Qualified Research Expenses (QRE): Complete Guide to What Counts
Qualified Research Expenses (QRE): Complete Guide to What Counts
Quick Answer
Qualified Research Expenses (QRE) are the foundation of your R&D tax credit calculation. QRE includes wages for employees performing qualified research, supplies consumed in R&D activities, and 65% of contract research payments. Understanding what qualifies—and what doesn’t—is critical to maximizing your credit while maintaining audit defensibility. The most common mistakes are including non-qualifying activities, missing supply expenses, and incorrectly applying the 65% contractor rule.
Key Takeaways
- Three QRE categories: Wages, supplies, contract research
- Wages include benefits: Total compensation, not just salary
- Supplies must be consumed: Tangible materials used up in R&D
- Contractors at 65%: Only 65% of payments qualify (75% for basic research)
- Documentation required: Track each category by project and employee
The Three Categories of QRE
Overview
| Category | What’s Included | Percentage Counted |
|---|---|---|
| Wages | Employee compensation for qualified research | 100% |
| Supplies | Tangible materials consumed in R&D | 100% |
| Contract Research | Payments to third parties for R&D | 65% (or 75%) |
How They Build Your Credit
Total QRE = Wage QRE + Supply QRE + Contract Research QRE
Example:
Wage QRE: $500,000
Supply QRE: $50,000
Contract Research QRE: $32,500 (65% of $50K contractor payments)
Total QRE: $582,500
Wage QRE: Detailed Breakdown
What Counts as Wages
| Component | Qualifies? | Notes |
|---|---|---|
| Base salary | Yes | For qualified research time |
| Bonuses | Yes | If tied to qualified work |
| Commissions | No | Generally not for R&D roles |
| Health insurance | Yes | Employer-paid portion |
| 401(k) match | Yes | Employer contribution |
| Payroll taxes | Yes | Employer FICA, FUTA, SUTA |
| Stock options | Complex | See tax advisor |
| Education benefits | Sometimes | If directly related to R&D work |
Who Qualifies for Wage QRE
Employees must be engaged in qualified research activities:
| Role | Qualifying Activities |
|---|---|
| Directly engaging | Performing experiments, writing code, conducting tests |
| Directly supervising | Managing R&D teams, making technical decisions |
| Directly supporting | Technicians maintaining R&D equipment |
Time Allocation
Not all employee time qualifies. Track:
| Time Type | Qualifies? |
|---|---|
| Performing experiments | Yes |
| Designing new features | Yes |
| Testing alternatives | Yes |
| Meetings about R&D | Yes |
| Routine maintenance | No |
| Administrative work | No |
| Customer support | No |
| Sales activities | No |
Calculating Wage QRE
Employee: Senior Developer
Annual Compensation: $150,000
Benefits (employer-paid): $35,000
Total Compensation: $185,000
Time Allocation:
R&D activities: 80%
Non-qualifying: 20%
Wage QRE for this employee: $185,000 × 80% = $148,000
Common Wage QRE Mistakes
| Mistake | Impact | Fix |
|---|---|---|
| 100% allocation for all engineers | Overstates QRE | Track actual time |
| Excluding benefits | Understates QRE | Include all compensation |
| Including admin time | Overstates QRE | Separate non-R&D time |
| Not tracking at project level | Documentation weakness | Implement time tracking |
Supply QRE: What Materials Count
Definition
Supplies are tangible materials that are:
- Consumed or transformed during R&D
- Used directly in qualified research
- Not recoverable or reusable
What Qualifies as Supplies
| Category | Examples | Qualifies? |
|---|---|---|
| Lab materials | Chemicals, reagents, cultures | Yes |
| Prototypes | Physical models for testing | Yes |
| Test materials | Components for experiments | Yes |
| Small equipment (<$2,500) | Hand tools, sensors | Yes |
| Cloud computing | GPU hours for training | Yes |
| Data storage | For R&D experiments | Yes |
| Office supplies | Paper, pens, general | No |
| Large equipment | Manufacturing equipment | No (depreciate) |
| Production materials | For sale to customers | No |
Cloud Computing as Supplies
Cloud costs for R&D are a significant supply category:
| Cloud Cost Type | Qualifies? | Conditions |
|---|---|---|
| Development environments | Yes | Allocated to R&D |
| Training instances (GPU/TPU) | Yes | For qualified experiments |
| Data storage for R&D | Yes | Allocated to R&D |
| Production environments | No | Not R&D |
| Customer-facing services | No | Not R&D |
Allocating Cloud Costs
Monthly Cloud Bill: $40,000
R&D Environments:
Development: $15,000 → 100% R&D
Training/Testing: $10,000 → 100% R&D
Staging (experimental): $5,000 → 80% R&D = $4,000
Non-R&D:
Production: $8,000 → 0% R&D
Monitoring: $2,000 → 0% R&D
Monthly Supply QRE: $15,000 + $10,000 + $4,000 = $29,000
Annual Supply QRE: $29,000 × 12 = $348,000
Equipment vs. Supplies
| Threshold | Treatment |
|---|---|
| Under $2,500 per unit | May expense as supplies |
| Over $2,500 per unit | Must depreciate (not QRE) |
| Useful life > 1 year | Must depreciate |
Common Supply QRE Mistakes
| Mistake | Impact |
|---|---|
| Forgetting cloud costs | Understates QRE |
| Including production materials | Overstates QRE |
| Not tracking by project | Documentation weakness |
| Missing lab/prototype costs | Understates QRE |
Contract Research QRE
The 65% Rule
Only 65% of contract research payments qualify as QRE:
| Payment Recipient | Qualifying % |
|---|---|
| Third-party contractors | 65% |
| Qualified organizations (universities) for basic research | 75% |
| Government-funded research | May not qualify |
Why Only 65%?
The reduced percentage reflects that:
- The company doesn’t bear 100% of the risk
- Some overhead shouldn’t be credited
- The contractor has their own potential credit claim
Who Can Be a Contractor
| Contractor Type | Examples |
|---|---|
| CROs | Contract Research Organizations |
| Engineering firms | Design and testing services |
| Software consultants | Development contractors |
| Universities | Basic research collaborations |
| Labs | Testing and analysis services |
Requirements for Contract Research
For contractor payments to qualify:
| Requirement | Details |
|---|---|
| Qualified activities | Work must meet 4-Part Test |
| Payment basis | Must be for qualified research |
| Right to results | Company must own or have rights to research results |
| No government funding | Government-funded research has special rules |
Calculating Contract Research QRE
Contractor: Engineering consultancy
Annual payments: $200,000
Qualified research activities: 100% of contract
Contract Research QRE: $200,000 × 65% = $130,000
Common Contract Research Mistakes
| Mistake | Impact |
|---|---|
| Including 100% of contractor payments | Overstates QRE |
| Not verifying contractor activities | Audit risk |
| Including non-technical consultants | Does not qualify |
| Missing CRO payments | Understates QRE |
Non-Qualifying Expenses
What Doesn’t Count as QRE
| Category | Examples | Why Not Qualified |
|---|---|---|
| Overhead | Rent, utilities, general admin | Not directly related to R&D |
| Management | General management, HR | Not technical research |
| Marketing | Sales, advertising | Not R&D activities |
| Quality control | Routine testing | No technical uncertainty |
| Production | Manufacturing, operations | Not experimentation |
| Legal | Patent attorneys, IP work | Not technical research |
| Finance | Accounting, treasury | Not technical research |
Gray Areas
| Expense | Usually Qualifies? | When It Might |
|---|---|---|
| DevOps infrastructure | Sometimes | If supporting R&D environments |
| Technical writing | Rarely | If documenting experiments |
| Training | Rarely | If directly related to R&D skills |
| Travel | Sometimes | For R&D collaboration |
Documentation Requirements
What to Track
| Category | Documentation Needed |
|---|---|
| Wages | Payroll records, time tracking, job descriptions |
| Supplies | Purchase records, usage logs, allocation documentation |
| Contractors | Contracts, invoices, scope of work, deliverables |
Time Tracking Best Practices
| Method | Strength | Weakness |
|---|---|---|
| Weekly timesheets | Contemporaneous, defensible | Requires discipline |
| Monthly allocation | Simpler | Less precise |
| Project estimation | Easiest | Least defensible |
Recommendation: Weekly or bi-weekly timesheets by project
Project-Level Documentation
For each project, maintain:
Project Name: [Name]
Period: [Start - End]
QRE Summary:
Wage QRE: $XXX
- Employee A: $XX (XX% allocation)
- Employee B: $XX (XX% allocation)
Supply QRE: $XXX
- Cloud: $XX
- Materials: $XX
Contract Research QRE: $XXX
- Contractor A: $XX (65% of $XX)
QRE by Industry
Software/Technology
| Typical QRE Breakdown | Percentage |
|---|---|
| Wages | 85-95% |
| Supplies (cloud) | 5-15% |
| Contract research | 0-10% |
Biotech/Pharma
| Typical QRE Breakdown | Percentage |
|---|---|
| Wages | 60-80% |
| Supplies (lab) | 10-20% |
| Contract research (CROs) | 10-30% |
Manufacturing
| Typical QRE Breakdown | Percentage |
|---|---|
| Wages | 70-85% |
| Supplies (materials) | 10-25% |
| Contract research | 0-10% |
QRE Calculation Example
Company Profile
Business: SaaS company
Employees: 25 total, 18 technical
Contractors: 2 development consultants
Annual Financial Data:
Technical employee compensation: $2,500,000
Cloud costs: $300,000
Contractor payments: $150,000
QRE Calculation
Wage QRE:
Total technical compensation: $2,500,000
Average qualifying percentage: 75%
Wage QRE: $1,875,000
Supply QRE:
Total cloud costs: $300,000
R&D allocation: 70%
Supply QRE: $210,000
Contract Research QRE:
Contractor payments: $150,000
Qualifying activities: 100%
Contract Research QRE: $150,000 × 65% = $97,500
Total QRE:
Wage QRE: $1,875,000
Supply QRE: $210,000
Contract Research QRE: $97,500
Total QRE: $2,182,500
Estimated Credit (ASC, first-time filer):
$2,182,500 × 14% = $305,550
Frequently Asked Questions
Do wages include bonuses?
Yes, if the bonuses are tied to R&D work. Performance bonuses for technical employees can be included in wage QRE.
Can I claim equipment depreciation as QRE?
No. Equipment must be depreciated separately and is not part of QRE. Small equipment (under $2,500 per unit) may be expensed as supplies.
What about foreign contractors?
Foreign contractors can qualify, but the research must be performed for your benefit, and you must have rights to the results. Section 174 capitalization rules differ for foreign research.
How do I handle part-time employees?
Calculate wage QRE based on the portion of their time spent on qualified research. Part-time employees are treated the same as full-time for credit purposes.
Can I estimate time allocations?
Estimates are allowed but are less defensible than contemporaneous time tracking. The IRS prefers documented time records over after-the-fact estimates.
What if contractors do both R&D and non-R&D work?
Only the portion of payments for qualified research activities counts. Review contractor deliverables and allocate payments accordingly.
Disclaimer: QRE determinations involve complex technical and tax analysis. This guide provides general information. Consult a qualified tax professional for advice specific to your situation.
Related Guides
- R&D Tax Credit 4-Part Test
- ASC 730 vs Regular Method
- R&D Tax Credit Documentation Checklist
- Contract Research R&D Credits