The R&D tax credit for biotech startups
The short answer
Preclinical research, assay development, and process development usually qualify for the R&D tax credit. The sticking points are work done by foreign contract research organizations and research funded by an outside sponsor.
What qualifies, and what fights you
Biotech companies run structured experiments by default: testing a hypothesis, running an assay, measuring a result, and adjusting the next run. Assay development, formulation work, and manufacturing process development for biologics all involve real technical uncertainty and usually qualify.
Two issues come up more in biotech than in software. First, work performed by a contract research organization located outside the US does not count toward the federal credit, even if your company pays for it and owns the results. Second, if a sponsor funds a study and retains rights to the results while bearing the financial risk, that funded research is generally excluded, since your company was not the one bearing the risk of failure.
Clinical trial work can qualify, but it needs care. Protocol design and dose-finding work your own team performs and controls can qualify. A trial run entirely by an outside sponsor under a funded research arrangement usually does not. A CPA should review the structure of each study.
The four-part test, applied to biotech startups
Qualified purpose and technological nature are usually straightforward in biotech: the work improves a therapeutic, diagnostic, or manufacturing process, and it relies on biology, chemistry, and engineering. The interesting part is elimination of uncertainty, since so much of biotech work starts with a genuinely unknown answer, like whether a formulation will remain stable or whether a process will scale.
Process of experimentation is built into the scientific method itself. Running an assay validation study, testing a formulation across a range of conditions, or adjusting a manufacturing process to fix a yield problem and testing the fix are all direct examples of the iterative testing the four-part test asks for.
New to the test itself? Read what software work qualifies as R&D first.
Work that usually qualifies
Assay development and validation
Developing a new assay and running validation studies to establish its sensitivity and specificity involves resolving real technical uncertainty.
Formulation development
Testing a drug or biologic formulation across different excipients and conditions to find one that stays stable over time qualifies as experimentation.
Analytical method development
Developing and validating an HPLC or other analytical method to accurately measure a compound qualifies, since the method's accuracy is not known until it is tested.
Manufacturing process development for biologics
Adjusting upstream and downstream process steps to resolve a yield or purity problem, and testing each change, is qualifying process development.
Preclinical study design
Designing and running preclinical studies to test a dosing hypothesis, where the outcome is unknown at the outset, qualifies as research.
Work that usually does not
Work performed by a foreign CRO
Research conducted outside the US, even when your company funds it and owns the results, does not count toward the federal credit.
Client-funded research owned by the sponsor
If an outside sponsor funds a study, retains the rights, and bears the financial risk if it fails, that research is generally excluded as funded research.
Which expenses count
Lab supplies consumed during experiments count. Reagents, assay materials, and other consumables used up in a qualifying study are supply expenses, distinct from lab equipment, which is usually capitalized instead.
Wages for scientists and engineers doing or supervising qualifying research count, prorated to time spent on qualifying work. This includes bench scientists, process development engineers, and the technical leads directing a study.
US-based contract research counts at 65% of what you pay, which is why the location of your CRO matters. The same study run by a US-based CRO instead of a foreign one can change whether the cost qualifies at all.
A worked example
Hypothetical example. A biotech startup has 7 scientists and process engineers earning a blended average of $135,000, spending about 65% of their time on qualifying research and process development.
At 6 to 10% of total QRE, the federal credit lands between about $46,250 and $77,075. Under $5 million in revenue, the company can apply up to $500,000 of that against payroll taxes each year.