Can You Claim the R&D Tax Credit for Research You Pay a Contractor to Do?

TL;DR

Yes. If you pay an outside firm or a freelancer to do qualified research for you in the United States, you can generally count 65 percent of what you paid toward your R&D tax credit. The R&D credit rules call these contract research expenses. Three conditions decide it, and all three live in your contract: the agreement was signed before the work was done, you have to pay even if the research fails, and you have a right to the results. Any part of the price you owe only if the work succeeds doesn't count. And when the contractor carries the risk instead of you, the credit usually isn't yours to claim.

In Episode 34 of The Tax Strategy Playbook, I walk through the two contract tests that decide whose R&D credit it is when a client pays for the work, mostly from the side of the firm doing the work. This post takes the other chair. You're the company writing the checks. Here's what you can count, how to count it, and where the contract quietly takes it away.

Key Takeaways

• Contract research expenses are 65 percent of what you pay a non-employee to do qualified research on your behalf, under Internal Revenue Code Section 41(b)(3)(A).
• The agreement has to exist before the research is done, has to say the work is done on your behalf, and has to make you pay even if the research fails.
• You need a right to use the results. It doesn't have to be exclusive.
• A success bonus or any payment owed only if the work succeeds is excluded. That portion buys a result, not research.
• The 65 percent applies to the whole qualifying price, including the contractor's profit, but not to parts of the invoice that cover non-research services.
• Research done outside the United States doesn't count, and neither do payments to a company in your own controlled group.
• One research project generally produces one credit. Whoever carried the risk and holds the rights usually gets it. Sometimes nobody does.

Can you claim the R&D tax credit for work you paid a contractor to do?

You can, and plenty of companies leave this money on the table because they think the credit only covers their own payroll.

The R&D credit counts three kinds of spending. Wages for your own people doing or supervising the research. Supplies used up in it. And money paid to outsiders to do it for you. That third bucket has its own name in the statute. Section 41(b)(3)(A) defines contract research expenses as "65 percent of any amount paid or incurred by the taxpayer to any person (other than an employee of the taxpayer) for qualified research."

So the outside engineering firm that designed your new pump housing counts. So does the software shop that built the routing logic your own developers couldn't crack, and the lab you hired to run formulation trials. A 1099 developer counts too. What decides it is whether the work they did for you was qualified research, and whether your contract set the deal up the right way.

That second part is where most claims go wrong. Good work, bad paperwork, no credit.

What does your contract have to say?

The regulation spells it out. Treasury Regulation Section 1.41-2(e)(2) says an amount counts as paid for the performance of qualified research "only to the extent that it is paid or incurred pursuant to an agreement that" meets three conditions:

• It "is entered into prior to the performance of the qualified research."
• It "provides that research be performed on behalf of the taxpayer."
• It "requires the taxpayer to bear the expense even if the research is not successful."

The first condition is about timing. Sign first, then research. Work your contractor did before any agreement existed doesn't meet it, and an agreement written after the fact won't reach back and fix it.

The third condition is the risk test, seen from your side of the table. If the new design fails three times before the fourth one works, you still pay for all four. That exposure is what makes it your research. The regulation is blunt about the opposite case: when payment is "contingent on the success of the research, then the expense is considered paid for the product or result rather than the performance of the research, and the payment is not a contract research expense."

That cuts in a direction people don't expect. A contract that only pays when the work succeeds feels like a smart deal, since you never pay for failure. It also means you weren't at risk. In the eyes of the tax code, you bought a finished product.

Do you have to own the results?

No. You need a right to them, and that right can be shared.

The regulation's definition of "on behalf of" is one sentence long. Section 1.41-2(e)(3): "Qualified research is performed on behalf of the taxpayer if the taxpayer has a right to the research results." It goes on to say the research can be done on your behalf "notwithstanding the fact that the taxpayer does not have exclusive rights to the results."

That matters because good contractors often won't hand over everything. A software firm may give you the finished application and keep the right to reuse its general techniques on the next client's job. That's fine for you. You hold a right to the results, and they hold one too.

What doesn't work is a deal where the contractor keeps the results and you get a license you pay for, or where the contractor owns everything and sells you the product. If you can't use what the research produced without buying it again, it wasn't done on your behalf.

How do you calculate contract research expenses?

Take the qualifying part of what you paid, strip out anything contingent on success, and multiply by 65 percent.

Here's a made-up example with round numbers. A 40-person company that makes commercial kitchen equipment hires an outside engineering firm to design a new control board. Its own engineers have never built one that holds temperature within a degree under a full load, and nobody knows yet if it can be done at the price point. The contract is signed in January. The firm bills hourly, the company pays every invoice whether the design works or not, and the company gets the design. The firm keeps the right to reuse its general methods.

By December the company has paid $280,000. Three adjustments come next.

• $40,000 of it was a bonus, payable only if the board passed certification testing. It passed, and the company paid. That $40,000 is still out, because it was contingent on success.
• $15,000 of the hourly billing covered a study of competitors' pricing and features. That's market research, which Section 41(d)(4)(D) excludes from qualified research. Out.
• That leaves $225,000 paid for the research itself.

Sixty-five percent of $225,000 is $146,250. That's the company's contract research expense for the year, and it goes into the credit calculation alongside the company's own wages and supplies. What it's worth in actual credit depends on which calculation method the company's tax professional uses and on its spending history, so I won't put a dollar figure on the credit itself.

The regulation's own examples back each step. Example 3 in Section 1.41-2(e)(5) has a company reimbursing a contractor's costs and paying it an extra $100x on top. The 65 percent applies to the full $300x, profit included. Example 4 changes one fact: the extra $100x is "payable only if the research is successful." Now only $200x counts, so the contract research expense drops to $130x. Example 7 covers mixed invoices. A contractor paid for accounting work on a research project produces no contract research expense, because accounting isn't research.

Is it ever more than 65 percent?

Yes, in two narrow cases.

Payments to a qualified research consortium, for research on behalf of you and at least one unrelated taxpayer, count at 75 percent under Section 41(b)(3)(C). Payments for energy research to an eligible small business, a university, or a federal laboratory count at 100 percent under Section 41(b)(3)(D). Both come with definitions that need a careful read. Most companies paying an engineering firm or a software developer are at 65 percent.

When does a payment to a contractor not count at all?

Five situations come up again and again.

The research happened overseas. Section 41(d)(4)(F) excludes "any research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States." The test is where the work was done, not where the contractor is incorporated. A U.S. firm that hands your project to its developers abroad has moved that portion out of the credit.

You only pay if it works. Covered above. A fixed price owed on delivery of a working product, with nothing owed if it fails, is a purchase.

The contractor is your sister company. All members of a controlled group are treated as one taxpayer for the credit. Treasury Regulation Section 1.41-6(i)(2) says the member that pays "shall not treat any part of any amount paid or incurred as a contract research expense." The member doing the work counts its own in-house expenses instead. One credit either way, counted once.

The contract came after the work. The agreement has to be in place before the research is performed. Paperwork drawn up at year end to describe work already finished doesn't meet the regulation.

The invoice covers more than research. Section 1.41-2(e)(1) limits the 65 percent to "the portion of the amount paid or incurred that is attributable to" qualifying services. Project management fees, training, installation, and marketing work bundled into the same invoice have to come out.

Who gets the credit, you or your contractor?

Generally one of you. Sometimes neither.

The contractor faces the mirror image of your tests. Under the funded research rules, the firm doing the work can't claim research a client paid for regardless of success, and it can't claim anything if it kept no substantial rights. I covered those two tests from the contractor's side in If a Client Paid for the Work, Can You Still Claim the R&D Tax Credit?

Put the two sides together and the contract points the credit one way:

• You pay whether it works or not, and you have rights to the results. The research is funded from the contractor's side, and the credit points toward you.
• You pay only if it works, and the contractor keeps rights to use what it learned. The contractor carried the risk, and the credit points toward the contractor.
• You pay only if it works, and the contractor keeps no rights at all. Nobody gets it.

That last line surprises people, and it comes straight from the regulation. Section 1.41-4A(d)(2) says that when the performer keeps no substantial rights and its pay is contingent on success, "neither the performer nor the person paying for the research is entitled to treat any portion of the expenditures as qualified research expenditures." The current regulations send funded research questions back to that section through Section 1.41-4(c)(9). Two parties, one research project, zero credit.

So the hourly contract that hurts an engineering firm's own claim is the same contract that helps the company paying it. The terms don't change between the two chairs. The credit just lands on whichever side carried the risk.

Does it matter when you pay?

For prepayments, yes. If you pay this year for research the contractor won't do until next year, Section 41(b)(3)(B) treats the amount as paid during the period the research is actually conducted. A $60,000 deposit sent in December 2026 for work done in February 2027 belongs in 2027.

The reporting is also getting more detailed. Section G of Form 6765 has a separate column for contract research expenses, business component by business component. For many companies that section becomes required starting with tax years that begin in 2026. If you're above the exemption lines, you'll need to tie each contractor payment to the specific project it paid for. Here's what changed on Form 6765 and who has to fill out Section G.

What should you check before you sign the next research contract?

Four questions, and none of them need a tax background.

• If the technical approach fails, do we still owe the money? Look for language about payment on delivery or acceptance that's really a condition of success.
• Do we get a right to use the results without paying again? A shared, non-exclusive right is fine.
• Where will the work be done? Ask the contractor in writing whether any of it will be performed outside the United States.
• Is the research priced separately from everything else on the invoice? If the contract bundles research with installation, training, or market work, ask for the research piece to be billed on its own lines.

Then keep the signed agreement, every amendment, every change order, and every invoice in the project's folder. When the IRS reviews a research credit, it reads contracts first. Here's what that review looks like and what records hold up. And if you're still working out whether your projects qualify in the first place, start with the complete guide to the R&D tax credit for small businesses.

Whether your agreements meet these tests is a judgment your tax professional makes with the documents in hand, and the contract language itself belongs with your attorney. Those two rarely talk to each other. Put them on the same email before the next one gets signed.

Frequently Asked Questions

Can I claim the R&D credit for money paid to an outside contractor?

Generally yes, at 65 percent of the amount paid, if the contractor performed qualified research on your behalf in the United States. The agreement has to be in place before the research is performed, it has to require you to pay even if the research fails, and you need a right to the results.

Is the contract research rate always 65 percent?

Section 41(b)(3)(A) of the Internal Revenue Code sets contract research expenses at 65 percent of the amount paid. The rate rises to 75 percent for certain research consortia and to 100 percent for energy research paid to eligible small businesses, universities and federal laboratories.

Do I need to own the intellectual property to claim contract research?

No. Treasury Regulation Section 1.41-2(e)(3) says research is performed on your behalf if you have a right to the research results, and that exclusive rights aren't required. A shared, non-exclusive right to use the results works.

Does a success bonus paid to a contractor count?

No. Any portion of a payment that is contingent on the research succeeding is treated as paid for the product or result, not for the research. Only the part you owed regardless of success counts toward the 65 percent.

Can I count payments to offshore developers?

Not for research performed outside the United States. Section 41(d)(4)(F) excludes research conducted outside the United States, Puerto Rico and U.S. possessions. The location of the work decides it, not where the contractor is based.

Can both my company and the contractor claim the credit on the same project?

Generally the credit follows whoever carried the risk and has rights to the results. If you pay regardless of success and have rights, the contractor's side is treated as funded. If the contractor's pay depends on success and it keeps no substantial rights, neither party can claim it.

What if I prepay a contractor before year end?

Under Section 41(b)(3)(B), contract research expenses paid in one year for research done after that year ends are treated as paid in the period when the research is actually conducted.

Where to start

Pull the agreement for the biggest outside research project you paid for this year. Find two sentences in it: what happens to your payment if the work fails, and who gets to use the results. If you can't find either one, that tells you something too.

For the other side of this, how the same contract terms decide whether the firm doing the work keeps its own credit, listen to Episode 34 for both funded research tests, the two appeals court cases, and a six-step contract checklist.

And if you'd like a second set of eyes on whether your company has an R&D credit worth claiming, wages, supplies and contractors together, I'll run a no-cost analysis through my relationship with CSSI. It comes with no obligation and no pitch, and if your contracts already gave the credit away or a study won't pay for itself, I'll tell you that. Book a time at calendly.com/david-wiener/cs or call 770-224-8504, option two.

Who does your outside research, and does your contract make you pay when it fails? I'd like to hear what yours says.

Nothing here is tax or legal advice for your company. Your contracts and your numbers need a tax professional and an attorney who know them.