If your business builds, improves, or figures things out for a living, the tax code will help pay for it. The federal research credit puts real dollars back for work you may already be doing, and Texas now layers one of the most generous state credits in the country on top. Here is how it works, in plain English.
Let’s Talk!A deduction lowers the income you pay tax on. A credit lowers the tax itself, dollar for dollar, which makes it one of the most valuable line items in the entire code. The federal research credit rewards businesses for trying to make something new or better: a product, a process, software, a technique, or a formula.
The name throws people off. You do not need a laboratory or a patent portfolio. Software teams shipping new features, manufacturers refining a production process, medical device and product companies iterating on designs, and engineering shops solving problems that did not have an answer yet are all doing what this credit was written for. Most owners underestimate what counts, which is exactly why so much of it goes unclaimed.
The work aims at a new or improved product, process, software, technique, or formula: better function, performance, reliability, or quality. Improving your own operations counts; it does not have to be new to the world.
The work relies on engineering, computer science, or the physical or biological sciences. Writing code, designing circuits, and testing materials all clear this bar comfortably.
When you began, you did not know whether it would work, how to build it, or what the right design was. If the answer was already sitting in a manual, it is not research.
You tested, modeled, prototyped, and iterated your way to the answer. Failed attempts count. In an exam, failure is often the best evidence you were actually experimenting.
Four buckets of spending feed the credit. First, W-2 wages for people doing the research, directly supervising it, or directly supporting it. Second, supplies consumed in development and testing, like prototype materials. Third, amounts paid to U.S. contractors for research, counted at 65 cents on the dollar. Fourth, cloud and computing costs used for development and testing.
What does not count matters just as much: research performed outside the U.S., work a customer fully funds and bears the risk on, routine data collection, market research, and cosmetic changes. Honest scoping up front is what keeps a credit defensible.
A Worked Example
A software company has $300,000 of qualified wages, $20,000 of testing supplies, $80,000 paid to U.S. contract developers (counted at 65 percent), and $28,000 of development cloud costs: $400,000 of qualified research expenses. With average R&D spending of $300,000 over the prior three years, the federal credit comes to about $27,650 after the standard reduced-credit election, and the new Texas credit adds roughly $21,805. That is about $49,000 back, roughly 12 cents of every R&D dollar, every year the work continues.
From 2022 through 2024, businesses were forced to spread their U.S. research deductions over five years, a painful cash-flow rule that caught many owners off guard. The 2025 tax law ended it. Starting with 2025 returns, domestic research costs are fully deductible again in the year you spend them, and businesses that were forced to spread out 2022 to 2024 research costs had options to recover the remaining balance faster. If that applies to you, it is worth confirming how your remaining balance was handled. Research performed outside the U.S. still spreads over 15 years.
Texas rewrote its research credit effective for franchise tax reports due on or after January 1, 2026. The rate jumped from 5 percent to 8.722 percent of qualifying Texas research spending over a base amount, and to 10.903 percent for research done with a Texas university. The definition now ties directly to your federal Form 6765 for work performed in Texas, which simplifies the paperwork considerably. The credit offsets up to half of your franchise tax with a 20-year carryforward, and here is the part built for small companies: if your revenue is under the no-tax-due threshold ($2.65 million for 2026 reports), the credit is refundable in cash even though you owe no franchise tax at all. The old sales-tax exemption on R&D equipment is repealed, so the credit is now the whole game in Texas. One deadline worth knowing: the Texas credit forms must be filed by November 15 of the report year, and late forms are not accepted.
A startup with under $5 million in revenue this year, and whose first revenue arrived within the last five years, can apply up to $500,000 of the federal credit per year against payroll taxes instead of income tax. That turns the credit into cash flow long before profitability, quarter by quarter. One catch that bites people: the election only exists on a timely filed original return. Miss it there and that year is gone.
The credit is claimed on Form 6765 with your return, and the IRS has been raising the bar on substantiation. Starting with 2026 tax years, most claimants must itemize their research project by project on the form itself, though startups using the payroll offset and smaller claims are exempt. The habits that make a claim hold up are simple: track who works on what, keep design notes and test results as you go, and make the key elections on the original return. We scope what qualifies, build the numbers, document each project, and file it like it will be examined, because occasionally one is.
Most owners underestimate what counts. A thirty minute conversation usually settles it.
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