Yes, a taxpayer may include labor costs when calculating the research credit under § 41 of the Internal Revenue Code. Specifically, labor costs can be included as part of the "qualified research expenses" (QREs) if they meet certain criteria.
Legal Reasoning and Rationale:
- Qualified Research Expenses (QREs):
- Under § 41(b)(1), QREs include in-house research expenses and contract research expenses.
- In-house research expenses, as defined in § 41(b)(2)(A), include wages paid or incurred to an employee for qualified services performed by such employee.
- Qualified Services:
- According to § 41(b)(2)(B), "qualified services" mean services consisting of:
- Engaging in qualified research, or
- Engaging in the direct supervision or direct support of research activities which constitute qualified research.
- Wages:
- The term "wages" is defined in § 41(b)(2)(D) and includes:
- Any wages paid or incurred to an employee for qualified services performed by such employee.
- For self-employed individuals and owner-employees, it includes the earned income as defined in § 401(c)(2).
- Allocation of Wages:
- If an employee performs both qualified and non-qualified services, only the amount of wages allocable to the performance of qualified services constitutes an in-house research expense. This allocation should be done by multiplying the total amount of wages paid to or incurred for the employee during the taxable year by the ratio of the total time actually spent by the employee in the performance of qualified services to the total time spent by the employee in the performance of all services during the taxable year (Treas. Reg. § 1.41-2(d)(1)).
- Examples and Clarifications:
- In the IRS Field Attorney Advice (FAA 20171601F), it was concluded that a taxpayer's method of allocating wages to determine the amount of its in-house research expense must follow the method provided in Treas. Reg. § 1.41-2(d)(1). This ensures that only the portion of wages attributable to qualified research activities is included in the QREs.
Conclusion:
Labor costs, specifically wages paid to employees for performing qualified research services, can be included in calculating the research credit under § 41. The wages must be properly allocated to reflect the time spent on qualified research activities. This ensures that only the portion of wages directly related to qualified research is included in the QREs.
Sources:
§ 41. Credit for increasing research activities
Rev. Rul. 2014-9
FAA 20214101F
TAM 9346006
Publication 535 (2022)
FAA 20171601F
