Employee wages are one of the categories of qualified research expenses (QREs) that may be taken into account in computing the federal R&D tax credit under Section 41. But not every wage paid to someone doing technical work qualifies. This page explains, in general terms, when certain employee wages may be considered qualified research expenses and what the rules emphasize.
When Employee Wages May Be Relevant
Under Section 41(b)(2), in-house research expenses include wages paid or incurred to an employee for "qualified services" performed by that employee. Whether a given employee's wages are relevant depends on what the employee actually did during the taxable year — not on the employee's job title or department. The analysis is generally a facts-and-circumstances determination supported by records of the employee's activities.
Three Categories of Qualified Services
Section 41(b)(2)(B) defines "qualified services" as services consisting of:
- engaging in qualified research;
- engaging in the direct supervision of research activities that constitute qualified research; or
- engaging in the direct support of research activities that constitute qualified research.
These three categories — direct research, direct supervision, and direct support — are the framework for evaluating whether an employee's wages may be taken into account. The Treasury Regulations under Section 41 (§1.41-2) provide additional detail on what each category involves.
Direct Research
The first category covers employees who engage in qualified research — that is, employees whose services involve performing the activities that satisfy the four-part test for qualified research. For more on what qualified research requires, see our pages on qualified research and the four-part test.
Direct Supervision
The second category covers employees who engage in the direct supervision of research activities that constitute qualified research. Direct supervision generally involves overseeing the qualified research activities of others, rather than general management or administration. The Treasury Regulations address what direct supervision includes, and not every supervisory role will qualify — the supervision must be of qualified research activities and must meet the regulatory standard.
Direct Support
The third category covers employees who engage in the direct support of qualified research activities. Direct support generally involves services that directly assist the conduct of qualified research, rather than general overhead or administrative functions. The Treasury Regulations address what direct support includes and what it excludes, and indirect or general support generally does not qualify.
What Generally Is Not Enough
Several things are generally not enough, by themselves, to make an employee's wages qualified research expenses:
- a technical or engineering job title;
- working in a research or development department;
- general management or administration of a research function;
- indirect support that is not directly tied to qualified research activities; or
- activities that do not satisfy the four-part test.
Section 41 also provides that wages do not include amounts taken into account in determining the work opportunity credit under Section 51(a), and defines wages by reference to Section 3401(a). Whether a particular employee's wages qualify depends on the specific services performed and the applicable rules.
Allocating Wages Across Activities
Where an employee performs qualified services for only part of the year, or splits time between qualified research and other work, the wages generally need to be allocated so that only the portion attributable to qualified services is taken into account. Section 41(b)(2)(B) includes a "substantially all" rule: if substantially all of the services performed by an individual for the taxpayer during the taxable year consist of qualified services, then all of the services performed by that individual for the year are treated as qualified services. Where that threshold is not met, an allocation is generally required. The specific allocation method should be supportable and consistent with the regulations and the Instructions for Form 6765.
Documentation That May Help
Because the analysis depends on what employees actually did, records created during the year can help support wage claims. Potentially useful records include project assignments, time and effort records, descriptions of the activities performed, and records connecting employees to specific business components and qualified activities. Generalized after-the-fact estimates tend to be less persuasive. The IRS has noted that studies relying on manager recollection without supportable records can fail to establish the required connection. For more, see our page on R&D tax credit documentation.
Example Fact Patterns
The following are general examples that may warrant review; none automatically qualifies, and each depends on the specific facts:
- An engineer who spends the year evaluating alternative designs to resolve a technical uncertainty about a new product may have wages that warrant review under the direct research category.
- A lead engineer who directly supervises a team conducting qualified research may have wages that warrant review under the direct supervision category.
- A technician who directly supports qualified research by conducting tests integral to the experimentation may have wages that warrant review under the direct support category.
- An employee who spends most of the year on routine production or general administration generally would not have those wages qualify, regardless of job title.
In each case, the question is whether the services fall within the qualified services categories and whether the underlying activities constitute qualified research.
Key Takeaway
Certain employee wages may be taken into account as qualified research expenses when the employee engages in qualified research, or in the direct supervision or direct support of qualified research activities. Job title alone does not determine treatment, all of an employee's wages are not automatically includable, and time and activity allocations can matter. Because these determinations are fact-specific, professional review is appropriate. For the broader cost framework, see our page on qualified research expenses.