Expenses that qualify for the R&D credit include:

All W-2 wages for employees engaged in qualified research activities. This number includes the wages of personnel directly involved in, supervising or supporting research and development efforts. If an individual spends 80% or more of their time working in the R&D area, then 100% of their wages are counted when calculating the R&D credit. If the percentage of time spent is less than 80%, then the actual percentage of time the individual spends in the R&D area is multiplied by his or her salary and allocated.

Non-capitalizable materials and supplies. Things that don't qualify for the R&D tax credit are things such as capitalizable assets. If a company purchases equipment and depreciates the equipment (which is done almost 100% of the time), then the cost of the equipment does not qualify for the credit computation.

Fully 65% of costs of contracted research, or 75% of contract research performed by a qualified research group; i.e., a University or consortium.

The rules for software development are still somewhat complicated, but one recent clarification states that if customized software is developed for sale or lease (not for internal purposes), then it is not subject to the extra hurdles of the High Threshold of Innovation Test. If a company develops internal use software, however, it may still qualify for the R&D Credit, providing that:

• The software is innovative,
• The development involved significant economic risk, and
• A similar product is not commercially available.

If the above three criteria are met, then the cost of developing software for internal use may qualify for the R&D Credit.