A company is able to obtain benefits from the Research and Development Tax Credit as long as they have Qualified Research Expenses (QREs).
Qualifying Expenses
The IRS defines Qualified Research Expenses (QREs) as the sum of “in-house research expenses” and “contract research expenses”. Those expenses include:
- Wages: Taxable or subject to self-employment tax of individuals performing, directly supervising or supporting the qualified research.
- Supplies: Amount paid or incurred for materials used in the conduct of qualified research.
- Contract Research: Payments for the conduct of research. The taxpayer must be at risk when conducting the research.
Non-Qualifying Expenses
Wage eligibility is based upon what an employee does during a period of time. The taxpayer also has to take into account, but not as conclusive evidence, the employee’s technical and education qualifications. Wages to general support personnel not involved in any experimental or technical projects such as payroll or janitorial staff are generally non-qualifying expenses.
Supplies usually represent a small portion of the total QRE. Thus, a taxpayer should be cautious when claiming supplies as part of their QREs. Ineligible supplies expenses include: travel, meals, entertainment, telephone expenses of researchers, relocation or rental expenses, professional dues or royalty, etc.
Lastly, contract research also makes up a portion of the QRE. However, a taxpayer won’t be able to claim a contract research expense as part of the R&D Tax Credit calculation unless it fulfills a three-part test imposed by the IRS. The IRS provides a three-part test which determines what is considered a contract research expense. The contract research agreement with a third party:
- Must be agreed on prior to the performance of the qualified research.
- States that the research is being performed on the taxpayer’s behalf.
- Requires the taxpayer to bear the expense of any risk involved with the research.
If the taxpayer claims this expense without a contract research agreement as stated above this expense will not pass an IRS audit.