Employee Activities That Can Qualify For The R&D Tax Credit
Qualified Labor Expenses
Qualified Labor Expenses are any wages that are paid to an employee for “qualified services” performed by that employee. The IRS defines the term “wages” as all taxable wages reported on Form W2, which includes bonuses and stock option redemptions.
Furthermore, the IRS defines a “qualified service” as an individual who:
- Engages in qualified research
- Directly supervises qualified research
- Directly supports qualified research
Engaging in qualified research means that the employee is the one that is actually conducting the qualified research.
For a company developing a new software platform, direct qualified research might include architecting, coding, and experimenting on product design iterations.
For a company that is developing a physical consumer product, direct qualified research might generally include designing, building, and testing the development of prototypes.
Examples of directly qualified research could include:
- Developing functional, design, and test specifications
- Building pilot or prototype models of the product to eliminate technical uncertainties
- Designing and executing experiments, pilots, trials, or betas to test hypotheses
- Writing Software programs that comprise a new or improved business component
- Research, analysis, or modeling that directly leads to recommendations for improving the product
- Creating user experience designs, interactions, or interfaces affecting product functionality or usability
- Conducting or designing quality assurance testing of core platform under development (including unit testing, regression testing, performance testing, and functional testing)
- Writing specs and product/technical requirements documents
Direct supervision is the immediate supervision (first-line management) of qualified research. This is the first-line management of qualified research, like a research scientist who directly supervises laboratory experiments, but who may not actually perform experiments. This could also be a VP or Director in a more flat, or matrixed organization like a startup.
Examples of potentially qualifying direct supervision could include:
- Team retrospectives ("retros" aka "sprint retrospectives" or iteration retrospective" or sometimes, 'post mortems')
- Team brainstorms
- Design reviews
- Running project status meetings
- Evaluating the performance of research items
Direct support occurs when an individual is performing activities that directly aide the actions of those conducting the qualified research, or supporting those who are directly supervising the individuals who are conducting the qualified research.
These activities do not include general and administrative services, or other services only indirectly of benefit to research activities.
Examples of potentially qualifying direct support could include:
- Obtaining estimates of resource requirements
- A member of an Ops or Support team providing feedback to the development team about how things are working in an a/b test
- A Sales person providing feedback directly to the development teams about a bug that may require qualifying research to be conducted in order to address
- Any individual doing user testing on a qualifying project
- Attending technical and design review meetings
- Compiling/pulling data necessary to perform testing
- Documenting the results of the research
What's Not Qualified?
Some subset of activities may never qualify for the R&D Credit because general administrative services or other services that only indirectly benefit research activities are not considered qualifying activities.
Examples of likely non-qualifying activities include:
- Most pure HR-type roles
- Building team job ladders, interview rubrics, or employee training programs
- Market research, market testing, or marketing development
- Research in the social sciences
- Setting up general company foundations (ex. setting up software or bank accounts)
- Routine bug fixing, data gathering, or maintenance on existing and stable software products (aka ineligible business components)
In Summary:
- Many start up companies are focused on developing their core product or platform, and may spend most of their time on qualified activities - either directly engaging in qualified research, or directly supporting or directly supervising qualified research
- Often, individuals may be performing qualified activities, even if their job title doesn't explicitly state that they do.
- To the extent that in individual spends 80% or more of their time performing qualified services, the IRS allows you to treat 100% of their services as qualified.
You are able to find additional information on Qualified Research Expenses & IRS definitions via the IRS’ Audit Techniques Guide.