IRC §41(b)

Qualifying activity is half the claim. These are the dollars.

§41(b) counts four categories of spending and nothing else: wages, supplies, contract research, and rented computing. It is a closed list - no amount of research in a cost makes it a qualified research expense. Here is what belongs in each category, at what percentage, and where first-draft credits usually go wrong.

Get your free credit estimate Start with the four-part test

The closed list

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.

Employee wages

Wages within the meaning of §3401(a) paid to employees for qualified services. Usually 70-90% of a study’s total - and the category examiners test hardest.

§41(b)(2)(A)(i)

Supplies

Tangible property consumed in the conduct of qualified research - never land, improvements, or anything depreciable.

§41(b)(2)(A)(ii)

Contract research

65% of amounts paid to non-employees for qualified research performed on your behalf. Two narrow tiers go higher.

§41(b)(3)

Computer rental & cloud

Amounts paid for the right to use someone else’s computers in the conduct of qualified research - the rule cloud compute now lives under.

§41(b)(2)(A)(iii)

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.

§41(b)(2)(A)(i)

Wages: the largest category, and the most contested

For most companies wages carry the claim. Four rules decide the number, and every one of them is somewhere a thin study loses dollars - or claims dollars it cannot defend.

Tie-out first. A wage base that cannot be reconciled to the W-2s and the payroll register is the first argument you lose in an examination, whatever the percentages say. Our studies tie the base out before anything is allocated.

01 “Wages” has a statutory meaning

§41(b)(2)(D)(i) defines wages by reference to IRC §3401(a) - in practice, the Form W-2 Box 1 figure, which already comes net of pre-tax elective deferrals and cafeteria-plan reductions. Cash bonuses are remuneration for services and belong in the base. Equity compensation that runs through Box 1, such as the spread on a nonqualified option exercise or RSU vesting, is §3401(a) wages too - though whether a particular amount belongs to that individual’s qualified services is a facts question, not an assumption. What is not in the base: the employer’s payroll taxes, retirement match, health premiums, and every other element of fully-loaded cost.

02 Qualified services: three buckets, and only three

§41(b)(2)(B) and Treas. Reg. §1.41-2(c) recognize direct performance of qualified research, direct supervision of it, and direct support of it. Direct supervision means the first-line manager actually directing the research - not the executive two levels up. Direct support is the machinist who makes a part for the experimental model, the technician who runs the assay, the person who records the test results. Support of support is not qualified, and general administrative services never are, however much they benefit the research.

03 The default is actual time, allocated

Where an individual performs both qualified and non-qualified services, Treas. Reg. §1.41-2(d)(1) allocates their wages on the proportion of qualified services. Contemporaneous time data is the strongest evidence; where it does not exist, a documented allocation built from interviews, ticket and commit history, project records, and system evidence can support the number - but the method has to be stated and applied consistently, because that is what an examiner tests.

04 The substantially-all gross-up, and its two limits

Treas. Reg. §1.41-2(d)(2) says that if substantially all - 80% or more, determined on a time basis - of the services an individual performs for you during the year meet §41(b)(2)(B)(i) or (ii) - direct performance of qualified research, or its direct supervision or direct support - then all of that individual’s wages are treated as qualified services. It is a genuine benefit and it is routinely missed.

Two things are worth knowing before you rely on it. First, the 80% is measured across that person’s whole year of services for you, not against a single project. Second, as a matter of policy our platform applies the gross-up more conservatively than the regulation’s outer edge - to direct performance and first-line supervision - and will not book it without an affirmative determination, a written basis, and a substantiated time source: it is the claim-increasing branch, so it has to be made, not inferred.

Not to be confused with the other 80% in §41 - the “substantially all of the activities” requirement in the process-of-experimentation test, which is about a business component, not a person.

§41(b)(2)(A)(ii), §41(b)(2)(C)

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.

Contract research

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.

IRC §41(b)(3) contract research inclusion rates
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. It is the only rate reachable 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.	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.

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.

§41(d)(4)(H) · Treas. Reg. §1.41-4A(d)

Funded research: two questions that decide whole claims

Research funded by grant, by contract, or otherwise by another person - including a governmental entity - is not qualified research to the party that was funded. The exclusion is not about whether money changed hands; it is about who took the risk and who kept the results. Both prongs must hold:

You bear the economic risk. Payment is contingent on the success of the research - you are not made whole if the work fails (§1.41-4A(d)(1)).
You retain substantial rights. You may use the results in your own business without paying for the privilege (§1.41-4A(d)(2)). Exclusive rights are not required; no rights - or rights you have to buy back - are fatal.

The contract decides, not the label. Cost-plus and time-and-materials arrangements typically shift the risk to the customer; a genuine fixed-price arrangement typically leaves it with the performer. Data- rights and IP clauses decide the second prong. The Eleventh Circuit’s 2015 Geosyntec decision turned on exactly this reading of the agreements; practitioners also cite a 2019 Tax Court order in Populous Holdings, which is unpublished and carries no precedential weight - so build the position on your contract terms, not on the case.

Grants deserve their own screen. SBIR and STTR awards, CRADAs, and state grants are funding from another person or a governmental entity by definition; whether the underlying work is nonetheless unfunded turns on the same two prongs and on how the award treats data rights. And note the mirror image: where research is funded, the funder may be the party entitled to claim it as contract research. Both sides claiming the same work is a fast route to an examination.

Screen these before you count a dollar

Customer-funded NRE and tooling Who owns the tooling and the design at the end of the program, and who eats the cost if it never works?
SBIR / STTR and federal awards Read the data-rights clause before the payment schedule. Retained rights are usually the closer question.
Development inside a services agreement A milestone that pays on delivery is not the same as one that pays on results.
Work-for-hire and assignment clauses A blanket assignment of everything created can end the substantial-rights argument on its own.

§41(b)(2)(A)(iii) · Treas. Reg. §1.41-2(b)

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.

The other list

What never becomes a QRE, however much research it funded

Most inflated first-draft credits are built from costs in this grid. Many of them are perfectly good §174A deductions - the two bases are not the same base.

Employer payroll taxes and benefits

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

Treated as general and administrative expenses, with one documented exception for extraordinary utilities required by the special character of the research.

Capital equipment and depreciation

A press, a bioreactor, a test rig, servers you own. Depreciable property is carved out of the supplies definition by statute.

Research performed outside the U.S.

Excluded by §41(d)(4)(F) - measured by where the work happens, not by who does it or who pays for it.

Funded research

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

Frequently research-related, frequently deductible, never in the four §41(b) categories.

Software licenses and SaaS subscriptions

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

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.

The deduction base is wider than the credit base. §174A generally sweeps in facility and overhead-type costs, certain rent and utilities, patent costs, and cost-recovery allowances that §41 never counts. A cost being deductible research or experimental expenditure does not make it a qualified research expense - and a study that blurs the two produces a credit you cannot defend and a deduction you understated.

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.

FAQ

QRE questions, answered precisely

Are employer payroll taxes and benefits part of the wage QRE?

No. §41(b)(2)(D)(i) defines wages by reference to §3401(a) - in practice the Form W-2 Box 1 figure. The employer’s share of FICA, unemployment tax, retirement match, and health premiums sit outside that definition, so a “fully-loaded cost” model will overstate the credit every time.

Do bonuses and stock compensation count?

A cash bonus is remuneration for services and belongs in the §3401(a) base. Equity compensation that runs through Box 1 - the spread on a nonqualified option exercise, RSU vesting - is also §3401(a) wages. Whether a given amount belongs to the year and the individual’s qualified services is a facts question a study has to answer and document, not assume.

Can we claim 100% of an engineer’s salary if they’re mostly on R&D?

Sometimes. Treas. Reg. §1.41-2(d)(2) treats all of an individual’s wages as qualified when substantially all - 80% or more, on a time basis - of their services for you that year meet §41(b)(2)(B)(i) or (ii): direct performance of qualified research, or its direct supervision or direct support. As a matter of house policy, Ricerca applies the gross-up more narrowly than the regulation allows - to direct performance and first-line supervision only - because support-role time records are where examiners probe hardest. Either way it needs a written basis and a substantiated time source, because it increases the claim.

Do we get the full amount we paid a contractor?

Generally 65% of it, under §41(b)(3)(A), and only for the portion that is qualified research performed on your behalf. The 75% and 100% rates are narrow - a qualified research consortium and certain energy research payments respectively - and each requires an affirmative written determination.

Our contractors are overseas. Does that matter?

Yes, but not for the reason most people assume. The test is where the qualified research is performed: work conducted outside the United States, Puerto Rico, or a U.S. possession is excluded under §41(d)(4)(F) regardless of the contractor’s nationality or where you pay from. Domestic work by a foreign-owned firm can qualify; offshore work by a U.S. firm does not.

Is our AWS or Azure bill a QRE?

The portion used to conduct qualified research can be, under §41(b)(2)(A)(iii) - rented compute you don’t own or primarily control, running research workloads. Production hosting that serves your customers generally is not, and software subscriptions are not computer rental at all. The practical requirement is an allocation method: tagged accounts or per-environment cost data, not a single consolidated invoice.

We have an SBIR grant. Can we still claim the credit?

It depends on the award terms, and it is worth checking before you count anything. Funding from another person or a governmental entity puts the work inside §41(d)(4)(H) unless you both bear the economic risk and retain substantial rights in the results. Data-rights clauses and payment-contingency terms decide it - see the rights-and-risk section above.

Are §174A costs and QREs the same list?

No, and conflating them is the most common source of an inflated first draft. The §174A deduction base is broader - it generally reaches facility and overhead-type costs, certain rent and utilities, patent costs, and cost-recovery allowances. §41 counts only the four statutory categories. A cost being deductible R&E does not make it a qualified research expense.

Get the QRE number your facts actually support

Send us your payroll shape, your contractor spend, and your cloud footprint. We’ll come back with what a study would likely capture, how it would be substantiated, and what it costs - free, and no obligation.

[email protected] We typically reply within one business day.

Get your free credit estimate Talk to our team