How Medtech Companies Can Maximize the R&D Tax Credit

Innovation in the medical device industry is rarely linear. From refining prototypes and testing new materials to improving embedded software and optimizing manufacturing processes, medtech companies invest heavily in solving complex challenges through iteration, technical rigor, and significant financial investment in research and development (R&D). 

Many organizations overlook the fact that a substantial portion of this work may qualify for the federal R&D tax credit under Internal Revenue Code Section 41, as well as various state-level R&D incentives (collectively, the R&D Tax Credit).

With engineering investment both continuous and capital-intensive, these incentives can meaningfully offset development costs. Recent legislative changes including the One Big Beautiful Bill Act (OB3)—which created IRC Section 174A and restored immediate write-offs for domestic R&D expenses—along with California Senate Bill 711 (significantly improving the state’s R&D credit) and Texas Senate Bill 2206 (creating a new, refundable franchise tax credit for R&D), the opportunity has never been more significant or more time-sensitive. 

How the R&D Tax Credit Applies to Medtech

The R&D Tax Credit provides a dollar-for-dollar reduction in tax liability for qualified research activities. Despite its name, it does not require groundbreaking discoveries or laboratory-only research. Instead, the credit focuses on whether a company is attempting to eliminate technical uncertainty through a structured, methodical process.

In the medical device space, qualifying activities often include:

• Designing new products or enhancing existing ones
• Improving device reliability, durability, or performance
• Testing materials for strength, sterility, or biocompatibility
• Developing firmware or software that powers a device or a series of devices
• Refining manufacturing processes to increase consistency or yield and reduce waste.

Importantly, the research does not need to succeed. The credit rewards the process of experimentation, a distinction that matters tremendously in an industry where iteration and redesign are standard practice.

The Four-Part Test: A Practical Framework

In general, R&D Tax Credit eligibility is evaluated under a four-part test. The components of the test closely align with how medtech development actually works.

1. The activity must serve a permitted purpose—i.e., aimed at improving the function, performance, quality, or reliability of a new or improved product, process, technique, formula, or software. 

2. The activity must be technological in nature, relying on principles of engineering, biological science, physical science, or computer science. 

3. There must be genuine uncertainty at the outset regarding the capability, design, or method. 

4. The activity must involve a documented process of experimentation, evaluating alternatives through modeling, simulation, prototyping, or systematic testing.

These elements are not abstract. Regardless of whether a research team is uncertain about a material’s ability to withstand repeated stress, about firmware achieving greater diagnostic accuracy, or about a manufacturing process meeting tight tolerances, the structured effort to resolve that uncertainty is precisely what the credit is designed to recognize. 

Key Considerations

1. Funded research risk—the primary gating issue: To qualify for the R&D Tax Credit, a business must demonstrate it bears financial risk and retains substantial rights to results of the research. For contract manufacturers, this qualification analysis becomes more nuanced, requiring a review of customer contracts to identify “risk.” 

Importantly, “substantial rights” do not require commercialization rights. This requirement may be satisfied where the business retains the ability to use process know-how, manufacturing techniques, or technical learnings internally or in collaboration with customers. If uncertainty exists around yield achievement, tolerance capability, automation feasibility, assembly method selection, material behavior, or process capability attainment, those engineering efforts may fall squarely within R&D Tax Credit eligibility.

2. Distinguishing qualified activities in a regulated environment: Medical technology includes many technical activities, but not all qualify. Activities that frequently qualify include product design and development, process development for new device manufacturing, and custom tooling. Routine production, regulatory compliance,
and technology transfer with no experimentation are examples of non-qualifying activities. 

3. Design controls as documentation support: Medical technology companies operate under formal quality systems that often require strong contemporaneous documentation that can be used to support R&D Tax Credit claims. Documentation such as design history files, engineering change orders, verification and validation protocols, and design review minutes will help substantiate an R&D Tax Credit claim. However, regulatory documentation alone is not sufficient; it must clearly demonstrate experimentation and resolve uncertainty.

Time-Sensitive R&D Opportunities: OB3 Changes

From 2022 to 2024, businesses were required to capitalize and amortize domestic R&D expenses over five years—delaying the tax benefit and constraining short-term cash flow. Per OB3 rules, businesses with average annual gross receipts of $31 million or less have until July 6, 2026 (or, if earlier, three years from the time the applicable return was filed) to amend tax year 2022, 2023, and 2024 returns to retroactively apply Section 174A. These small businesses can certainly benefit from OB3 changes without amending returns (by accelerating unamortized amounts into tax year 2025 or ratably into tax years 2025 and 2026). Still, the amended return option has a compelling rationale that warrants a thoughtful discussion with their tax advisors. Large businesses should also consult with their tax advisors about whether to amortize expenses over five years, accelerate the unamortized amounts into tax year 2025, or split them between tax years 2025 and 2026.

Similarly, businesses that qualify for the Qualified Small Business (QSB) election may claim up to $500,000 of the federal R&D Tax Credit against payroll taxes, but they must make this election on an original return (including extensions). A QSB is defined as a business with gross tax year receipts of less than $5 million and no more than five years with gross receipts. A QSB that fails to elect the payroll tax credit option on the original return can still claim the credit but is limited to using it against income tax.

There’s still time for medtech companies to take advantage of these tax credits before the July deadline—as long as they act quickly.

Why Many Medtech Companies Underclaim

Despite strong alignment between medtech activities and the credit criteria, many companies underclaim or assume they do qualify. 

Common challenges include engineering teams focused on regulatory and commercialization milestones rather than tax documentation; finance teams lacking detailed visibility into technical experimentation; and incremental product improvements being dismissed as “routine” rather than innovative.

Truth be told, even incremental improvements can qualify for the R&D Tax Credit if they involve technical uncertainty and systematic experimentation. Enhancing firmware to improve signal processing, testing alternative materials to reduce rejection risk, redesigning components to meet updated regulatory standards, or refining automation to reduce variability can all fall within the credit’s scope when properly analyzed.

Given the scale of medtech R&D budgets, missed credits can represent substantial lost value, especially when compounded over multiple tax years.

Turning Innovation into Sustainable Tax Value

Maximizing the R&D Tax Credit requires a disciplined approach: structured interviews with technical personnel, careful mapping of qualified research expenses, and documentation that aligns with IRS standards. 

For medical technology companies, where hardware, software, materials science, and manufacturing engineering often overlap, an effective R&D study must explain how these pieces fit together and how they satisfy the four-part test.

Experience in both tax law and technical industries is key to crafting an effective R&D study. With immediate write-offs for domestic R&D and the R&D Tax Credit now restored, leadership teams should reassess how research activities are captured and reported. Tax filing deadlines make this not just a strategic question, but an urgent one.

Some of the most relevant questions medtech companies should be asking themselves include: 

• Are we fully benefiting from Section 174A transition relief under OB3?
• Are we layering the Section 174A deduction and the R&D Tax Credit effectively? 
• Have prior years been re-evaluated considering recent legislative changes? 
• Does the documentation adequately reflect the technical uncertainty and experimentation involved?

For businesses investing heavily in device development, software integration, materials testing, or process engineering, an evaluation can now provide clarity and potentially significant financial benefits in the future.

Matt Davenport is the director of R&D Tax Credit Services at Sagemont, where he helps businesses identify and maximize tax credit opportunities. He previously led the R&D and Tax Controversy divisions at Omega Accounting Solutions, managing thousands of engagements across dozens of industries. Over the last decade, Davenport has combined technical experience with strategic guidance to substantiate more than half a billion dollars in credits and incentives for American businesses. For questions about the R&D Tax Credit, contact [email protected]