Qualified Research Expenses in Pharmaceutical R&D: Identifying QREs Across Discovery, Preclinical, and Clinical Stages
For purposes of the R&D tax credit, pharmaceutical companies typically engage in Qualified Research Expenses (QREs) across Discovery, Preclinical, and Clinical stages. To qualify, activities must meet the Four-Part Test under §41 of the Internal Revenue Code (IRC):
Permitted Purpose – Develop or improve a drug, process, formulation, or technique.
Technological in Nature – Based on principles of physical or biological sciences, engineering, or computer science.
Elimination of Uncertainty – Resolve uncertainty regarding capability, method, or design.
Process of Experimentation – Evaluate alternatives through simulation, modeling, trial-and-error, or other systematic approaches.
1. Discovery Stage
This phase involves identifying potential new drug candidates and developing early-stage compounds. QREs may include:
Target Identification & Validation – Studying biological pathways to identify drug targets (e.g., proteins, enzymes).
High-Throughput Screening (HTS) – Using automated methods to test thousands of compounds for biological activity.
Lead Optimization – Refining molecular structures for efficacy and reducing toxicity.
Computational Drug Design – Using AI/machine learning models to predict molecular interactions.
Formulation Feasibility Studies – Assessing solubility, bioavailability, and stability.
Process Development – Experimenting with synthetic pathways for active pharmaceutical ingredients (APIs).
2. Preclinical Stage
This phase includes laboratory and animal studies to assess safety and efficacy before human trials. QREs may include:
In Vitro & In Vivo Testing – Conducting cell-based assays and animal studies for toxicity and pharmacokinetics.
Pharmacokinetics & Pharmacodynamics (PK/PD) Studies – Understanding absorption, distribution, metabolism, and excretion.
Toxicology Studies – Evaluating short- and long-term toxicity in animal models.
Analytical Method Development – Creating assays for drug purity, potency, and stability.
CMC (Chemistry, Manufacturing & Controls) Development – Refining manufacturing processes, formulation studies, and scale-up.
IND Preparation & Submission – Research related to Investigational New Drug (IND) applications may qualify, particularly the scientific studies supporting it.
3. Clinical Stage
This phase involves human trials (Phases I-III) to evaluate safety and efficacy. QREs may include:
Clinical Trial Protocol Development – Designing experiments to test safety, dosage, and efficacy.
Dose Optimization Studies – Determining optimal dosing strategies and regimens.
Biostatistics & Data Analysis – Evaluating trial results to measure efficacy and side effects.
Clinical Endpoint Determination – Identifying and validating biomarkers for clinical success.
Manufacturing for Clinical Trials – Producing and refining drug formulations for testing.
Process Improvements for Scale-Up – Addressing manufacturing challenges to ensure consistency in larger production runs.
Costs That May Be Considered QREs
Wages of researchers, lab technicians, and clinical staff conducting qualified activities*.
Supplies used in experiments, including reagents, lab materials, and test compounds.
Contract Research (65% of eligible costs) for third-party preclinical and clinical trial work.
Computer Costs for modeling, simulation, and bioinformatics.
*Wages paid to employees performing qualified research activities under IRC §41(b)(2)(A)(i) can be included in QREs if they fall under one of the following categories:
Qualified Research (Direct Performance) – Employees who actively conduct R&D activities that meet the four-part test. This includes:
Scientists, chemists, and biologists performing laboratory experiments.
Engineers and process development specialists refining drug formulations.
Biostatisticians conducting computational modeling for clinical trials.
Pharmacologists evaluating drug safety and efficacy in preclinical or clinical studies.
Direct Supervision of Qualified Research – Employees who directly manage or oversee the qualified research activities. This includes:
R&D managers and principal investigators leading laboratory teams.
Senior scientists overseeing experimental design and methodology.
Clinical trial directors supervising trial execution.
Direct Support of Qualified Research – Employees who directly assist or support qualified research without merely providing indirect benefit (as defined in Treas. Reg. §1.41-2(c)(3)). Examples include:
Lab technicians preparing reagents and maintaining testing environments.
Animal care specialists handling test subjects for preclinical studies.
Data analysts processing research findings for statistical validation.
Regulatory Reference: Under Treas. Reg. §1.41-2(c)(3), direct support includes activities that are necessary for and directly benefit qualified research but excludes activities that only indirectly benefit research, such as general administrative support, HR, or legal functions.
Exclusions
Market research, regulatory compliance, and FDA interactions after final formulation approval typically do not qualify.
Post-approval (Phase IV) studies focused on marketing and sales do not qualify.
While it is often clear that pharmaceutical companies engage in qualified research for purposes of the R&D tax credit, determining which specific costs are includable—and which are not—can be more complex. This is especially true when evaluating wages and ensuring that employee activities meet the statutory definitions of qualified research, direct supervision, or direct support under Treas. Reg. §1.41-2. It is also critical to consider who bears risk and who owns rights to the research which can be very nuanced and require review of contract/agreement terms. Finally, it is also critical to effectively establish a clear nexus between employees, their specific activities, and the development or improvement of qualified business components.
If you are a CPA scoping out opportunities for your client or a company looking to claim the R&D credit yourself, feel free to reach out directly with any questions or to get an assist from us. You can book a call or “skip the call” here.
