A contract research expense is paid or incurred for the performance of qualified research to the extent it is paid or incurred pursuant to an agreement that (i) is entered into prior to the performance of the qualified research, (ii) provides research be performed on behalf of the taxpayer (taxpayer retains substantial rights to the research results), and (iii) requires the taxpayer to bear the expense even if the research is not successful. There does not necessarily have to be a written agreement.
The applicable percentage for contract research expenses is sixty-five percent (65%) of any expense paid or incurred to any person other than an employee of the taxpayer for the performance of qualified research on behalf of the taxpayer. The applicable percentage for contract research expenses increases to seventy-five percent (75%) for payments to a qualified research consortium for qualified research conducted for the taxpayer and one or more unrelated persons. The applicable percentage for contract research increase to one hundred percent (100%) for amounts paid to eligible small businesses, institutions of higher education, and federal laboratories for research that is energy research.
Written agreements are generally used to establish which party bears the economic risk of the research and which party has rights to the research results. A taxpayer has substantial rights to the research results if they are able to make commercial use of the research results without any restrictions from the entity that performed the research. A taxpayer is deemed to have substantial rights to the research results if the written agreement does not address the issue.
Common examples of contract research include the use of design and development firms, independent contractors, and testing labs. Companies should explore third party expenses related to research and development and assess if they are financially at risk for the research and development and if they retain substantial rights to the research results.
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