Can Contractor Costs Qualify for the R&D Tax Credit?

Last reviewed October 14, 2026

Yes. Payments to contractors who perform qualified research on your behalf can count as contract research expenses under IRC Section 41(b)(3) — but only 65% of the amount paid is included as a qualified research expense (QRE). This is one of the most important distinctions in the R&D tax credit: contractor costs are valuable, but they are treated differently from employee wages.

This page explains the 65% rule, who counts as a contractor for R&D purposes, the requirements your contractor arrangements must meet, and how to document everything for an IRS-ready claim.

The 65% rule for contract research expenses

IRC Section 41(b)(3) is clear: when you pay a contractor to perform qualified research on your behalf, only 65% of the amount paid is included in your qualified research expenses. This limitation is automatic — it is built into the tax code and applies to all contract research expenses without exception.

Here is how it works in practice:

The rationale behind the 65% limitation is that the contractor also bears some of the research burden and may benefit from the knowledge gained during the engagement. Congress set the rate at 65% to reflect this shared benefit.

When you enter contractor costs in TaxCredit4U, the platform applies the 65% limitation automatically. You enter the full amount paid to the contractor, and the system calculates the includable QRE amount for you.

Who counts as a contractor for R&D purposes

For purposes of the R&D tax credit, a contractor is any third-party individual or firm that performs qualified research on your behalf. This includes:

The key distinction is the employment relationship. Contractors are typically paid on a 1099 basis, not a W-2. They operate independently, use their own tools and methods, and are engaged for specific projects or time periods rather than as permanent staff.

Key requirements for contractor QREs

Not every payment to a contractor qualifies as a contract research expense. The arrangement must meet several requirements under IRC Section 41:

The work must meet the four-part test

The contractor's work must satisfy the same four-part test that applies to all qualified research: permitted purpose, technological in nature, technical uncertainty, and process of experimentation. If the contractor is performing routine services — such as standard IT support, graphic design, or bookkeeping — the payments do not qualify.

The work must be performed in the United States

Under IRC Section 41(d)(4)(F), only research conducted within the United States qualifies for the credit. If you hire a contractor who performs the work offshore — even if they are employed by a US-based company — those costs do not qualify. This is one of the most common disqualifiers for contractor expenses.

You must bear the financial risk

The taxpayer claiming the credit must bear the economic risk of the research. This means you are paying the contractor to attempt the research regardless of the outcome. If the contractor is paid whether or not the project succeeds, the arrangement generally qualifies.

Conversely, if a client pays you to perform R&D and retains the rights to the results, that is funded research — and funded research does not qualify for your credit. The client who funded the work may be able to claim it instead.

You must retain substantial rights to the research results

To claim contractor costs as QREs, you (the taxpayer) must retain substantial rights to the results of the research. If the contractor retains all intellectual property rights and you are merely licensing the finished product, the arrangement may not qualify as contract research under Section 41.

Written agreements should document the research

While not strictly required by the tax code, written contracts or statements of work (SOWs) that specify the scope, nature, and purpose of the research are strongly recommended. These documents serve as contemporaneous evidence that the work constituted qualified research and that you directed and funded the effort.

Contractor vs. employee: impact on the credit

The distinction between contractors and employees has a direct impact on the value of your R&D tax credit:

This means that, dollar for dollar, employee wages are more valuable for credit purposes than contractor payments. A company that spends ,000 on an employee performing qualified research includes ,000 in QREs. A company that spends ,000 on a contractor performing the same work includes only ,000.

This does not mean you should avoid using contractors — there are many valid business reasons to engage contractors, and 65% of a qualifying expense is still valuable. But it is worth understanding the difference when planning your R&D credit strategy and when evaluating the total credit available to your business.

Common contractor scenarios that qualify

The following are examples of contractor engagements that commonly produce qualifying contract research expenses:

The funded research exclusion

One of the most important rules to understand when dealing with contractor costs is the funded research exclusion under IRC Section 41(d)(4)(H). This rule works in two directions:

When you are the one paying: If you pay a contractor to perform R&D on your behalf, at your financial risk, and you retain substantial rights to the results, you can claim 65% of those payments as QREs. This is the standard contract research arrangement.

When someone else is paying you: If a client pays you to perform R&D and the client retains the rights to the results, that work is funded research from your perspective. You cannot claim it for your own R&D credit because you are not bearing the economic risk — the client is. The client may be able to claim the expense on their own return (at 65% as a contract research expense).

The funded research exclusion prevents double-dipping: the same research expense cannot generate credits for both the party funding the work and the party performing it. If you are unsure whether an arrangement constitutes funded research, look at who bears the financial risk and who retains the rights to the results.

Documentation needed for contractor QREs

To support contractor costs as qualified research expenses, you should maintain the following documentation:

For a comprehensive overview of documentation requirements, see Documentation Checklist.

How TaxCredit4U handles contractor costs

TaxCredit4U is a self-service platform that guides you through identifying and documenting your R&D expenses, including contract research costs. Here is how it works for contractors:

Frequently asked questions

Why is the contractor rate only 65%?
IRC Section 41(b)(3) limits contract research expenses to 65% of the amount paid. This reflects that the contractor also bears some of the research burden. The 65% rule is built into the tax code and applies automatically to all contract research expenses — there is no way to claim 100% of contractor payments as QREs.
Can offshore contractor costs qualify?
No. Only research performed within the United States qualifies under IRC Section 41(d)(4)(F). Payments to contractors who perform their work outside the US are excluded from qualified research expenses, regardless of whether the contractor is a US-based company or a foreign entity. If you use a mix of domestic and offshore contractors, only the US-based work qualifies.
What if a contractor works on both R&D and non-R&D tasks?
Only the portion of their work that constitutes qualified research counts toward the R&D tax credit. You should have documentation showing the allocation between qualifying and non-qualifying activities. Contracts, invoices, and project records should clearly delineate R&D work from other services. The 65% limitation then applies only to the qualifying portion.

Related pages

Include contractor costs in your R&D credit claim. Estimate your R&D tax credit in about three minutes — free, no account required.