In the world of research and development (R&D) tax credits, a massive "translation gap" often exists. While your engineering team and you speak the language of ideas and projects, the Internal Revenue Service (IRS) speaks the language of business components.
To successfully claim the R&D tax credit—and defend it during an IRS audit—you must understand how your daily work translates into these specific categories. Here is the roadmap from a concept in a meeting to a qualified claim on your tax return.
Conceptualization: Why the 'spark' isn't enough
Every great innovation starts with an idea—perhaps a sketch on a napkin or a "what if?" during a stand-up meeting. In the eyes of the IRS, however, an idea is just a concept. You cannot claim time spent brainstorming unless there is a specific technical hurdle to overcome.
- The threshold: To move from an idea to a qualified research activity, you must attempt to solve a technical uncertainty, which is a scientific question.
- Rule of thumb: If you are debating what the product should do (i.e., functional requirements), it is an idea. If you are debating how to achieve those benchmarks through engineering, you are progressing toward a claim.
Projects: How you manage, not how you claim
Most companies track R&D through projects. A project is an organizational bucket. It has a name (e.g., "Version 2.0 Launch"), a timeline, and a team. While projects are convenient for organizing work, the IRS does not care about internal nomenclature. In fact, relying solely on project-level data is a common mistake.
- The catch: One project might contain three distinct sub-innovations that qualify, while the remainder of the work is routine maintenance.
- The modern requirement: Recent IRS revisions of Form 6765 require increased granularity. You can no longer claim a flat amount for an AI project. Instead, you must break down the project into its business components.
Business components: The legal unit of measurement
The business component is the most important term you have likely never heard. It is the legal unit of measurement for the R&D tax credit. According to Section 41 of the tax code, a business component is the specific product, process, software, formula, technique, or invention you are attempting to develop or improve.
To secure the R&D tax credit, your R&D must be evaluated against two core regulatory frameworks:
- The four-part test: Every business component must independently pass a four-part test: permitted purpose (business components), technical uncertainty, experimental process, and scientific principles.
- The "shrink-back" rule: The "shrink-back" rule safeguards your claim. If an entire project (e.g., a motor vehicle) fails to qualify because the majority of the R&D uses existing technology, you can isolate the specific business component—such as a new experimental braking system—that does meet the requirements. This principle ensures you still capture the value of your innovation even when the broader project is ineligible.
Compare at a glance: From concept to credit
| Level | Definition (Software example) | Can you claim it? |
| Idea | A functional goal or a hunch (e.g., a "what if" about using AI to reduce latency) | No |
| Project | An administrative bucket (e.g., a Jira epic labeled "2026 Core Infrastructure") | Only if mapped to a business component |
| Business Component | A specific product or process (e.g., a proprietary load-balancing algorithm) being developed or improved | Yes. The business component is the legal requirement. |
Granularity: The key to maximizing credits and defending audits
To maximize your R&D tax credit, avoid treating your projects as monoliths.
Instead, identify the individual business components hidden within those initiatives.
By documenting work at the business component level, you create a defensible audit trail that demonstrates to the IRS exactly which technical problems your team attempted to solve.
Connect, learn, and maximize R&D tax credits
Optimize your tax strategy. Schedule a complimentary R&D consultation with Randy Eickhoff, CPA, Founder & Head Coach of Acena Consulting, for expert guidance.
Register for our free monthly webinar, next on Feb. 17, 2026: Cracking the (Tax) Code for R&D.
- This workshop provides one continuing education (CPE) credit for professionals maintaining their continuing education (CEs).
- Discover more about qualifying and documenting R&D activities to receive tax incentives.
Visit our Acena Events page to sign up for our newsletter and stay abreast of all upcoming events.
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Edited by Laura Whittenburg, MSBME, Sr. Technical Writer at Acena Consulting. Photo courtesy of NASA Goddard Photo and Video on Flickr.
