R&D tax credits for capital markets firms: What to know now

For decades, businesses could generally deduct R&D expenditures under section 174 while also potentially claiming the valuable research credit under section 41. That changed significantly following the Tax Cuts and Jobs Act of 2017 (TCJA), which required taxpayers to capitalize and amortize R&D costs beginning in 2022.

Then Congress enacted section 174A under the OBBBA, restoring immediate expensing for domestic research expenditures beginning in 2025.

Although section 174A restored favorable treatment for many domestic R&D expenditures, taxpayers still face numerous complexities. State conformity varies widely, foreign research expenditures remain subject to separate capitalization requirements, and the interaction between deductions and the research credit continues to require careful analysis.

Most importantly, the ability to deduct a cost under section 174A does not automatically mean that the cost qualifies for the research credit. Taxpayers must still satisfy the section 41 requirements and maintain adequate documentation to support their positions.

Since the initial proposal in 2023, the IRS has increased transparency requirements through revisions to Form 6765, Credit for Increasing Research Activities, with the finalized version released in early 2025. Beginning with tax years after 2025, many taxpayers will be required to provide significantly more detailed information regarding the business components that generate qualified research expenses.

For purposes of the research credit, a “business component” generally refers to a product, process, software application, technique, formula or invention developed or improved through research activities.

Under the revised reporting framework, taxpayers generally must report detailed information covering at least 80% of total qualified research expenses, subject to a maximum of 50 business components.

Required disclosures may include business component descriptions, expense categories, wage information, contract research amounts and other business-component-level information designed to provide greater transparency into how qualified research expenses are identified and calculated.

These new reporting requirements signal that the IRS is seeking greater visibility into how taxpayers calculate their credits and identify qualifying activities.

Historically, many taxpayers could support claims through aggregate calculations and high-level business component descriptions. For example, organizations often grouped multiple development sprints, enhancements and releases associated with a single trading platform, risk management system or digital application under one broader business component.

Going forward, taxpayers should expect increased scrutiny and greater emphasis on business-component-level substantiation, detailed cost tracking and documentation capable of supporting each category of qualified research expense reported on Form 6765.

Several tax controversies demonstrate where the IRS is focusing its enforcement efforts surrounding the R&D credit. Courts continue to scrutinize whether taxpayers can prove that their activities involved technical uncertainty, a process of experimentation, and qualified research activities. The IRS has also focused heavily on documentation supporting employee wage allocations, executive involvement in research activities and whether taxpayers can tie claimed costs directly to qualifying business components.

Several recent court decisions illustrate the importance of detailed documentation.

• Moore v. Commissioner: The Tax Court rejected certain wage-based research credit claims because the taxpayer could not demonstrate that executive time was spent performing qualified research activities, even though management was heavily involved in product development. The court distinguished between general oversight activities and the specific technical work required for research credit eligibility. (T.C. Memo. 2023-20, aff'd, 7th Cir. 2024.)
• Phoenix Design Group, Inc. v. Commissioner: The court denied credits for which the taxpayer failed to adequately demonstrate objective uncertainty and a documented process of experimentation. The case highlighted the importance of maintaining contemporaneous records rather than relying solely on generalized descriptions of innovative work. (T.C. Memo. 2024-113.)
• Smith v. Commissioner: The Tax Court analyzed individual projects and underlying contractual arrangements to determine credit eligibility. The decision reflects the same trend driving the revised Form 6765 reporting requirements: increased emphasis on business-component-level analysis, contemporaneous documentation and the ability to connect qualified research expenses to specific research activities. (T.C. Memo. 2026-50.)

As IRS examinations continue to focus on detailed business-component-level information, taxpayers should expect similar scrutiny of their own R&D positions.

These recent legislative changes, court decisions, and reporting requirements point to a clear conclusion: Taxpayers should proactively evaluate their R&D positions rather than waiting until an examination occurs. Many businesses, particularly those involved in software development, data analytics, digital transformation, engineering, financial technology and other innovation-driven activities, may be either overlooking available credits or claiming credits without sufficient supporting documentation. In either circumstance, there is substantial value in conducting a comprehensive review.