What Expenses Actually Qualify for the R&D Tax Credit?
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The R&D tax credit is calculated on "qualified research expenses" — but what actually qualifies isn't always obvious. Many companies undercount their QREs because they focus only on obvious categories like lab costs or dedicated R&D staff, missing wages, contractor payments, and supply expenses that would clearly qualify under the IRS rules.
Here's a straightforward breakdown of the three expense categories that make up most QRE calculations.
1. Wages Paid to Employees Conducting Qualified Research
Employee wages are typically the largest component of a company's QRE base, and they're often the most underestimated. The key principle is that wages are qualified to the extent the employee is directly engaged in qualified research activities — or directly supervising or supporting those who are.
A software engineer writing and testing code for a new product feature? Qualified. A project manager whose time is split between overseeing a qualifying development effort and managing unrelated client relationships? Their wages are qualified in proportion to the time spent on the qualifying activity. An executive reviewing research outputs? Potentially qualified for a portion of their compensation.
This is why a proper time-tracking and allocation methodology matters. Businesses with solid time records can claim a higher and more defensible percentage of wages.
2. Contractor and Subcontractor Costs
If you engage outside contractors to perform qualified research activities, a portion of those payments can be included in your QRE base — specifically, 65% of amounts paid to contractors who perform qualified research on your behalf.
The 65% rule exists because the IRS recognizes that not all contractor billings relate directly to research activity. The contractor must be performing research for your company, using your specifications, with your company bearing the financial risk of the work. Contractors who merely deliver a finished product under a fixed contract — without exposure to research risk — generally don't qualify.
3. Supplies Used in the Conduct of Qualified Research
Tangible materials consumed in the research process can be included as QREs. This includes raw materials used in prototyping, components destroyed in testing, and similar items.
Supplies do not include depreciable equipment or property, general overhead, or administrative materials. The key test is whether the supply was directly consumed in the course of conducting a qualifying research activity.
What Doesn't Qualify
Common exclusions include research conducted after commercial production begins, research related to social sciences, management studies, or market research, funded research (where another party pays for the work and bears the financial risk), and research conducted outside the United States.
Getting the QRE Calculation Right
Most companies that do their own R&D credit calculations undercount their QREs — either because they exclude categories that legitimately qualify, or because they use conservative allocations without a systematic methodology. A properly conducted credit study typically produces a meaningfully higher QRE base, and therefore a higher credit, than a back-of-envelope estimate.
