Qualified Research Expenses (QREs)

Qualified Research Expenses (QREs) are the costs that form the basis of the R&D tax credit calculation. Under IRC Section 41(b), QREs include three categories of expenses: in-house research wages, supply costs, and contract research expenses.

Only expenses tied to activities that pass the four-part test count as QREs. If an activity doesn't qualify as research, the associated costs can't be included — regardless of how much was spent.

Wages are typically the largest QRE category for software companies. Qualifying wages include:

• W-2 wages for employees who directly perform qualified research
• W-2 wages for employees who directly supervise qualified research
• W-2 wages for employees who directly support qualified research (e.g., a data engineer building infrastructure used exclusively by the R&D team)

Key rules: - Only the portion of wages attributable to qualifying activities counts. If a developer spends 70% of their time on qualifying R&D, 70% of their salary is a QRE. - Owner wages are included if the owner takes a W-2 salary and performs qualifying work. - Benefits, bonuses, and stock compensation generally don't count — only cash W-2 wages. - 1099 contractor payments are NOT wages — they fall under contract research.

Supply costs include tangible property (other than land or depreciable property) used in and consumed during qualified research. For software companies, this category is typically small but can include:

• Cloud computing costs for research experiments (arguable — consult your CPA)
• Hardware consumed during testing
• Prototype materials

Most software R&D supply costs are minimal compared to wages.

If you pay a third party to perform qualified research on your behalf, 65% of those payments count as QREs. This includes:

• Outsourced development work where you retain the IP rights
• Research performed by universities or other qualified research organizations (these may qualify at 75%)

Important: you must have the right to the research results, and the research must be performed on your behalf. Simply licensing finished software from a vendor doesn't count.

For a typical software company, the QRE calculation focuses on wages:

1. Identify qualifying employees — anyone performing, supervising, or supporting R&D
2. Determine time allocation — what percentage of each person's time is spent on qualifying activities
3. Calculate qualifying wages — W-2 salary × qualifying percentage

Example: A developer earning $130,000 who spends 65% of their time on qualifying R&D contributes $84,500 in QREs.

The accuracy of your time allocation is critical — it's the number most frequently challenged in audits. Contemporaneous time tracking (not year-end estimates) provides the strongest substantiation.