The Research & Development (R&D) tax credit is one of the most valuable incentives available to innovative U.S. businesses, offering dollar-for-dollar reductions in tax liability, or even offsetting against payroll taxes for qualified small businesses. But one of the biggest questions for companies looking to claim the credit is understanding which expenses actually qualify.

At its core, the federal R&D credit is built around the Qualified Research Expenses (QREs) your business incurs in the process of developing or improving products, processes, or technologies. These QREs must be for U.S.-based work, and generally fall into three main categories: wages, contractor expenses, and supply costs.

Let’s break each of them down:

1. Wages

In general, the largest portion of the R&D tax credit value comes from employee wages. If your team includes engineers, developers, designers, or technicians working on qualifying projects, their compensation may count toward the credit.

To be eligible, an employee must perform qualified services, which generally fall into three buckets:

  • Direct research (e.g., coding a new software feature or testing a prototype)

  • Direct supervision of those doing research (e.g., a manager leading an R&D team)

  • Direct support of research activities (e.g., a technician collecting lab data)

Only the wages for time spent on qualifying R&D activities count, not all of their wages. This is why good time-tracking or project documentation is important for maximizing your credit.

2. Contract Expenses

Many companies outsource part of their R&D work to outside vendors, consultants, or independent contractors. The IRS allows you to include a portion of these contract research expenses in your credit calculation, typically 65% of the amount paid to the contractor.

To qualify, the work must be:

  • Performed within the U.S.

  • Involving a degree of technical uncertainty

  • Conducted under an agreement where your company retains substantial rights to the results

This includes software developers, product design firms, testing labs, and other specialists who work alongside your team to drive innovation.

3. Supplies: Materials That Fuel Development

You can also claim the cost of tangible materials used during the R&D process. This includes:

  • Prototypes

  • Raw materials used in testing

  • Components used in experimental models

  • Lab supplies and testing equipment (excluding depreciable capital assets)

Supplies must be consumed in the course of qualified research. For example, materials used to build a prototype device for testing would qualify, but a laptop purchased for general use would not.

Why This Matters

Understanding these categories is essential to claiming the R&D tax credit accurately and confidently. Companies often leave money on the table by underestimating which costs qualify, or by overlooking key supporting documentation.

At Arvo, our platform and team of experts guide you through identifying and documenting every eligible expense, ensuring you maximize your credit while staying compliant with IRS rules.

Curious what you could be missing?
Schedule a free consultation with our team today to see if your wages, contractor work, or supply costs could qualify for the R&D credit.