R&D Tax Credit Qualifying Activities and Expenses: What Counts (and What Gets Missed)

The R&D Tax Credit Four-Part Test

Most people with a passing knowledge of the R&D tax credit know of the four-part test:

• Permitted purpose – developing or improving a product, process, software, formula, invention, or technique (new or improved function, performance, reliability, or quality)
• Technological in nature – relies on principles of engineering, physics, chemistry, biology, or computer science
• Elimination of uncertainty – intended to resolve uncertainty about capability, methodology, or design
• Process of experimentation – involves testing, modeling, simulation, trial and error, or systematic evaluation of alternatives

Activities That Typically Qualify

Passing the test is one thing. Knowing which day-to-day activities actually meet it is another. These tend to qualify:

• Designing or engineering new products or prototypes
• Developing new formulations or materials
• Writing or improving software (internal-use software has extra tests, but many projects still qualify)
• Improving manufacturing processes to increase efficiency or reduce waste
• Building and testing pilot models or first-of-a-kind production runs
• Integrating new technology into existing systems
• Developing new or improved algorithms

R&D Tax Credit Qualified Expenses (QREs)

Qualifying activities are only half of it. The other half is the qualified expenses, also called Qualified Research Expenses, or QREs, that actually make up the claim. They fall into four buckets:

1. Wages

• W-2 wages for employees directly conducting research
• Wages for those directly supervising research
• Wages for those directly supporting research (e.g., building test equipment, running trials)

2. Supplies

• Materials consumed in the R&D process (not capital items or general admin supplies)
• Prototype materials that are ultimately scrapped or destroyed in testing

3. Contract Research

• Payments to third parties (contractors, consultants, universities) performing qualified research on the company’s behalf, typically only 65% is includable

4. Cloud Computing / Hosting Costs

• Rental or lease costs of computers used in research, which increasingly includes cloud/server costs for software development and testing

Commonly Overlooked Qualifying Expenses

A few expenses get missed all the time, even though they usually qualify:

• Time spent by quality assurance/testers debugging or validating new features, often overlooked because it “feels” like QA, not R&D
• Failed or abandoned projects. A project that never launched can still generate credit; success isn’t required, only the attempt to resolve uncertainty
• Prototype materials that get destroyed or scrapped during testing (e.g., 3D-printed parts, test batches of a chemical formulation)
• Time spent by production/manufacturing employees on process improvement trials on the factory floor, not just lab-based R&D staff
• First production run costs for a new product line, if the run is also used to test and resolve design uncertainty (pilot models)
• Cloud computing/AWS or Azure charges tied to running test environments, training models, or load-testing new software
• Contractor payments for testing, not just development, such as a third-party lab hired to test material durability
• Supervisory and support staff time, not just the engineers actually building things. A project manager or lab technician’s time can partially qualify if it directly supports experimentation

Not Sure What Qualifies?

Many companies claim only the obvious wages and materials and leave real money on the table because they never look past the rest of their qualified expenses. A closer look at QA time, failed projects, and cloud costs often turns up a larger, better-supported claim than expected.

If you’re not sure whether your current activities and expenses qualify, or you want a second look at a claim you’ve already filed, connect with us or contact Brian Applebaum directly at bapplebaum@kbfadvisory.com.