The pharmaceutical and biotechnology sectors operate on a tightrope of financial and scientific considerations. The mandate to develop life-saving therapeutics requires a substantial capital expenditure and entails significant technical risk. This developmental cost, spanning years of preclinical and clinical research, continually dictates a company's runway and viability.

Federal and state Research and Development (R&D) tax credits are critical financial instruments amid these investment demands. These tax incentives convert the cost of scientific experimentation into a dollar-for-dollar reduction of tax liability, providing essential capital to mitigate risk and fuel technical breakthroughs.

R&D Tax Credits: A Strategic Lifeline

The R&D tax credit rewards businesses for conducting U.S.-based qualified research at both the federal and state levels. These credits are especially valuable due to the fundamental distinction between tax deductions and tax credits:

• A tax deduction reduces a company's taxable income.
• A tax credit directly reduces the tax bill owed, acting as a dollar-for-dollar offset.

The financial relief offered by the credit is not limited to profitable enterprises. Qualifying startups may elect to apply the credit against tax obligations, providing crucial cash infusions during the lengthy, pre-revenue phases I through IV of drug development.

Lab to Launch: Qualifying R&D Across the Developmental Pipeline

Drug discovery stages are often replete with qualified research activities (QRAs). Federal R&D tax credit eligibility hinges on the systematic and scientific effort required to overcome technical uncertainties.

Eligible activities frequently occur across the entire developmental pipeline:

• Drug delivery: 
  • Developing and improving mechanisms to enhance specific targeting, absorption, or bioavailability.
• Formulation and stability: 
  • Creating and testing new chemical compounds and drug formulations to improve drug consistency, efficacy, or shelf life.
• Preclinical research: 
  • Discovering new pharmacological targets, performing in vitro (laboratory) and in vivo (animal) testing, and performing assays to characterize drug pharmacokinetics and pharmacodynamics.
• Clinical trials (Phases I through IV):
  • Designing and conducting clinical trials to establish the therapeutic dosing, efficacy, and long-term effects of a drug or biologic.
• Manufacturing:
  • Engineering and testing processes for large-scale production, including developing automated batch-scaling procedures or customized bioreactor controls.

Substantiating R&D: Passing the Scientific and Financial Four-Part Test

To count toward the federal R&D Tax Credit, expenditures must be directly attributable to activities that satisfy the Internal Revenue Service (IRS)’s Four-Part Test. In other words, an expenditure must fall into an eligible category (e.g., contract research, supplies, and wages) and directly relate to a qualified activity to be included in the tax credit calculation.

The subtests of the four-part test are:

• Permitted purpose:
  • The activity must aim to create or improve a business component's function, performance, quality, or reliability.
• Elimination of uncertainty:
  • The research must seek to eliminate technical questions regarding appropriate design, capability, or method.
• Process of experimentation:
  • A systematic process (e.g., clinical trials, computer simulation, or laboratory testing) must be employed to evaluate alternatives and address the uncertainty.
• Technological in nature:
  • The research must rely on the hard sciences, including biology, chemistry, engineering, or computer science.

Qualified Research Expense (QRE) categories include:

• Wages:
  • Salaries for domestic employees (e.g., chemists and clinical scientists) directly conducting, supervising, or supporting qualified research.
• Contract research:
  • 65% of amounts paid to U.S.-based Contract Research Organizations (CROs) or laboratories performing qualified work.
• Supplies:
  • Costs of chemicals, components, lab materials, or reagents consumed or destroyed during experimentation.

• Computer lease:
  • Fees for cloud computing services and specialized server time used for data modeling, simulation, and analysis.

Accelerating Timelines: R&D Funding and Competitive Advantage

R&D tax credits are crucial to the financial success of biotechnology and pharmaceutical companies. Qualified Research Expenditures (QREs) that count toward R&D tax credits directly mitigate the upfront capital costs inherent in Phases I–IV of development, thereby extending the operational runway. This financial credit secures a decisive competitive advantage, ensuring capital immediately accelerates clinical timelines in the race for medical advancement.

Connect, Learn, and Maximize R&D Tax Credits

Optimize your tax strategy. Schedule a complimentary R&D consultation with Randy Eickhoff, CPA, Founder & Head Coach of Acena Consulting, for expert guidance.

Register for our free monthly webinar, next on Nov. 18, 2025: Cracking the (Tax) Code for R&D.

• This workshop provides one continuing education (CPE) credit for professionals maintaining their continuing education (CEs).
• Discover more about qualifying and documenting R&D activities to receive tax incentives.

Visit our Acena Events page to sign up for our newsletter and stay abreast of all upcoming events.

Follow Acena on LinkedIn and X for the latest industry-specific incentives and tax policy updates.

//

Photo courtesy of e-MagineArt.com on Flickr.