Have more questions? Submit a request

Subcontractor expenses have several requirements that need to be considered before qualification can happen.


For subcontractor costs, regardless of where the actual vendor is located or where the invoice is sent, subcontractors should be attributed to the state where significantly all their qualifying activity took place. For instance, if you hired an engineer who lived in Utah, but that engineer traveled to your facility in Nevada to do all their work, the state listed should be Nevada as this is where the development activity occurred.

Payment Type

Agreements with subcontractors performing qualifying activity need to be structured as hourly, Time & Material, or Cost Plus type agreements. If a contractor is performing development work for you, but is being paid on a fixed fee, fixed scope model, these expenses do not qualify. The only exception to this rule is if the contractor is conducting testing for development purposes, but do not also propose solutions for any problems that might arise.

Qualified Percentage of Time

In order to determine a subcontractor’s qualified percentage of time, the first step is to analyze what Business Components they worked on over the year. The term “business component” means any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer (I.R.C. § 41(d)(2)(B)). For instance, if you are a software company that develops a SaaS platform, your business components may be individual modules of that platform. If you are a manufacturing company, your business components may be the various families of products that you design and mass produce.


Development work that is performed via a Fixed Fee contract is not qualifiable for the R&D tax credit.

Once you determine the number of qualified business components that you are actively developing, you begin analyzing how much time an employee spends conducting qualified activities. For instance, if my software company has two (2) SaaS platform products and my lead developer spends 50% of their time designing code and conducting code reviews for Product A and 50% of their time doing the same for Product B, their overall qualified time would be 100%.

Below is a table with examples of qualifying activity along with a description. Please use this as a reference in conducting your analysis.

Qualified Activities


Computer Simulation & Modeling

Developing computer software models and/or analytical tools for analysis purposes or solving technical problems.

Conceptual Development

Developing concept drawings/prototype details, preparing performance calculations, determining material/component requirements, etc..

Design / Code Review

Review and analysis of engineered designs and/or software code.

Equipment Programming

Development of programs for production equipment utilized in pre-production runs.

Patent Research

Assisting with patent applications, including patent research and preparation of documentation; not including legal or filing issues.


Work regarding patent applications such as patent research and preparation of documentation; not including legal or filing issues.

Product & Process Development

Conducting hands-on research and development activities associated with new or improved products or manufacturing processes.

Prototype Development

Design, fabrication, and/or assembly of prototypes, pilot models, first articles, and/or samples for validation.

Quality Assurance

Development of Quality Assurance processes designed to validate new products and/or processes.

Scale to Full Production

Problem-solving relating to scale-up of new products to full-scale production.

Software Development

Developing computer software for sale or licensing to external parties (e.g. SaaS platform).

Software Development Tools

Developing computer software for internal non-business-related functions (e.g. scripts developed for automated testing of code, programs developed for new production processes, etc.).

Specifications & Requirements Definition

Work relating to the development of performance parameters and specifications for new or improved products and/or manufacturing processes.


Developing designs using engineering and/or computer modeling.

Technical Project Management

Direct supervision of employees developing new or improved products and/or manufacturing processes.

Technical Project Support

Participating in R&D activities such as preparation of data and reports, product/process demonstrations, meetings and presentations, etc.

Technical Project Support

Providing technical support (e.g. code review, subject-matter expertise, etc.) to employees carrying out qualified R&D activities.

Technical Sales

Conducting application engineering work such as preliminary computations and concept development in support of sales team.

Testing & Validation

Conducting tests and/or analyzing new or improved products and/or process systems.

Tooling Development

Work relating to the development of tooling, fixtures, jigs, molds, casts, etc..


Any activity that occurs outside the United States is non-qualifiable. This includes activity performed by a U.S. based contractor that then has a foreign entity perform development activities. These expenses are attributable where the actual research and development activity took place, NOT where the invoices were paid to.



Next: Revenue »

Articles in this section

Was this article helpful?
0 out of 0 found this helpful
  • 8:00am - 8:00pm CST Monday to Friday; 9:00am - 6:00pm CST Saturday
  • Get the latest news and updates first



Article is closed for comments.