Can the R&D Tax Credit Help Offset Your AI Investment?

Many companies are preparing to invest in custom AI workflows, agents, integrations, and software. That work can require real experimentation: comparing architectures, testing retrieval methods, measuring accuracy, resolving security constraints, and discarding approaches that fail.

Those activities can look a lot like the technical development Congress intended the research credit to encourage. But the words AI project do not make an expense eligible. The substance of the work matters.

This article is general business information, not tax or legal advice. White Rabbit Advisory Group can help define and document the technical work. Your CPA or qualified tax professional must determine whether the project and expenses qualify and how any credit should be claimed.

Buying AI Is Not the Same as Developing AI

Paying for ChatGPT, Microsoft Copilot, or another off-the-shelf service is ordinary technology adoption. Configuring a standard chatbot, training employees to use prompts, or moving data between established systems may improve productivity, but those activities alone generally do not demonstrate qualified research.

A stronger candidate begins with a genuine technical question whose answer is not readily known. For example:

• Can a retrieval system answer questions from conflicting company documents at an acceptable accuracy level?
• Can an AI workflow reliably classify unstructured records while meeting a defined error threshold?
• Can multiple business systems be coordinated without exposing restricted data or creating unauthorized actions?
• Can a new AI-enabled customer feature meet performance, reliability, and security requirements?

The project becomes more defensible when the team evaluates alternatives, measures the results, learns from failures, and preserves evidence of that process.

The IRS Four-Part Test

The IRS applies what it calls the “four-part test” separately to each business component—such as a product, process, computer software, technique, formula, or invention. In plain English, qualified research generally needs all four elements:

1. Permitted purpose The work is intended to create or improve the function, performance, reliability, or quality of a business component—not simply change its appearance or adapt it cosmetically.
2. Technological in nature The discovery process relies on principles of computer science, engineering, physical science, or biological science. Most custom AI-software candidates rely on computer science or engineering.
3. Elimination of uncertainty At the outset, the team does not know whether or how the desired capability can be developed, or what design will achieve the required result.
4. Process of experimentation The team evaluates alternatives through modeling, simulation, systematic trial and error, testing, or another structured experimental process.

A project can use sophisticated AI and still fail this test. If the technical path was already established and the work consisted mainly of installation, routine configuration, data entry, training, or maintenance, the required uncertainty and experimentation may be missing.

Potential Candidates and Likely Non-Qualifiers

These are illustrations, not eligibility determinations. Contract terms, where the work occurs, who bears the financial risk, who owns the results, the nature of the software, and other facts can change the tax analysis.

Internal-Use Software Has an Additional Hurdle

Internal-Use Software deserves special attention. Under the current Form 6765 instructions, software developed primarily for a company’s general and administrative functions may need to satisfy a higher-threshold-of-innovation test in addition to the ordinary qualified-research requirements.

That test considers whether the software is innovative, involves significant economic risk because of technical uncertainty, and is not commercially available for the intended purpose without qualifying modifications. Software developed for sale, lease, license, or third-party interaction can be treated differently.

This distinction is fact-specific. Do not assume that an internal AI workflow qualifies merely because it is custom or important to the business.

Which Costs Might Enter the Calculation?

The research credit is generally calculated from qualified research expenses over a base amount—not from the project’s entire budget. Depending on the facts, potential categories can include:

• Employee wages for people performing, directly supervising, or directly supporting qualified research;
• Supplies used in conducting the research, subject to the tax rules;
• Contract research, often subject to percentage and risk-retention rules; and
• Certain payments for the right to use computers in qualified research.

Do not treat that list as a project budget template. Your tax adviser should map expenses to the applicable rules and remove routine implementation, production, training, maintenance, foreign research, funded research, and other excluded activities.

What to Document Before the Tax Return

Trying to reconstruct a year of technical work after the project is finished is expensive and unreliable. Documentation should be a normal project output, not a tax-season emergency.

For tax years beginning after 2025, the current Form 6765 instructions make business-component reporting in Section G required for many filers, subject to the form’s guidelines. That makes project-level records even more important.

What About the Payroll Tax Credit?

A qualified small business may be able to elect to apply part of its research credit against payroll tax rather than waiting to use it against income tax. The IRS states that the maximum annual election is $500,000 for tax years beginning after December 31, 2022. The credit first reduces the employer share of Social Security tax, subject to the applicable limit, and then the employer share of Medicare tax; remaining amounts can carry forward to later quarters.

The $500,000 figure is a ceiling, not a promised benefit. A company must meet the qualified-small-business rules, generate a calculated research credit, make a timely election on Form 6765, and use Form 8974 with its employment tax return. Ask your CPA whether the election is available and useful for your business.

A Practical Way to Plan the Project

1. IdentifyChoose a business problem where a custom capability—not a routine subscription—could create measurable value.
2. ScopeDefine the business component, technical uncertainties, performance targets, security constraints, and ownership terms.
3. ExperimentEvaluate alternatives systematically and keep the failed tests. Failure can be evidence of real experimentation.
4. DocumentConnect people, time, expenses, decisions, and test results to the specific business component as the work happens.
5. CoordinateGive the technical record to a qualified tax adviser who can apply the law and prepare the tax forms.