi.com/learn/what-is-the-rd-tax-credit
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**What is the R&D tax credit, and can a startup actually use it?** A federal credit for qualified research, usually wages: what it is, the three places it can go, and why a tool reseller doesn't get one.

The [R&D tax credit](https://lopifi.com/md/glossary/research-credit) is the federal credit for increasing research activities, IRC §41. It pays a company back part of what it spends on [qualified research](https://lopifi.com/md/glossary/qualified-research): mostly the wages of the people doing it. A credit cuts tax dollar for dollar. A deduction only lowers the income the tax is figured on, so at the 21% corporate rate a dollar of credit is worth about 5 dollars of deduction.

The catch for a startup is that it usually owes no income tax. It loses money, so it has a [net operating loss](https://lopifi.com/md/glossary/net-operating-loss) and nothing for an income tax credit to cut. That leaves three places the credit can go.

Research (Wages, supplies and contract research on qualified work.) → Credit figured (Form 6765, with the income tax return.) → Payroll election (A qualified small business can take it against payroll tax.) → Income tax or carryforward (Whatever is left: against income tax now, or carried.)

Where a research credit goes, in the order a founder should think about it.

**Against income tax**
- Pro: No election and no five-year window
- Pro: Used on the same return that figures it
- Con: Needs income tax to offset, which most startups don't have
- Best for: A company with taxable income

**Payroll election**
- Pro: Turns the credit into cash this year, as lower payroll tax
- Pro: Doesn't need taxable income
- Con: Only for a qualified small business: under $5,000,000 of gross receipts and none more than 5 years back
- Con: Up to $500,000 a year, for at most 5 years
- Con: Only on a timely filed original return; it starts the quarter after the return is filed
- Best for: A young company with little revenue and a payroll

**Carry it forward**
- Pro: Unused credit carries back one year and forward twenty
- Pro: Nothing to elect
- Con: Worth nothing until there's income tax to offset
- Con: An ownership change can limit carryforwards later
- Best for: A company that expects to be profitable

The three ways to use the credit.

— [IRC §39(a)(1)](https://www.law.cornell.edu/uscode/text/26/39), Unused business credits: carried back 1 year and forward 20

## Northwind, honestly

**Northwind — Reselling tools isn't research.** Northwind buys tools from suppliers and sells them on. It develops no product, process or software, so it has no [business component](https://lopifi.com/md/glossary/business-component) for research to be about. Choosing which tools to stock is market research, which the Code excludes by name. A reseller's September is worth no research credit at all, and pretending otherwise is how a credit gets disallowed.

**Scenario — Hypothetical: Northwind builds StockMatch.** So the rest of this track is a hypothetical. In 2027 Northwind starts building StockMatch: software that reads a supplier's part numbers and matches them to a reseller's catalog, which Northwind plans to license to other tool resellers. Nobody knows at the start whether a matching model can be accurate enough on messy supplier data. That uncertainty, worked through by engineers, is what the credit pays for.

*[Figure: rd credit]*

StockMatch, 2027: Northwind's hypothetical qualified research expenses, the credit, and the payroll tax it can be poured against.

Lesson by lesson, the track works that year through: [which work qualifies](https://lopifi.com/md/learn/four-part-test-qualified-research), [which costs count](https://lopifi.com/md/learn/what-counts-as-qualified-research-expenses) ($251,700 of them), [how the credit is computed](https://lopifi.com/md/learn/how-to-calculate-the-rd-credit) ($15,102), [how it comes back through payroll](https://lopifi.com/md/learn/rd-credit-against-payroll-tax) in 2 quarters, [what Form 6765 asks for](https://lopifi.com/md/learn/how-to-fill-out-form-6765), [how Section 174A treats the same costs](https://lopifi.com/md/learn/section-174a-and-the-rd-credit), [the records it stands on](https://lopifi.com/md/learn/rd-credit-documentation-and-refund-claims) and [how it sits on the books](https://lopifi.com/md/learn/accounting-for-the-rd-tax-credit).

> **For a startup the research credit is usually worth most against payroll tax, because there is no income tax for it to cut.**

## Where this lesson's rules come from

- [Wikipedia, “Research & Experimentation Tax Credit”](https://en.wikipedia.org/wiki/Research_%26_Experimentation_Tax_Credit) — The credit's history, from the Economic Recovery Tax Act of 1981 to the PATH Act (reference)
- [IRC §39(a)(1)](https://www.law.cornell.edu/uscode/text/26/39) — Unused business credits: carried back 1 year and forward 20 (statute)
- [IRC §41(d)(4)(A)](https://www.law.cornell.edu/uscode/text/26/41) — Activities for which the credit is not allowed (statute)
- [IRS, Qualified small business payroll tax credit for increasing research activities](https://www.irs.gov/businesses/small-businesses-self-employed/qualified-small-business-payroll-tax-credit-for-increasing-research-activities) — The payroll election must be on a timely filed original return (irs)

## Read further

- https://lopifi.com/md/startups/rd-tax-credit-and-section-174
- https://lopifi.com/md/accounting/rd-tax-credit
- https://lopifi.com/md/accounting/section-174
- https://lopifi.com/md/accounting/form-1120

- **Track:** [R&D tax credit](https://lopifi.com/md/learn/rd-credit)
- **Lesson:** Lesson 1 of 9 — 8 min
- **Terms taught:** [Research credit](https://lopifi.com/md/glossary/research-credit), [Qualified research](https://lopifi.com/md/glossary/qualified-research), [Business component](https://lopifi.com/md/glossary/business-component), [Net operating loss](https://lopifi.com/md/glossary/net-operating-loss), [Payroll tax offset](https://lopifi.com/md/glossary/payroll-tax-offset)
- **Previous:** [Accounting for employee benefits, Benefits · Lesson 10](https://lopifi.com/md/learn/accounting-for-employee-benefits)
- **Next:** [The four-part test: what counts as qualified research, R&D credit · Lesson 2](https://lopifi.com/md/learn/four-part-test-qualified-research)
- **The course:** https://lopifi.com/md/learn