Qualified Research Expenses (QREs): What Counts
Qualifying activity is half the claim. These are the dollars.
QRE meaning: qualified research expenses are the costs the federal R&D tax credit is computed on. Under IRC §41(b) they are four things and nothing else: taxable wages for performing, directly supervising or directly supporting qualified research; supplies consumed in it; amounts paid for the right to use computers in it, which today mostly means cloud compute; and 65% of amounts paid to contractors to perform it. It is a closed list: no amount of research in a cost makes it a QRE if it is not one of the four. Here is what belongs in each category, at what percentage, and where first-draft credits usually go wrong.
The shape of a QRE base
Wages usually carry the claim; the other three categories decide whether it is complete.
- Wages 68%
- Supplies 9%
- Contract research 18%
- Cloud and computer rental 5%
Contract research enters the QRE base at 65% of the amount paid, §41(b)(3)(A). Certain qualified research consortia enter at 75% and certain qualified energy research at 100%.
Data table
| Category | Share of QRE | Statute |
|---|---|---|
| Wages | 68% | §41(b)(2)(A)(i), (b)(2)(D) |
| Supplies | 9% | §41(b)(2)(A)(ii), (b)(2)(C) |
| Contract research | 18% | §41(b)(3)(A) |
| Cloud and computer rental | 5% | §41(b)(2)(A)(iii) |
| Total | 100% |
Four categories, and only four
Qualified research expenses are in-house research expenses - wages, supplies, and computer rental - plus contract research expenses. Everything else is a deduction question, not a credit question.
| Category | Authority | What counts | How much counts |
|---|---|---|---|
| Wages | §41(b)(2)(A)(i), (B), (D); Treas. Reg. §1.41-2(c)-(d) | Taxable wages under §3401(a), in practice Form W-2 Box 1, paid to employees who perform qualified research, directly supervise it as first-line managers, or directly support it, such as the technician who runs the test. | The qualified share of each person’s wages. All of them when at least 80% of that person’s wages for the year are for qualified services (Treas. Reg. §1.41-2(d)(2)). |
| Supplies | §41(b)(2)(A)(ii), (C); Treas. Reg. §1.41-2(b) | Tangible property used and consumed in qualified research: prototype material, test articles, reagents. Never land, improvements to land, or property subject to depreciation. | The qualified portion in full. Utilities only where the special character of the research required extraordinary additional amounts. |
| Computer rental and cloud | §41(b)(2)(A)(iii); Treas. Reg. §1.41-2(b)(4) | Amounts paid to another person for the right to use computers in qualified research. The computer must be owned and operated by someone else, located off your premises, and you must not be its primary user. | The portion used to conduct qualified research, less anything you receive from others for the right to use substantially identical property. |
| Contract research | §41(b)(3); Treas. Reg. §1.41-2(e) | Amounts paid to anyone other than an employee for qualified research performed on your behalf, under an agreement made before the work that requires you to pay even if the research fails. | 65% of the qualified portion. 75% for a qualified research consortium; 100% for energy research paid to an eligible small business, a university, or a federal laboratory. |
Two further components of the credit sit outside these four and rarely apply outside large corporate or university-sponsored programs: basic research payments to qualified organizations above a base amount (§41(a)(2), §41(e)) and payments to an energy research consortium (§41(a)(3)). If you fund university research, raise it - the mechanics differ from contract research and the money is often left on the table. Everything below assumes the activity has already cleared the four-part test at the business-component level.
Supplies: consumed, tangible, and not depreciable
The statute defines supplies as tangible property used in the conduct of qualified research, other than land or improvements to land and other than property of a character subject to the allowance for depreciation. Two exclusions doing an enormous amount of work: capital equipment is out by definition, and so is anything intangible.
The category rewards physical industries. Manufacturers and hardware companies consume real material proving out a process; life-science companies burn through reagents and single-use consumables. Pure-software companies usually find little here, which is fine - their claim lives in wages and compute.
One nuance worth money. Treas. Reg. §1.41-2(b) treats utilities as general and administrative - but where you can establish that the special character of the qualified research required additional extraordinary utility expenditures, such as a furnace campaign or a sustained environmental-chamber run, those additional amounts are treated as supplies. It is a documented exception, never a default.
Typically counts
- Prototype and test-article material
- Test coupons and scrapped first articles
- Raw stock consumed in trial and qualification runs
- Reagents, media, and single-use bioprocess consumables
- PCB fabrication and assembly for test boards
- Tooling consumed in the trial rather than capitalized
Doesn’t count
- Capital equipment and its depreciation
- Rent, facilities, and ordinary utilities
- Shipping, freight, and travel
- Software licenses and subscriptions
- Patent, legal, and professional fees
- General lab or shop supplies not traced to qualified research
One question examiners do ask: pilot-run material that is later sold at full value. Whether it was consumed in the conduct of qualified research is a facts determination, and it should be made deliberately rather than discovered during an exam.
65% is the rule. 75% and 100% are not upgrades you can elect.
§41(b)(3) counts amounts paid to any person other than an employee for qualified research performed on your behalf - at a statutory percentage that depends entirely on who the payee is.
| Rate | Authority | Who it applies to | What it takes to use it |
|---|---|---|---|
| 65% | §41(b)(3)(A) | Any person other than an employee of the taxpayer, for qualified research performed on your behalf. | The default. In our studies it is the only rate applied without a specific, written determination about the payee. |
| 75% | §41(b)(3)(C)(i) | A qualified research consortium under §41(b)(3)(C)(ii): a tax-exempt §501(c)(3) or §501(c)(6) organization, organized and operated primarily to conduct scientific research, and not a private foundation - for research on behalf of you and one or more unrelated taxpayers. | A documented basis that the payee meets the §41(b)(3)(C)(ii) definition. “Our vendor is a research organization” does not reach it. |
| 100% | §41(b)(3)(D) | Energy research payments to an eligible small business, an institution of higher education, or a Federal laboratory. | Energy research only, with the payee’s status established. Narrow by design. |
Three conditions before any percentage applies
Treas. Reg. §1.41-2(e)(2) treats an amount as paid for the performance of qualified research only if it is paid under an agreement that is entered into before the research is performed, provides that the research is performed on your behalf, and requires you to bear the expense even if the research is not successful. Any part of a payment that is contingent on success is treated as paying for the result, not the research, and drops out. “On your behalf” means you have a right to the results, though not necessarily an exclusive one.
There is no 75% rate for a “qualified research organization.” That concept comes from §41(e)(6) and governs basic research payments - a different component of the credit entirely. Importing it into §41(b)(3) is one of the most common overstatements we see in prior-year workpapers. Absent a recorded consortium or energy determination, 65% is the ceiling, and our engine enforces it at read time no matter what a spreadsheet upstream says.
Timing follows the research, not the invoice. Under §41(b)(3)(B), amounts paid for research to be conducted after the close of the taxable year are treated as paid in the year the research is actually conducted. Prepayments do not accelerate the credit, and the reduction to 65% is applied after the qualified portion of the engagement is determined - gross, then qualified share, then the statutory percentage.
Computer rental was written for mainframes. It now means cloud.
The statute counts amounts paid to another person for the right to use computers in the conduct of qualified research. The regulation sets the shape of it: the computer is owned and operated by someone other than you, it sits off your premises, and you are not its primary user - and the amount is reduced by anything you receive for letting others use it.
Those conditions were drafted for time-shared mainframes, and they map cleanly onto rented cloud compute used to run qualified research: training runs, simulation clusters, load-test rigs, ephemeral development and test environments. For software companies it is often the only non-wage category with real dollars in it.
What generally does not fit: production hosting that serves paying customers, because that is running your commercial product rather than conducting research - and §41(d)(4)(A) is waiting there anyway. Nor do SaaS seat licenses and software subscriptions, which buy a right to use software, not computers. Nor storage and delivery for production traffic. Nor anything running on hardware you own, which is depreciation.
The practical constraint is allocation. One consolidated cloud invoice is not a qualified research expense. Tagged accounts, per-environment cost allocation, or a stated usage-based method is what turns a bill into a defensible number - and it is far easier to switch on in January than to reconstruct in March.
The four conditions
- Paid to another person for the right to use computers
- Owned and operated by someone other than you
- Located off your premises
- You are not the primary user
Reduced by amounts you receive for granting others the use of the same computing. Applying these conditions to a modern cloud account is a facts exercise; the answer depends on the service, the workload, and the contract.
What reaches the base, and what never does
The four categories that count, then the costs that do not. Most inflated first-draft credits are built from the lower half - and many of those costs are perfectly good §174A deductions, because the two bases are not the same base.
| Cost | Counts toward QRE | Why |
|---|---|---|
| Employee wages | In full, for the qualified portion | §41(b)(2)(A)(i) - Wages within the meaning of §3401(a) paid to employees for qualified services. Usually the largest category - and the one examiners test hardest. |
| Supplies | In full, for the qualified portion | §41(b)(2)(A)(ii) - Tangible property consumed in the conduct of qualified research - never land, improvements, or anything depreciable. |
| Contract research | 65% (75% / 100% in two narrow cases) | §41(b)(3) - 65% of amounts paid to non-employees for qualified research performed on your behalf. Two narrow tiers go higher. |
| Computer rental & cloud | In full, for the qualified portion | §41(b)(2)(A)(iii) - Amounts paid for the right to use someone else’s computers in the conduct of qualified research - the rule cloud compute now lives under. |
| Employer payroll taxes and benefits | No | FICA, FUTA, the 401(k) match, health premiums, and other fringe benefits are not §3401(a) wages. Fully-loaded cost is a management number, not a QRE. |
| Rent, facilities, and general utilities | No | Treated as general and administrative expenses, with one documented exception for extraordinary utilities required by the special character of the research. |
| Land, capital equipment and depreciation | No | Land and improvements to land, a press, a bioreactor, a test rig, servers you own. Land and depreciable property are carved out of the supplies definition by statute. |
| Research performed outside the U.S. | No | Excluded by §41(d)(4)(F) - measured by where the work happens, not by who does it or who pays for it. |
| Funded research | No | Grant-, contract-, or customer-funded work where you don’t bear the risk or don’t keep substantial rights. §41(d)(4)(H), covered below. |
| Patent, legal, travel, and recruiting costs | No | Frequently research-related, frequently deductible, never in the four §41(b) categories. |
| Software licenses and SaaS subscriptions | No | A right to use software is not a right to use computers, and it is not tangible property consumed in research. |
| Overhead allocations of any kind | No | If a cost arrives as a percentage allocation of general overhead rather than as one of the four categories, it does not belong in the credit base. |
QRE examples: how $809,000 of spending becomes a QRE base
An invented hardware start-up, nine cost lines, and the rule that decides each one. Most of the gap between what a company spends on R&D and its QREs is explained by a handful of rules.
| Cost | Amount paid | Rule applied | QRE |
|---|---|---|---|
| Engineer A: 85% of wages for qualified services | $160,000 | 80% rule: all wages count (Treas. Reg. §1.41-2(d)(2)) | $160,000 |
| Engineer B: 50% of wages for qualified services | $140,000 | Qualified share only (Treas. Reg. §1.41-2(d)(1)) | $70,000 |
| First-line engineering manager: 40% directly supervising qualified research | $180,000 | Direct supervision share (Treas. Reg. §1.41-2(c)(2)) | $72,000 |
| Employer payroll taxes and benefits on the three people above | $95,000 | Not §3401(a) wages | $0 |
| Prototype material consumed in trial runs | $18,000 | Supplies, in full | $18,000 |
| Test fixture, capitalized | $40,000 | Depreciable property is never a supply | $0 |
| Cloud bill, of which $30,000 ran experiments in a tagged environment | $90,000 | Computer rental, research portion only | $30,000 |
| Engineering firm, fixed price, paid even if it fails, results yours | $50,000 | Contract research at 65% | $32,500 |
| Share of office rent | $36,000 | General and administrative | $0 |
| Total | $809,000 | $382,500 |
From QREs to a credit
The QRE total is the input, not the answer. The credit is 20% of QREs above a base amount under the regular method, or 14% of QREs above half the prior three-year average under the ASC. Put your own figures through the R&D tax credit calculator, or see how the methods compare in calculation methods.
Where QREs land on the return
On the current Form 6765, QREs are summarized by category in Section F and, for tax years beginning after 2025, reported by business component in Section G unless an exemption applies. The Form 6765 guide walks through it line by line, and our worked SaaS example shows a full QRE base being built.
Every rule above is an evidence problem before it is arithmetic
A QRE total is only as good as the trail behind it: a wage base reconciled to the W-2s and the payroll register, an allocation with a stated method, supplies traced from a general-ledger account to a specific business component, contracts read for rights and risk with the determination written down, and cloud costs allocated by a method you can describe. Then every dollar has to be attributable to a business component - which is exactly what Form 6765’s Section G now asks you to report.
That is the discipline our platform is built around: figures that reconcile in every direction, each removed dollar carrying a §41 basis, and nothing restated twice. What examiners request, what to keep, and how the record gets assembled is covered on documentation & substantiation. Once the QRE total is settled, the calculation method decides what it is worth - and a qualified small business can take the result as cash against payroll taxes rather than waiting on income-tax liability.