To make the R&D credit concrete, it helps to walk through a real-world scenario.

Consider a California-based rocket engineering company building next-generation propulsion systems. The company has been operating for a few years, employs a tight but highly technical team, and is still pre-profit — a profile that will feel very familiar to many deep-tech founders.

Here’s what their year looks like.

The Company Profile

• Industry: Aerospace / Rocket engineering

• Location: California

• Team size: 20 core engineers

• Years in business: Early-stage (post-formation, pre-scale)

From a tax perspective, this is exactly the type of company that often underestimates the value of the R&D credit — not because the work isn’t real, but because the benefit isn’t intuitive.

Step 1: Identify Qualified Research Expenses (QREs)

For the year, the company incurred the following costs:

Wages

• Total wages: $1.5M

• Wages tied to qualified research activities: $1.1M

These include engineers designing, testing, iterating, and troubleshooting rocket engine components — classic qualified research activity.

Supplies

• Prototype materials and test components: $380K

Because these supplies are consumed during the R&D process (and not capitalized equipment), they qualify.

Contract Research

• Contract research expenses: $157K

• Eligible portion (65% rule): ~$102K

Under federal rules, only 65% of qualifying contract research expenses are included in QREs.

Total Qualified Research Expenses

When you add everything together:

• Qualified wages: $1.1M

• Qualified supplies: $380K

• Qualified contract research: ~$102K

Total QREs: ~$1.582M

Step 2: Apply the Federal R&D Credit Framework

Because this company is still early-stage and significantly ramped up R&D in the most recent tax year, its historical qualified research expenses are relatively low compared to the current year.

For context:

• Average qualified research expenses over the prior three years: ~$350K

• Current-year qualified research expenses: ~$1.582M

Let's use the Alternative Simplified Credit (ASC) for this case study example.

Under the ASC, the credit equals:

• 14% of current-year QREs that exceed 50% of the average prior three years’ QREs

In this case:

• 50% of the prior three-year average QREs ≈ $175K

• Excess QREs ≈ $1.582M − $175K = ~$1.407M

Applying the ASC rate:

• $1.407M × 14% ≈ $197K federal R&D credit

That’s a substantial credit for a 20-person engineering team — especially for a company that is still in a growth phase and not yet paying federal income tax.

Step 3: How the Federal Credit Is Actually Used

Because the company is still in a growth phase, it likely doesn’t have federal income tax liability.

That doesn’t make the credit useless.

Instead, the company can:

• Apply the federal credit against payroll taxes

• Offset up to $500K per year of employer payroll tax liability

• Use the benefit immediately, improving cash flow

In practice, this means the credit helps fund engineers — not just reduce future taxes.

Step 4: Layering in California R&D Credits

Now let’s look at California.

California’s R&D credit:

• Is calculated separately from federal

• Uses a different rate structure

• Applies only to California-based research

Given that all of this company’s engineering work is done in California, the same wage, supply, and contractor base largely applies.

California’s credit rate is:

• 15% of excess QREs (regular method), or

• ASC, which California now conforms to

Without getting lost in mechanics, this company generated ≈ $100K California R&D credit.

However, California credits:

• Are non-refundable

• Cannot offset payroll taxes

• Carry forward indefinitely

So while California doesn’t deliver immediate cash, it creates a long-lived tax asset.

Step 5: Why This Is Strategically Valuable

This is where many companies miss the bigger picture.

For this rocket company:

• The federal credit improves near-term cash flow through payroll tax offsets

• The California credit builds a permanent tax shield for future profitability

• Both credits become valuable tax attributes if the company raises capital or is acquired and provides ≈ $300K in Total Value.

Even though the company isn’t profitable today, these credits:

• reduce future tax drag,

• strengthen the balance sheet,

• and signal operational maturity to investors and buyers.

The Bigger Takeaway

Nothing about this case is exotic.

This is a relatively small engineering team, with:

• real technical uncertainty,

• real experimentation,

• and real financial impact.

Yet many companies in this exact position assume:

“We’ll worry about R&D credits later, once we’re profitable.”

This case study shows why that’s often the wrong conclusion.

The value of the R&D credit isn’t just about today’s tax bill — it’s about funding innovation now and stacking tax attributes for the future.

That’s especially true for deep-tech companies building something genuinely new.