Why Tracking by "Project" Kills Your R&D Credit Claim

TLDR: Most businesses track R&D by "Project" (e.g., "2026 Product Launch"). The IRS, however, audits by "Business Component" (e.g., "The specific formula"). If you file Form 6765 using broad project names, your claim will likely be denied. To prevent this, you must stop tracking generic initiatives and start documenting the specific legal business components the IRS actually funds.

Key Highlights:

• The Trap: Filing Form 6765 with broad project names is a red flag for auditors.
• The Rejection: The IRS denies "project" claims because they include non-qualified costs, such as marketing or routine updates.
• The Fix: You must isolate the specific Business Component (the innovation) to prove your claim is valid.

If you look at your company's roadmap, you likely see "Projects" like "Summer Product Line" or "Mobile App Refresh." These are excellent for managing deadlines, but they are of no use for tax claims.

When you submit a claim for the R&D Tax Credit, the IRS looks specifically for a Business Component, the exact product, process, formula, or invention you created. If you only provide a list of projects, the IRS often views the entire claim as unsubstantiated and disallows the refund.

The "Bucket" Concept: Why Projects Get Rejected

Think of a "Project" as a bucket containing a mix of activities.

• Pollutants (Denied): Marketing research, routine quality control, aesthetic design.

• Gold (Approved): Technical innovation and experimentation.

If you hand the IRS the entire "Project Bucket," they will reject it because it contains non-qualified costs. To get your check, you must filter the bucket and submit only the specific technical pieces that count.

The Litmus Test: Does Your Component Qualify?

Once you have isolated a specific Business Component, it must pass the IRS Four-Part Test to be eligible for the credit. If it misses even one, it does not count.

• Permitted Purpose: You must intend to create a new or improved business component (product, process, or software) with better performance, quality, or reliability.
• Elimination of Uncertainty: You must face a technical unknown at the start. If you already know precisely how to do it, it is not R&D.
• Process of Experimentation: You must use a systematic trial-and-error process (modeling, simulation, testing) to solve that uncertainty.

• Technological in Nature: Your process must rely on hard sciences such as engineering, physics, chemistry, or computer science, not on soft sciences such as economics or market research.

Real-World Translation: The App Update

Consider a company launching a significant update to its mobile app. To the business, this is simply "The 2026 Refresh."

This project includes a new colorful design, updated terms of service, bug fixes, and some faster loading speeds. If you claim the entire "Refresh" project, the IRS will likely reject it. Why? Because new designs and legal updates aren't innovations, they are standard maintenance.

However, hidden inside that project is a "New Offline Sync Feature."

This feature ensures the app continues to work even when the user loses internet connection. Your team had to experiment and fail multiple times to get the code right. That is a Business Component. By isolating the syncing feature from the rest of the project, you strip away the routine costs and secure the tax savings for the actual innovation.

The "Shrink-Back" Rule: Your Safety Net

What happens if your major initiative fails to qualify as a whole? The "Shrink-Back" Rule allows you to preserve the claim by focusing on a smaller part.

In our app example, the "2026 Refresh" project might fail the IRS test because it includes too much routine work (design, legal updates, bug fixes). However, you can use the Shrink-Back rule to zoom in on the specific New Offline Sync Feature.

By shrinking the claim down to that single component, you strip away the routine costs and keep the tax savings for the actual innovation.

Why This Matters for Audit Defense

The finalized Form 6765 now includes Section G, which makes business-component reporting mandatory for the 2026 tax year.

If your records only show generic project names, you cannot accurately answer this question. This connects directly to the warning we gave in Why Ignoring Bookkeeping Can Hurt Your Business, generalized records leave you without the evidence you need to defend your money.

Final Thoughts

The One Big Beautiful Bill Act (OBBBA) has officially restored the 100% immediate deduction for R&D expenses. This is a massive win for your cash flow, but it means the IRS is watching closer than ever. You cannot capture this restored benefit if your claim is buried in vague "Project" names.

Stop looking at the "Project" level and start identifying the specific assets, the formulas, processes, and systems that drive your value. This strategic review is the definition of Tax Prep vs. Tax Planning. Don't wait until tax season to determine what qualifies. Contact Us to perform a feasibility study and translate your hard work into the credits you deserve.