When most business owners hear “R&D tax credit,” they think of pharmaceutical labs and Silicon Valley. The reality is much broader. The credit covers any business that develops or improves products, processes, software, formulas, techniques, or even internal systems. Houston has a substantial number of engineering firms, software shops, oilfield service companies, manufacturers, and even contractors that qualify for the credit and don’t claim it. Here’s how to know if your business is leaving money on the table.
The four-part test
The IRS uses a four-part test to determine if an activity qualifies as research and development. The activity must:
- Have a permitted purpose: developing or improving a business component (product, process, software, technique, formula, or invention)
- Be technological in nature: rely on principles of engineering, computer science, biology, chemistry, or physics
- Eliminate uncertainty: there must be uncertainty about capability, methodology, or design at the start
- Involve experimentation: evaluate alternatives through systematic trial and error, modeling, simulation, or testing
You don’t need a PhD or a research lab. A Houston engineering firm developing a new piping configuration for an oil and gas client meets all four tests. A software company writing a new feature for their SaaS product meets all four tests. A specialty manufacturer designing a custom part for a customer meets all four tests.
Common Houston industries that qualify
- Engineering, architecture, and construction services (custom design work)
- Software development (proprietary platforms, custom integrations, internal tools)
- Oilfield services and equipment (drilling techniques, downhole tools, processing methods)
- Specialty manufacturing (custom fabrication, new product development)
- Food and beverage production (recipe development, process improvement, packaging)
- Aerospace, defense, and aviation
- Biotech, medical devices, healthcare technology
- Industrial automation and controls
What counts as a qualifying expense
The credit is calculated on Qualified Research Expenses (QREs):
- Wages paid to employees who perform, supervise, or support qualifying R&D activities
- Supplies consumed in the research process (not capital equipment)
- Contract research performed by third parties (65% of the cost qualifies)
- Cloud computing used for qualifying research activities (added in recent years)
How big is the credit?
Most small and mid-sized businesses use the Alternative Simplified Credit, which is 14% of QREs above 50% of the average QREs from the prior three years. That sounds small until you run the math. A Houston engineering firm with $400,000 of qualifying wages and contractor costs can generate a $30,000-$50,000 federal credit annually. The credit reduces tax dollar-for-dollar — not a deduction, an actual credit against tax owed.
The startup payroll offset
For qualified small businesses (less than $5M in gross receipts and no gross receipts more than five years prior), the R&D credit can be applied against payroll taxes (employer share of FICA) up to $500,000 per year. This is huge for early-stage Houston tech companies that aren’t yet profitable — you don’t need income tax liability to use the credit; it offsets payroll tax instead.
State-level credits
Texas does not have an income tax, so there’s no Texas R&D credit on income. However, Texas does have a sales and use tax exemption for qualifying research equipment, and some industries qualify for franchise tax credits. Always check both layers.
The documentation problem
The R&D credit is one of the most-audited credits in the code. The IRS expects contemporaneous documentation of qualifying activities, time spent, and expenses. Most small businesses fail this part — they have the activities but not the records. The fix is a year-round system: track project hours, keep design iteration emails, photograph prototype testing, log experimental supplies. A specialist firm can help reconstruct prior years if you didn’t track at the time, but contemporaneous documentation is always cleaner.
Why most CPAs don’t bring it up
The credit calculation requires specialized knowledge of qualifying activities, statutory tests, and audit defense. Many general practice CPAs don’t do enough R&D credit work to be confident on the documentation standards, so they avoid the topic. We work with R&D credit specialists when a client’s situation warrants it — the specialist firm runs the study, our office integrates it with the broader tax return.
Should you investigate?
If your Houston business has any of these characteristics, the credit is worth a 30-minute conversation:
- You design custom products or solutions for clients
- You write proprietary software or maintain in-house tech development
- You experiment with materials, processes, or formulations
- You have technical staff (engineers, developers, scientists)
- Your wages for technical staff exceed $200,000 annually
To find out whether your business has a meaningful R&D credit opportunity, call the office at (832) 594-0339 or reach out through the contact page. We coordinate the analysis as part of annual tax planning.