Most manufacturers we talk to have decided one of two things about the research credit: that it is for laboratories and software companies and not for them, or that their accountant would have mentioned it. Both are usually wrong. The credit under Section 41 is a credit for solving technical problems, and a shop that redesigns a fixture to hold a tolerance, or reformulates a coating because the old supplier stopped making it, is doing exactly that.
What follows is the qualifying test, the costs that count, the exclusions that catch manufacturers specifically, and what the record has to look like.
The four-part test
An activity qualifies only if all four are true of it:
- Permitted purpose. The work is intended to improve the function, performance, reliability, or quality of a product or a process. Process counts — a better way of making the same part qualifies.
- Technological in nature. It relies on engineering, physics, chemistry, biology, or computer science. Not aesthetics, not market fit.
- Elimination of uncertainty. At the outset you did not know whether it could be done, how to do it, or what the right design was.
- Process of experimentation. You evaluated alternatives — modelled, prototyped, tested, iterated. A single idea that worked first time is a weak claim.
The test is applied activity by activity, not company-wide. A production run is not research; the tooling trials that preceded it may well be.
What costs count
Qualified research expenses are narrower than most people expect, and they are the only thing the credit is computed on:
- Wages paid to people performing, directly supervising, or directly supporting qualified research — the taxable wages figure, for the portion of their time actually spent on it.
- Supplies consumed in the process. Prototype material, scrapped test runs, trial lots. Not capital equipment, and not general overhead.
- Contract research, at 65 percent of the amount paid, where the work is done on your behalf and you bear the risk.
- Rental or lease of computers used in qualified research, which in practice usually means cloud compute.
The exclusions that catch manufacturers
Three of the statutory exclusions do most of the work in a manufacturing setting:
- Research after commercial production. Once the process is in production, routine refinement and quality control fall out. The line is when the product or process meets the functional requirements it was designed to, not when the first unit ships.
- Adaptation to a particular customer’s requirement. Making a standard part to a customer’s dimensions is adaptation, not research — even when the engineering is real.
- Funded research. This is the big one for contract manufacturers. If the customer pays regardless of success and owns the resulting rights, the research is funded and does not qualify. If you are on a fixed price, bear the economic risk of failure, and retain substantial rights to what you develop, it can. Which of those two you are in is a question about the contract, and the answer is often not what the parties assumed when they signed it.
Contract terms decide this, not engineering effort. Two shops can do identical work on the same part and only one of them has a credit. Where R&D is a meaningful part of the business, the risk-and-rights language belongs in the negotiation, not in the tax return eighteen months later.
Deduction treatment, which changed and changed back
Separate from the credit, Section 174 governs whether research costs are deducted now or amortised. For tax years beginning after December 31, 2021, the Tax Cuts and Jobs Act required domestic research expenditures to be capitalised and amortised over five years — a cash-flow shock for companies whose spending had always been immediately deductible. Legislation enacted in 2025 restored immediate expensing for domestic research for tax years beginning after December 31, 2024, with transition relief available to smaller businesses for the years in between. Foreign research remains on a fifteen-year amortisation.
If you capitalised research costs in 2022, 2023, or 2024, there is a question worth asking about whether the relief applies to you and how it is claimed. It is not automatic.
The payroll tax election, for companies with no tax liability
A qualified small business — broadly, gross receipts under $5 million for the year and no gross receipts more than five years before it — can elect to apply part of the credit against the employer share of payroll taxes rather than income tax. That matters for a company that is investing and not yet profitable, because it converts a credit it cannot use into cash it can. The election is made on the originally filed return. Miss it and it is gone for that year.
What the documentation has to look like
The credit is a facts case, and the facts have to have been recorded at the time. What holds up is unglamorous: a list of projects with the technical uncertainty stated in a sentence, time recorded against them rather than allocated to them afterwards, and the test and iteration records the engineering side was producing anyway. What does not hold up is a percentage of the engineering payroll estimated at year end.
The reporting on Form 6765 has also become more detailed, with business-component-level disclosure now required rather than a single aggregate number. That is a documentation requirement dressed as a form change: the return now asks for information a reconstructed claim cannot supply.
If some part of what your shop did last year involved not knowing whether it would work, it is worth an hour to find out whether the credit is there. And if you are already claiming it, the funded-research question is the one to check first — it is the one most likely to be wrong and the most expensive to be wrong about.
