For startups and tech companies, every dollar counts, especially in the early stages. One of the most valuable yet often underutilized opportunities is the Research and Development (R&D) tax credit. This federal (and in many cases, state-level) incentive is designed to reward companies that invest in innovation, product development, and software engineering. When calculated and claimed correctly, the R&D tax credit can offset a significant portion of payroll and income tax liabilities.
But here’s the catch: calculating the R&D tax credit isn’t always straightforward. From tracking eligible expenses to categorizing technical labor and ensuring audit readiness, many companies leave money on the table or worse, open themselves up to compliance issues, due to poor documentation or manual processes.
To help the busy entrepreneur, we’ve outlined a simple guide to determine your R&D tax credit, back of the envelope style. And that’s where Rho comes in.
Using Rho’s easy-to-use expense tracking feature, startups can get a quick sense of what their credit looks like.
What Is the R&D Tax Credit?
The R&D tax credit is a government incentive aimed at encouraging innovation. It provides dollar-for-dollar tax savings for businesses that invest in research and development, whether they’re building new products, improving software, or experimenting with technical processes.
The tax credit offsets actual tax liability. Profitable? It will offset income taxes. Not profitable, the credit can be used against payroll taxes. And it is a dollar-for-dollar tax credit.
Payroll Tax Example
For a company that has $500,000 in annual development payroll spend, the payroll tax liability at 8% would be about $40,000. Assuming that all that amount is qualifying the credit would equal about $50,000. So even if the company is not profitable on an income tax basis, the $40,000 can be offset by the credit, with the remaining claimed against future payroll liabilities.
Income Tax Example
For example if the company has income of $100,000 instead of paying the $21,000 liability (at 21%), the company can take that credit against the liability (assuming a $50,000 credit), and bank the remaining amount for future years. This saves the company cash that can be used for growth, instead of paying it to Uncle Sam.
Who Qualifies?
Contrary to what some think, you don’t need to be a massive tech corporation with a research lab to qualify. Many startups, SaaS companies, ecommerce platforms, and engineering-driven businesses can claim the credit especially if they:
- Develop or improve software
- Build custom platforms or internal tools
- Employ developers, engineers, or data scientists
- Use contractors for technical projects
- Deploy cloud/hosting services
In short, if your tech stack is customized because off-the shelf solutions don’t solve your specific problem for your specific ICP, the activities you perform qualify under Internal Revenue Code (IRC) Section 174. Now the question is how much can you claim, which we answer in the next section.
What Expenses Count?
The IRS allows companies to include a variety of expenses in the R&D tax credit calculation, such as:
- Employee wages: Specifically for internal staff who work on qualified R&D activities (often software engineers, designers, and product managers).
- Contractor costs: Payments to external developers or technical freelancers.
- Cloud and hosting expenses: Tools used in the R&D process, like AWS, Google Cloud, Microsoft Azure, GitHub, Figma, or other proprietary platforms.
- Supplies and prototypes: In some cases, raw materials used to create mockups or test new products.
Common Challenges in Calculating the R&D Credit
Despite its benefits, many founders and finance teams struggle to claim the R&D tax credit effectively. Here’s why:
1. Tracking Qualifying Expenses
It’s not enough to have an R&D budget, you need to track specific spend by employee/contractor/vendor, project, and time period. Without a clear system, expenses get lumped into general categories and become hard to justify during an audit.
2. Categorizing Payroll and Contractor Work
The IRS requires granular detail about how much time your personnel spend on qualifying activities. That means splitting payroll between R&D and non-R&D work and tagging contractor payments accurately. Manual spreadsheets make this tedious and open to questioning.
3. Documentation and Audit Readiness
The IRS (and your state tax board) may ask you to prove your R&D work. That includes project descriptions, technical goals, cost breakdowns, and evidence that your work involved technical uncertainty and experimentation. Without solid documentation, credits can be denied or clawed back.
How Rho Simplifies R&D Tax Credit Calculation
Rho takes the guesswork and manual work out of the process. Here’s how:
Automated Spend Tracking
Rho allows you to tag transactions by department, project, and purpose—including R&D. That means every eligible expense (from payroll to cloud costs) is already labeled and ready for reporting.
Payroll and Contractor Categorization
With integrated payroll tracking, Rho helps finance teams categorize employee costs by role and function. You can tag developers, engineers, and technical contractors so their costs are clearly separated.
Real-Time Visibility
Through dashboards and reporting tools, Rho gives you a real-time view of your R&D spend, helping you avoid surprises at tax time and making it easier to plan quarterly or annual filings.
Ready-to-Export Reports
Whether you’re working with an R&D tax advisor or filing internally, Rho provides clean, exportable data for your forms and documentation. No more scrambling through spreadsheets.
Step-by-Step – Using Rho to Calculate the Credit
Ready to put this into action? Here’s how finance teams use Rho to simplify the R&D tax credit process:
Step 1: Set Up Financial Tags for R&D
Start by creating custom tags in Rho to identify R&D-related transactions—this includes payroll categories, contractor types, and cloud/hosting services. Clear tagging from day one = less clean-up later.
Step 2: Track Payroll and Contractor Payments
Use Rho’s payroll integration to assign employees to R&D categories based on their roles. For contractors/vendors, apply tags to invoices and payments so you can isolate R&D-specific work.
Step 3: Isolate Cloud, Software, and Dev Expenses
Review your recurring spend on platforms like AWS, Google Cloud, Microsoft Azure, GitHub, or Figma. With Rho’s smart categorization, you can tag these as technical infrastructure, making it easy to include them in your claim.
Step 4: Generate Reports for Your Advisor
At the end of the quarter or fiscal year, export your tagged R&D spend data into a clean report. This makes collaboration with your tax advisor much easier and minimizes back-and-forth.
Step 5: Finalize Documentation and File
Use your Rho-generated data to complete Form 6765 (for federal claims) and any relevant state forms. Attach narratives, time-tracking, and project overviews as needed. You're audit-ready now.
Bonus – Best Practices for R&D Tracking Year-Round
Even with great tools, habits matter. Here’s how to stay ahead of the curve:
1. Keep Clear Documentation
Maintain a folder with project briefs, engineering timelines, and work logs. Annotate what each technical initiative aimed to achieve and what obstacles it addressed.
2. Categorize Spend Monthly
Don’t wait until year-end. Use Rho to tag and review R&D expenses every month, so you’re not scrambling during tax season.
3. Engage Your Tax Advisor Early
Loop in your advisor before Q4. They can help you identify overlooked expenses and ensure your categorization matches IRS expectations.
4. Use Rho to Stay Audit-Ready
The IRS loves organized records. By leveraging Rho's real-time dashboards, tags, and reports, you’ll be able to defend your credit without the stress.
Closing Thoughts
The R&D tax credit is one of the best-kept secrets for startups and tech companies. It’s not just a deduction, it’s a direct savings opportunity that can help fund your next engineering hire, product sprint, or tech infrastructure upgrade.
But to unlock its full value, you need to track your spend, document your work, and stay compliant. Rho makes that possible.
From real-time expense tagging to report generation, Rho gives finance teams the visibility and structure they need to claim the credit confidently.
Join our upcoming webinar to see how Rho helps streamline the R&D tax credit process from start to finish. Live demo, expert Q&A, and real-world examples.
About Tax Hack
Founded in 2017, Tax Hack was born out of a mission to bring Fortune 500-level tax strategies to businesses of all sizes. We are a strategy-first tax compliance firm that specializes in helping entrepreneurs, investors, and operators in industries such as SaaS / Software, Digital Marketing, Iot / Big Data and Manufacturing leverage tax and operational strategies for long-term success.
Our founding team consists of ex-PwC and ex-Deloitte managers who were determined to provide high-level tax solutions to businesses that typically don’t have access to such resources. Since then, we’ve grown into a diverse and distributed team, with technical and support staff across the United States, Mexico, and Vietnam. This global presence allows us to offer tailored solutions that support the unique needs of our clients, whether they’re looking for tax-efficient growth, reinvestment strategies, or help with complex tax credits.
In recognition of this growth and impact, Tax Hack was named to Inc. 's 2025 list of the Fastest-Growing Private Companies, a milestone that underscores our commitment to delivering world-class tax strategy with measurable results.
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This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.
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