Research & Development Tax Credits for Qualified Supplies Expenses

The Research & Development (R&D) Tax Credit is a tax incentive that can be applied as a dollar-for-dollar offset against a company’s tax liability if the company engages in activities related to the design and development of a product, process, formula, invention, software or technique within the United States. Additionally, start-up businesses with less than $5 million in gross receipts in the current taxable year and no gross receipts prior to the fifth previous taxable year (e.g., for 2025, the company must not have gross receipts prior to tax year 2021) would be considered a qualified small business (QSB). They can use the credit to offset up to $500,000 of their payroll tax liability.

R&D tax credits can be claimed for eligible expenses incurred while conducting qualified research activities within the United States and its territories. IRC § 41(b) defines qualified research expenses (QRE) as:

For taxpayers creating physical products and prototypes, such as manufacturers and life sciences companies, supplies expenses can represent a significant portion of the QREs claimed for the R&D tax credit. According to Section 41(b)(2)(C), the term “supplies” refers to tangible property, excluding the following:

Supplies expenses are deemed to be QREs if they are utilized in the performance of “qualified services.” These services include engaging in, directly supervising or directly supporting qualified research by an employee of the taxpayer or an individual acting in a similar capacity. To be considered an eligible expense, the supplies item must be directly tied to the delivery and performance of these qualified services. Expenditures related to general and administrative functions do not meet the criteria for supplies QREs.

The most easily identifiable supplies expenses that qualify for R&D tax credits are materials consumed or used up in the process of developing prototypes, samples or during experimentation. These may include:

These materials are typically non-depreciable and are directly tied to the experimentation and development process. R&D tax credits exclude depreciable property, which is a critical distinction. Any item with a useful life beyond one year that is subject to wear and tear, exhaustion or obsolescence is considered depreciable and therefore not eligible as a supplies expense for the R&D credit. For example, equipment, machinery, tools and furniture do not qualify, as they are depreciable in nature and would therefore not be considered a qualified supplies expense.

There has been a growing tendency among taxpayers to classify a broad range of non-qualifying research-related costs as supplies in credit claims. When evaluating these claims, it is critical to adhere to the statutory and regulatory definitions. For instance, general and administrative costs associated with self-constructed supplies, such as assets produced by a taxpayer for use in its trade or business, are frequently misclassified. During the review of supplies expenses, it is necessary to evaluate any prototype-related costs to determine whether they include components subject to depreciation.

Additional examples of costs that do not qualify as supplies QREs include:

Uncovering the proper data and support for specific taxpayers is a challenging undertaking that should only be performed by qualified R&D Tax Credit specialists. Withum’s R&D Tax Credit Services Team has performed R&D studies, and supported those claims on audits, for clients across a range of industries and sizes, ranging from start-ups and beyond.

Author: Sarah Hammond | [email protected]