R&D Tax Credits for SaaS Companies: What Qualifies and How to Claim
Most SaaS Companies Are Leaving Significant Money on the Table
If you’ve built a SaaS product, it’s likely that you’re doing work that qualifies for research and development (R&D) tax credits, and it’s also likely that you’re not claiming them.
The IRS designed R&D tax credits to reward activities that SaaS companies deal with regularly during research and development, and yet it’s estimated that fewer than 30% of companies claim these credits; some don’t know if they qualify, some feel it would be too complicated to be worth the effort, and some don’t even know what R&D tax credits are. Regardless of the reason, these companies are leaving potential credits on the table.
These credits aren’t loopholes, and they’re not grey areas. They’re incredibly specific and legitimate incentives built into U.S. tax code to encourage companies to be innovative domestically. When engineering payroll is one of the largest expenses for a SaaS company, R&D tax credits have the potential to put tens, perhaps even hundreds of thousands of dollars back into the company so that it can continue to grow and transform.
Does Your SaaS Company Qualify for R&D Tax Credits?
If your software engineers are solving technical problems, there’s potential that you could claim, but the IRS uses this specific four-part test to determine whether your activities qualify.
- Permitted purpose: the work must be aimed at creating or improving a product, process, software, technique, formula, or invention. In SaaS, this means work tied to your core product: building a new feature, improving how your system handles load, or making your platform more reliable all fit. Work done for internal administrative purposes (i.e., setting up Slack or migrating a spreadsheet) does not.
- Elimination of uncertainty: there must be genuine technical uncertainty at the outset of the work, meaning your team did not know if the solution was achievable or how to build it. If your team prototypes an approach without knowing if it will perform, evaluates competing architectures, or solves a problem without a simple, “off-the-rack” solution, it may meet this requirement.
- Process of experimentation: substantially all of the work (at least 80%, measured by cost) must involve a process of evaluating alternatives, testing hypotheses, iterating on approaches, and/or ruling out methods that don’t work. A/B testing architectural decisions, iterating algorithm designs, refactoring after discovering a better method, or running load tests to validate an approach can all qualify. Note that merely completing a project successfully - without a documented evaluative process - is not sufficient.
- Technological in nature: the work must rely on a hard science - engineering, computer science, physics, or biology. For software companies, this could mean engineers designing data structures, optimizing queries, or architecting a distributed system. UI tweaks, copy changes, and website updates generally won’t count, but much of the underlying engineering work may.
With that test in mind, the following are some (but not all) common activities performed by SaaS companies that would qualify for the credits:
- Building new product features that involve non-obvious engineering challenges.
- Developing or improving algorithms, recommendation engines, and/or data pipelines.
- Creating or refining machine learning and AI models.
- Designing and building APIs or integration frameworks.
- Security and compliance engineering.
- Database optimization and scaling.
- Prototyping mobile commerce platforms.
- Performing technical research on requirements, domain, software elements, or scope analysis for new functional software enhancements.
- Infrastructure work that improves scalability, reliability, or performance.
Activities that generally do not qualify:
- Routine bug fixes and maintenance.
- UX and design work, unless it involves underlying technical experimentation.
- Copying or replicating existing functionality without technological challenge.
- Market research, customer interviews, or sales tooling.
- Any work performed outside the United States.
Common Questions SaaS Companies Have About R&D Tax Credits
Claiming R&D tax credits may sound straightforward once you get an understanding of the basics, but there are a handful of mistakes that companies often make. These mistakes can leave a lot of money on the table, or even cost you.
Assuming they won’t qualify.
The most common issue. Most companies hear research and development and picture chem labs or aerospace engineers. Software development is one of the most commonly qualifying activities. If your engineers are writing code to solve technical problems, there is strong potential for your company to claim.
Can my company qualify if we use contractors?
If your contractors are based in the U.S., are directly involved with the R&D activity, and your company bears the economic risk of the research (meaning you pay regardless of whether the project succeeds), you can claim 65% of what you pay them.
If we’re in a pre-revenue startup phase, can we file?
Yes, with important nuances. Qualified small businesses - those with $5 million or less in gross receipts and no more than five years of gross receipts history - may be able to use up to $500,000 of R&D credits per year as an offset against payroll taxes, even before they’re profitable. For companies that don’t meet that threshold, credits can still be carried forward up to 20 years to offset future tax liability.
Conflating routine activity with R&D activity
Not every engineering hour or project will count as a qualifying activity. Routine maintenance, customer support, sales calls, and other activities do not pass the four-part test, and companies that roll 100% of their engineering team into QREs without a defensible breakdown are putting themselves at risk of an audit.
Can’t we just do this ourselves? We already have a CPA.
We want to work with your CPA to make sure that everything is being claimed properly and compliantly. But our team only works on R&D tax credits, period. That makes us experts, and we’ve found money that had been overlooked for other companies. One was under claiming, and we increased their yearly claim from $120,000 to $1.12 million.
Conclusion
R&D tax credits are one of the most under-utilized tax incentives in the U.S. for SaaS companies, yet they are one of the highest ROI incentives when properly claimed. Whether your company is a pre-revenue startup, a growth-stage company looking to reinvest in engineering, or a mature business optimizing your tax strategy, the credit is certainly worth exploring.
The key is knowing what qualifies, making sure the documentation is correct, and working with people who understand the nuances of R&D tax law. The cost of a mistake or a missed credit almost always outweighs the cost of expert help.
RK Partners has tax attorneys, CPAs, and consultants who are dedicated solely to R&D tax credits – nothing else. We’ve worked with SaaS companies at all stages to identify qualifying activities, build defensible documentation, and maximize credits, without complexity and with total compliance. If you don’t know if your company qualifies, schedule a no-risk consultation with one of our experts to go through your company’s R&D activities to determine qualifications.
