A Life Sciences Leader’s Guide to R&D Tax Credits

Research and Development (R&D) Tax Credits Aren’t Just a Benefit…

They’re your edge. They’re a key source of funding to keep your life sciences business in play for its next breakthrough. 

In this guide, you’ll find:

• An overview of the 4-part criteria you must meet to qualify for R&D tax credits.
• Tips on common mistakes that can cost you your R&D tax credit. (CRO contracts, states you conduct research in, documentation.)
• A comparison of in-house, software, and tax advisors to find the right fit for you.
• Suggested questions to pick any third-party partner.

How do I know if I qualify for an R&D Tax Credit?

Qualifying for an R&D tax credit isn’t dependent on whether you’re successful or not. It’s based on your research activities and expenses meeting all the criteria in the IRS’ Four-Part Test. (Permitted purpose, technological information, technical uncertainty, and experimentation)

The IRS Four-Part Test to Pass R&D Tax Credit Audit

Example of a Life Sciences Company Passing the Test

Below, I’ve shared a fictional example of a test a life sciences company is doing that would make them eligible for an R&D tax credit. 

I should note that if they were working with well-known ingredients and predictable outcomes, it wouldn’t pass the test. But in this example, they’re facing chemical degradation uncertainty and using repeated lab testing and supplies to solve it. So this formulation phase could earn a credit.

Factors That Can Cost You a Life Sciences R&D Tax

If you want to avoid losing millions of dollars in R&D tax credits for your life sciences business, be cautious in your contracts with research organizations, geographic states the research is conducted in, and ways your clinical team is documenting R&D work. These are the 3 top factors that can influence how much you gain financially from a tax credit. And if you navigate them with care, you’ll see a strong benefit from claiming R&D credits.

1. Your Contract with a Contract Research Organization

For some teams, choosing a contract research organization is a savvy business move. But you must be aware of what the perks and tradeoffs are when you sign. A poor contract is one of the most common mistakes in R&D tax credit claims that can cost you.

You can lose your R&D tax credit to your CRO if the contract:

• States you pay for successful outcomes or has a money-back guarantee for failed studies. (The IRS considers that work funded by the CRO.)
• Gives the CRO ownership of new data, processes, and study protocols, without giving you broad rights to use or license. This means you’re forfeiting your right.
• Is written like a ‘product purchase’ instead of stating clearly that the CRO is conducting experimental services on your behalf.
• Allows or requires the CRO to run trials or testing in foreign facilities where the expenses won’t qualify for the R&D tax credit.
• Bundles all the costs into one large flat fee that includes general administrative costs, longer-term product manufacturing, etc. You need to have R&D expenses listed clearly and separated.

The IRS also won’t give credit if you have verbal agreements, retroactive work orders, or contracts signed after the trial or study has started.

It’s best to consult a legal expert who can give advice specific to your contract, but audit it for some of these points to retain your eligibility:

• Foreground IP ownership stating that all IP developed during the project belongs to you.
• All deliverables, data, and inventions are labeled “work made for hire” and assigned with rights to you.
• You have a background IP license to use any of the CRO’s pre-existing IP required to exploit the results.
• The CRO is prohibited from deconstructing your proprietary compounds or biological materials.
• Your ownership of IP rights stays in effect even if the contract expires or is terminated.

2. The State You’re Conducting Research In

Another common mistake in R&D tax credit claims is not choosing the right geographical location. Different states offer different benefits when it comes to claiming R&D tax. Some are more favorable than others, and alternatively, some that used to be favorable are becoming less so.

For example, California passed a permanent cap on R&D tax credits after 2030. Life sciences companies will only be able to claim tax credits up to the greater 70% of the tax imposed or 5 million in a tax year. You also won’t be able to elect an annual refundable credit amount. 

Regulations are constantly shifting, which is where working with a team that’s up-to-date on the latest tax legislation can benefit your business. Doing so can help you make sure you’re not leaving significant amounts of money behind.

3. How Your Clinical Teams are Documenting Research & Development

At Centri, we understand what auditors are looking for. How you document your R&D work can make or break your ability to earn the credit. In my experience, the teams that bridge the gap between compliance requirements and the day-to-day clinical work fare better in maximizing their tax strategy.

Five key steps that can help your life sciences team include:

1. Incorporating R&D tax logs into the systems and processes already being used. Separating it out can add more friction and potentially lead to missed tracking.
2. Clear R&D tax credit documentation of the hypothesis, the variance or failure, and the iterative process. Auditors want to see uncertainty, not just what worked.
3. Set clear parameters for your team on the minimum viable documentation standard. You don’t want your scientists to spend time overwriting or documenting beyond what’s needed for tax purposes.
4. Automated project-based time tracking when possible. That way, you’re making it easier for clinical teams who are fast-moving and focused on other things.
5. A framework to translate your clinical team’s language into IRS definitions. This helps your data be export-ready so you’re prepared ahead of an audit. 

If you’re looking for recommendations of R&D tax credit automation solutions, Centri’s team finds Altryx useful. It adds the right blend of AI-forward tech to capture details and automate processes, allowing our tax experts to focus on key, value-added activities instead.

Comparing Your Options for Tackling R&D Tax

The right tax strategy looks different across life science companies. Optimizing your R&D tax will involve deciding between immediate expensing, leveraging different calculation methods, and deciding on what type of support you need. An in-house team, SaaS software, or life sciences tax consultant — the combination of support you choose should fit the complexity of your business. A startup, middle market team, and enterprise group all require different solutions to maximize R&D tax credits and ensure compliance.

	In-House Team	SaaS	Life Sciences Tax Consultant
Clinical Team Burden	High The internal team has to do a lot of work and is responsible for keeping up with regulations.	Low Systems pull the required data automatically.	Moderate Consultants do interviews and need some data outside of what’s manually collected.
Audit Risk & Defensibility	High Internal teams lack regulatory knowledge or don’t have context on nuanced areas.	High Software lacks nuance and narrative justification.	Low Consultants know what auditors look for and have robust narratives.
Optimization of the Credit	Low Teams tend to skew conservative and miss qualified costs.	Medium It can identify payroll trends but misses unique scenarios.	High Experts can analyze complex scenarios to maximize the study.
This Works Well For…	Enterprise Teams Teams with a robust internal tax department are well-equipped.	Startups A newer company with a straightforward approach and fewer resources can use this.	Middle Market & Complex Companies From complicated studies to lacking internal tax expertise, a partner fills the gap and understands the nuances.

Questions to Ask Before Picking Your Life Sciences Partner

Choosing carefully is important, especially for Life Sciences. You need a partner who doesn’t just understand R&D tax, but also understands the complexity of your industry.

Some good questions I recommend asking are:

• What’s the breadth of your service?
  • Why? Some companies focus on R&D, but someone with broader tax and accounting expertise can help you take advantage of every opportunity available to you, not just one. You may even find you’d benefit with other areas of support, like outsourced accounting. 
• What’s your framework for capturing documentation?
  • Why? You want to hear that they’re using the best AI technology paired with a people-led process to capture nuances. All while lightening the burden on your internal team.
• What’s the time commitment required from my clinicians and team?
  • Why? If it’s too low, they’re potentially cutting corners or not providing the value you need from the relationship.
• What is your audit defensibility track record?
  • Why? You want to ensure your partner understands and knows what auditors are looking for, so you get the most value from trusting them to help you earn your R&D tax credit.
• How do you identify niche or edge-case research costs that standard software misses?
  • Why? This is a great way to test their depth of knowledge in life sciences and make sure you’re getting the best-in-quality work.