The IRS R&D tax credit program has been around for over 40 years, encouraging businesses to keep innovating and developing new products. Tax credits are a powerful source of alternative funding — you can reinvest those resources to drive more innovation, stand out from competitors, and unlock new growth opportunities.
This reduction in tax liability can make a real difference for startups and small businesses in fields like computer science, software development, biotech, and food and beverage manufacturing.
Yet many companies miss out on the full benefits of the program, often because they’re unsure which expenses or R&D activities actually qualify.
Find out what expenses qualify for the R&D tax credit so you can take advantage of the program and keep pushing your business into the next era of innovation.
What Counts as Qualified Research Expenses?
There are two main types of qualified research expenses (QREs): in-house research expenses and contract research expenses.
In-house research expenses include:
- Wages or payments to employees for performing qualified services
- Supplies purchased for qualified research
- Contract research expenses paid to conduct qualified research
In this context, wages include all taxable compensation reported on an employee’s W-2 form, but do not include untaxed income or benefits.
To count as providing qualified services, an employee must be directly performing, supervising, or supporting the qualified research. If only part of an employee’s job involves qualified services — for example, one-third of their time — only that portion counts as a qualified research expense.
Any tangible property bought to carry out qualified research can be considered a supply. For example, if a company is developing a new cell phone case, the materials used for prototyping would count as supply expenses. Similarly, a pharmaceutical company creating a new drug formula can include the ingredients used in research as supply expenses.
Contract research expenses apply when a person or business conducts qualified research for the taxpayer. In these cases, 65% of the amount paid to the non-employee can be claimed as a qualified expense. These expenses can be claimed on your tax return once the work is completed.
To reduce your tax liability, these expenses must be incurred as part of qualified research activities.
What Counts as Qualified Research Activities?
Qualified research expenses are incurred when you perform qualified research activities during the tax year. To claim these activities on your income tax return, they must pass what’s known as the four-part test.
Qualified research activities must meet all four criteria: the section 174 test, the discovering technological information test, the business component test, and the process of experimentation test.
- To pass the section 174 test, the expense must be related to your trade or business and must be an R&D cost in an experimental or laboratory sense.
- To pass the discovering technological information test, your research must aim to discover information that helps resolve uncertainty in creating or improving a business component.
- To pass the business component test, you must intend to use the information gained to develop a new or improved business component.
- To pass the process of experimentation test, your business’s experimentation must:
- Identify uncertainties related to improving an existing business component or developing a new one.
- Identify one or more alternatives to resolve the uncertainty.
- Identify and carry out a method to evaluate those alternatives.
As the taxpayer, it’s your responsibility to make sure you meet the requirements for the business component. If you don’t meet the requirements for the entire project, you can break it down and claim a smaller part. For example, if the whole project doesn’t qualify, maybe a specific phase or element does.
What Expenses and Activities Don’t Qualify for the R&D Tax Credit?
When calculating your tax savings for the year, it’s just as important to know which research expenses and activities don’t qualify.
For in-house expenses like wages, you can’t include an employee’s entire salary if part of their job is unrelated to qualified R&D activities. When calculating supply costs for your R&D credit, you can’t include general administrative costs like utilities, depreciable property, land, or land improvements.
For contract research expenses, the work must be used solely for qualified research. If the work is also used for other products or projects that don’t qualify, those expenses can’t be included in your credit claim.
If your research activities don’t pass the four-part test, neither the activities nor the related expenses qualify. In that case, you can’t use them to increase your R&D tax credit.
How Boast Helps Companies Maximize R&D Tax Credits
The Internal Revenue Code can be confusing, but understanding it is key to getting the most out of your tax benefits. Having an expert on your side who knows the ins and outs of the R&D tax credit program ensures you don’t leave money on the table.
With Boast’s help, healthtech company Smirta has been able to secure larger claims and continually reinvest in R&D, delivering better experiences for cancer patients and bringing solutions to market faster.
Smirta’s team uses artificial intelligence to create innovative solutions for oncologists and cancer centers. For example, Smirta leverages advanced algorithms to forecast patient volumes, helping optimize future appointments, maximize resources, and reduce wait times.
Want to learn how you can get larger claims, faster? Book a free one-hour consultation with a Boast tax expert.
