R&D tax credit eligibility for employees is much broader than many companies realize, and qualifying supervisory and support activities are often overlooked because of uncertainty around which salary expenses are eligible for this incentive.
Companies that are involved in developing new or improved products, processes, techniques, formulas, and inventions are often eligible for the R&D tax credit, saving them money that can be reinvested to help develop and grow their business rather than paid to the IRS or state governments.
For these companies, the R&D credit can apply not only to salaries paid to employees for direct development activities but often to supervisory and support services as well. This is why it’s important for companies to look beyond the obvious when determining which employees might be eligible for the credit to those involved in the direct supervision or support of R&D activities.
Eligible Research Expenses
Many companies recognize only core engineering employees as engaging in qualified activities, but there’s often a wide variety of direct supervisory roles that are also eligible for the tax credit.
In the past, technical leaders, managers, or supervisors that provided first-line—not executive—direction were eligible to qualify for the credit. However, due to Suder v. Commissioner—a case decided on by the US Tax Court in October 2014—there have been new opportunities to identify qualified supervisory and research activities performed by executives.
The definition of direct supervision isn’t always straightforward. The engineers who perform qualified research, for example, are sometimes given technical direction by their direct supervisors. In such instances, both the direct research and its direct supervision qualify for the tax credit.
Executives, Vice Presidents, and High-Level Researchers
In Suder v. Commissioner, the US Tax Court rejected the IRS’s historically categorical exclusion of executives from receiving the R&D tax credit because it found that high-level executives with technical degrees often perform or directly supervise research. This means their time should be considered qualified research, which effectively broadens the scope of eligible supervisory activities.
The hierarchy of technical departments is often very flat, which means vice presidents of technical departments can be heavily involved in actual research and the direct supervision of research. Some examples of qualified research activities include:
- Brainstorming and technical problem solving
- Attending technical and design review meetings
- Participating in concept and process development
- Designing experiments and tests and documenting research results
- Directly supervising first-line managers who also perform research
Organizations often don’t include the time a high-level executive spends on supervising or conducting research activities in an R&D credit calculation because research activities only account for one of the many tasks they perform daily. However, including these qualified activities can yield a larger research credit because executives often command a higher salary than first-line managers or engineers. Accordingly, organizations can benefit from understanding and documenting the activities of higher-level executives in their research departments.
Qualified R&D services also include direct support of research activities—in other words, services that directly support the people conducting qualified research. Qualified direct support could include activities like a machinist machining a part of an experimental model used in qualified research or an employee typing reports describing laboratory results derived from qualified research.
Direct support doesn’t include general and administrative services or other services that only indirectly benefit research activities regardless of if general and administrative personnel are part of the research department.
Companies can’t solely base their determination of whether an employee is engaged in qualified supervisory or support services on job descriptions or titles, as credit eligibility is based on what an employee actually does during the analysis period. Instead, all employees involved in qualified supervisory or support activities should be closely reviewed to avoid overlooking significant qualified research expenses.
To be eligible for this credit, an employee’s supervisory or support activities must pass the IRS’s four-part test:
- Technical uncertainty. An organization must demonstrate that it has attempted to eliminate uncertainty about the development or improvement of a product or process.
- Process of experimentation. An organization must demonstrate that it has evaluated alternatives for achieving a desired result.
- Technological in nature. The experimentation process must rely on hard sciences.
- Qualified purpose. The research must be conducted with the aim of creating a new or improved product or process that increases performance, function, reliability, or quality.
We’re Here to Help
To learn more about these often-overlooked R&D tax credit opportunities and how much you might save, contact your Moss Adams professional.