6765 instructions: a step-by-step guide

What is Form 6765?

Form 6765, Credit for Increasing Research Activities, is an Internal Revenue Service (IRS) tax form you can use to calculate, claim, and allocate the Research and Development (R&D) tax credit.

If your business has qualified research expenses, you may be able to use the R&D credit under Internal Revenue Code (IRC) Section 41 to offset your federal income tax or payroll tax liabilities dollar-for-dollar, up to certain limits.

Who should file Form 6765?

Generally, any business that wants to claim the R&D tax credit should file Form 6765. 

A pass-through entity, such as a partnership or S Corporation, must then allocate the resulting credit to their owners’ tax returns, while a C corporation claims the calculated amount directly on their own.

Which activities qualify as R&D activities?

Your business’s research activities qualify as R&D activities for the purposes of the tax credit if they meet the following four tests outlined by the IRS:

1. Elimination of uncertainty: Also called the IRC Section 174 test, this requires that your research activity aims to resolve some kind of technological uncertainty, such as limitations in engineering capabilities.
2. Technological in nature: This test requires that the activity be technological in nature and involve the use of hard sciences, such as computer science or biological sciences.
3. Component for permitted purpose: To satisfy this test, your activities must be for the development of a business component intended for internal use or commercial sale, such as a product, process, or software.
4. Process of experimentation: Finally, your research activities must involve ongoing experimentation, such as testing, simulation, or trial and error to determine the best solution.

For example, a company developing a new type of heat-resistant material for industrial equipment could likely qualify for the credit if they could demonstrate:

• Test 1: The best material composition is unknown and requires technical research
• Test 2: Their research relies on chemical engineering
• Test 3: They intend to create a new product for commercial sale
• Test 4: Their team conducts experiments to test different material properties

What are unqualified R&D activities?

The IRS specifically excludes the following types of R&D activities from eligibility for the research credit:

1. Research conducted after commercial production begins: Once a product or process is in commercial production, further modifications generally don't qualify.
2. Customization for a specific customer: Adapting an existing product or process to meet a particular client’s needs doesn't count as R&D.
3. Duplication of an existing product or process: Replicating an existing product, process, or software without innovation doesn't qualify.
4. Surveys or studies: Market research, consumer preference studies, efficiency surveys, and other similar analyses are ineligible.
5. Certain internal-use software: Development of internal-use software may qualify, but it must meet stricter criteria. Basic software developed solely for internal operations usually doesn't.
6. Research conducted outside the U.S. or its territories: Only research performed within the United States and its territories is eligible.
7. Research in social sciences, arts, or humanities: Studies in psychology, economics, literature, or other non-hard sciences don’t qualify.
8. Research funded by another entity: If another company or a government agency funds the research, it isn’t eligible.

In addition, any other R&D activity that fails one or more of the tests in the previous section is considered unqualified for the purposes of the credit.

Step-by-step Form 6765 instructions

1. Determine if your research activities qualify

Use the four IRS tests to determine if your research activities qualify for the R&D tax credit. They must resolve a technical uncertainty, be scientific in nature, develop a permitted business component, and involve an experimentation process.

2. Gather your qualified research expenses

Add up your qualified research expenses (QREs), which are the costs involved in your research activities and the basis for your credit amount. These primarily include:

• Wages: You can include any wages—including bonuses and stock option redemptions—paid to in-house employees for “qualified services,” which include directly engaging in, supervising, or supporting qualified research.
• Supplies: You can include the cost of any tangible property used to complete qualified services, as long as it isn’t land or depreciable.
• Contract research expenses: You can include 65% of any expense paid to a person who isn’t an employee for activities that would count as qualified services or research if performed in-house.

Typically, wages are the most significant contributor to a startup's total QRE, so make sure you keep careful records of which employees spend time on R&D.

3. Decide whether to make the section 280C election

The 280C election affects how you claim your startup R&D tax credit. You can only make the election on a timely tax return, so you can’t change your mind later by filing Form 6765 again with an amended return.

Without the election, you can claim the full amount of your credit, but you must add the amount back into your taxable income. With the election, you must reduce your credit by the corporate tax rate (21%), but you don’t have to add it back into your income.

4. Complete both calculation methods (Section A and Section B)

You can calculate your R&D tax credit using the regular method or the Alternative Simplified Credit (ASC). Typically, it’s beneficial to calculate your credit using both and choose the higher amount.

The regular method calculates your credit as 20% of the difference between your current-year QREs and an amount based on your historical R&D spending. It can be better for businesses with a long history of consistent R&D spending.

The ASC method calculates your credit as 14% of the difference between your current-year QREs and 50% of your average QREs from the past three years. Or, if you don’t have any QREs in the last three years, it’s 6% of your current-year QREs.

5. Consider electing the payroll tax credit (Section D)

If your business is a qualified small business (QSB), you can elect to apply a portion of your R&D credit up to $500K against your payroll taxes instead of income taxes.

To qualify as a QSB, your company must:

• Have less than five years of gross receipts
• Have less than $5 million in gross receipts for the current year

6. Provide additional information in the remaining sections

With the hardest parts done, use Section C to provide detailed information about the current year’s credit, such as the portion attributable to various entity types.

Section E asks for other relevant details, such as the number of business components generating QREs. Meanwhile, Section F requires a summary of your QREs, and you can use Section G to expand on your business component information.

For specific guidance, consult the current revised form of the tax document.

Typical 6765 mistakes self-filers make

The R&D tax credit is complex, and claiming it using IRS Form 6765 without professional tax guidance can lead to costly mistakes. Some of the most common ones to avoid include:

• Misidentifying qualified activities, causing you to claim ineligible activities or fail to claim eligible ones
• Failing to document QREs properly, such as exactly when you paid wages to employees for qualified services
• Choosing the wrong calculation method and leaving money on the table by failing to compare the regular and ACS credit amounts
• Ignoring the 280C election, another easy way to accidentally increase your tax liability due to a lack of due diligence
• Mishandling the payroll tax option, which can be a lucrative opportunity for startups without sufficient income tax liability

Partner with Zeni for startup tax guidance

Without expert tax instruction, you risk making costly mistakes that could lead to missed business tax credits or an IRS audit. Rather than navigating this challenging tax credit alone, partner with a professional startup tax accountant like Zeni provides.

We specialize in helping founders achieve compliance and maximize their tax savings, having already secured more than $6.5 million in R&D credits for our clients. Schedule a demo today to see how Zeni can improve your tax planning and financial management.

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