The Technical Definition and Compliance Framework for Supplies Used in Qualified Research in Delaware

Supplies Used in Qualified Research (Delaware) refers to tangible raw materials and consumable items directly utilized in experimentation and prototyping as part of activities qualifying for the Delaware R&D Tax Credit, provided these materials are not depreciable assets or land improvements.1 These expenditures form a core component of Delaware Qualified Research Expenses (QREs), defined under state law by reference to the stringent definitions of IRC Section 41, and contribute directly to a significant, fully refundable state tax incentive.3

1. Executive Summary: The Definition and Strategic Value of QRE-Supplies in Delaware

The Delaware R&D Tax Credit, authorized under Delaware Code Annotated, Title 30, Sections 2070-2075, is administered by the Delaware Division of Revenue (DOR) and represents one of the state’s most valuable corporate tax incentives.4 The unique strategic value of the Delaware credit lies in its structure: it is fully refundable, meaning that if the claimed credit exceeds the taxpayer’s corporate income tax liability, the unused portion is paid out directly as a cash refund.4 This attribute provides immediate, direct cash flow to companies, making the precise tracking and substantiation of all Qualified Research Expenses (QREs)—particularly supplies—a critical financial management task.

Delaware allows taxpayers to choose between two annual calculation methodologies: 10% of excess QREs over a determined base amount, or 50% of the state’s apportioned share of the federal Alternative Simplified Credit (ASC).4 For small businesses, defined as those with average annual gross receipts not exceeding the $\$20,000,000$ threshold, these rates are substantially enhanced to 20% and 100%, respectively.5

The fact that the credit is fully refundable immediately heightens the regulatory scrutiny applied by the DOR to all claimed QREs. Since the state is distributing cash, rather than merely reducing future liability, the burden of proof for the underlying expenses is amplified. This dynamic necessitates absolute adherence to the rigorous federal documentation standards for supplies, as Delaware’s legislation relies entirely on these federal definitions and compliance methods. Therefore, the successful quantification of supplies is paramount to securing this highly desirable, refundable cash benefit.

2. Statutory and Regulatory Foundation: The Federal Nexus Defining QREs

The eligibility framework for research supplies in Delaware is established not by independent state rules but through a direct legislative reference to the Internal Revenue Code (IRC), creating a seamless regulatory synchronization with federal tax law.

2.1. Legislative Framework: Delaware Code Title 30, § 2070

Delaware law provides the administrative mechanisms for the credit, including the requirement for businesses to apply annually for approval from the Delaware Division of Revenue.4 The statute allows for two primary calculation approaches—the Traditional Credit method and the ASC method—and stipulates that the taxpayer’s annual election for the Delaware calculation method is independent of the method used for the federal research and development tax credit determination.5

2.2. Adoption of Federal QRE Definitions (IRC § 41(b))

The crucial statutory foundation is established in Delaware Code Title 30, Chapter 20, Subchapter II, which mandates that “Delaware qualified research and development expenses” shall be defined as “qualified research expenses as defined in § 41(b) of the Internal Revenue Code of 1986”.3

This legislative adoption means that all definitions, methodologies, and exclusion criteria established by the IRS under IRC Section 41(b) govern the eligibility of supplies claimed in Delaware.4 To qualify, the research activity supported by the supplies must satisfy the federal four-part test: the activity must be technological in nature, designed to improve product functionality or performance, aimed at eliminating technological uncertainty, and involve a process of experimentation.1 Furthermore, all such activities and the associated expenses must be conducted within the state of Delaware to be considered “Delaware QREs”.4

2.3. Supplies as a Pillar of In-House Research Expenses

Qualified Research Expenses are defined federally as the sum of in-house research expenses and contract research expenses.2 Supplies constitute one of the three specific categories of eligible in-house research expenses, alongside qualified wages for employees and certain computer rental or lease costs.4 The classification of supplies within this primary grouping confirms their role as a fundamental, measurable cost of the research process.2

The state’s full adoption of IRC $\S 41(\text{b})$ signifies that Delaware outsources the definitional risk assessment for QREs to the IRS. For Delaware taxpayers, this structure means that compliance requires continuous monitoring of all federal developments, including Treasury Regulations and case law that interpret terms like “supply” or “depreciable property.” Any successful federal audit challenge against a claimed supply expenditure based on IRC $\S 41$ methodology would automatically invalidate the corresponding QRE amount claimed for the state credit, emphasizing the necessity of robust, federal-level substantiation.

3. Technical Definition of “Supplies Used in Qualified Research”

The determination of a qualified supply expense is governed by the meticulous application of IRC $\S 41(\text{b})(2)(\text{C})$ and associated Treasury Regulations.

3.1. The Three Essential Statutory Criteria (IRC § 41(b)(2)(C))

For an expenditure to qualify as a supply QRE, it must satisfy all three criteria derived from federal statute:

1. Tangible Property: The expenditure must be for tangible physical material.2 This inherently excludes intangible costs, such as utility fees, general administrative overhead, licensing fees, and the cost of leasing assets other than computers.2
2. Exclusion of Land and Improvements: The cost cannot be related to land or permanent improvements to land.2 This criterion ensures that capital expenditures for real property development are isolated from the consumable materials used in research.
3. Exclusion of Depreciable Property: This is the most crucial test: a supply must not be “property of a character subject to the allowance for depreciation”.2 To meet this requirement, the materials must be consumed, used up, or rendered useless entirely during the conduct of the research and development process. Materials that are capitalized or possess a demonstrable residual value extending beyond the current tax year fail this test and must be excluded.1

3.2. Requirement for Direct Use in Qualified Research (Treasury Regulation § 1.41-2(e))

Furthermore, Treasury Regulation $\S 1.41-2(\text{e})$ mandates that supplies must be used in the conduct of qualified research.2 This means the materials must be directly tied to the execution of qualified services (experimentation, prototyping, testing) performed by the taxpayer’s employees.11

This requirement serves to exclude general and administrative (G&A) expenses. Expenditures for supplies that constitute indirect research expenditures or G&A expenses are explicitly ineligible as in-house research expenses.11 Examples of excluded costs include general office supplies, non-specialized cleaning materials, or general facility maintenance costs, as these items are not directly consumed in the act of resolving technological uncertainty.1

3.3. Examples of Qualified and Excluded Supply Costs

Qualified supply expenses include raw materials used to fabricate and test prototypes, specialized chemicals or biological media that are consumed, and disposable laboratory supplies.1 These materials are sacrificed in the pursuit of the R&D objective.

Conversely, excluded items include durable tools, machinery, research equipment, and specialized glassware that is reusable and therefore subject to depreciation.1 Also excluded are materials used in activities deemed non-qualified, such as materials utilized in routine quality control testing or market research.8

For manufacturing or biotechnology firms, raw materials often originate in general inventory, creating a substantial documentation challenge. To successfully claim a material as a supply QRE, the taxpayer must demonstrate not only that the material was non-depreciable but, critically, that it was actually consumed or rendered worthless in the direct act of qualified experimentation. This necessitates linking specific inventory depletion records (e.g., consumption logs, batch withdrawal documentation) directly to R&D project activities, proving the material was expended for the technical purpose of eliminating uncertainty, rather than being diverted to routine commercial production or inventory.

Table 1: Statutory Criteria for Qualified Research Supplies (Delaware/Federal Nexus)

4. Operationalizing Compliance: The Role of the Delaware Division of Revenue

Compliance with the Delaware R&D tax credit requires mandatory administrative procedures managed by the Delaware Division of Revenue (DOR), which governs the approval, application, and reporting of QREs.

4.1. Administrative Approval and Timeline

The DOR maintains administrative oversight of the credit.4 Taxpayers must obtain approval from the DOR before they can claim the credit amount.13 The official application form is Delaware Form 2070AC (Application and Computation Schedule), which must be fully completed and submitted to the DOR.14 The deadline for this submission is rigidly set: on or before September 15th following the end of the taxable year in which the qualified research and development expenses were incurred.14

4.2. Reporting Requirements: Delaware Forms and Federal Linkage

For reporting purposes, the key document is Delaware Form 2070AC. However, the most critical compliance instruction is the mandatory requirement to attach a copy of the Federal Form 6765 (Credit for Increasing Research Activities) to the state application.14

This procedural linkage is central to the DOR’s review process. Form 2070AC itself only requires the aggregation of QREs, such as the “Total Delaware qualified R&D expenses for the credit year”.14 By demanding the attachment of the federal form, the DOR relies on the federal-level substantiation and calculation to validate the expense totals. Taxpayers must ensure that the underlying documentation supporting the supply costs reported on the Federal Form 6765 is robust enough to withstand potential state audit review.

4.3. Proving Delaware Nexus for Supplies

The Delaware statute mandates that QREs must be associated with qualified research conducted within the state.3 Therefore, taxpayers must be prepared to rigorously demonstrate that the claimed supply costs relate directly to research activities physically performed in Delaware.

For taxpayers utilizing the ASC calculation (Method B), the credit is apportioned based on the ratio of Delaware QREs (including supplies) to total nationwide QREs.13 This calculation reinforces the need for accurate geographic allocation. To verify in-state usage, documentation must include internal consumption records, lab logs tied to specific Delaware personnel, and vendor invoicing showing delivery to the Delaware research facility. Research activities and corresponding supply costs incurred outside of the United States are ineligible.8

The reliance on the Federal Form 6765 means the most effective documentation strategy requires establishing an audit trail that goes beyond mere financial totals. The documentation must connect supply consumption records to specific R&D projects, recording the ‘who, what, when, and where’ of material usage and explicitly linking that usage to the technological objective that satisfies the four-part test. Since the Delaware credit is refundable, any inadequacy in this underlying federal substantiation directly exposes the state cash refund to audit risk.

5. Calculation Mechanics and Enhanced Benefits

Qualified supply costs directly augment the taxpayer’s total QRE base, which in turn determines the size of the available tax credit.

5.1. QREs as the Base Multiplier

The total expenditure on qualified supplies is combined with wages and computer costs to form the Total Delaware Qualified R&D Expenses.4 This cumulative figure is the essential component used in both calculation methodologies, reported on Line 6 (Method A) or Line 2 (Method B) of Delaware Form 2070AC.14 Maximizing this base through rigorous supply documentation ensures the highest possible credit output.

5.2. Calculating the Credit: Method A vs. Method B

Taxpayers make an annual election between the two methods:

• Method A (Traditional): The credit is calculated as 10% of the excess QREs over the Delaware base amount.4 The base amount is calculated using the four preceding years of historical data but is subject to a statutory floor of 50% of the current year’s QREs.4
• Method B (Alternative Simplified Credit – ASC): The credit is calculated as 50% of Delaware’s apportioned share of the federal alternative incremental credit.5 The apportionment relies on the ratio of Delaware QREs (including supplies) to total QREs nationwide.13

5.3. Enhanced Rates for Small Businesses

A key strategic advantage in Delaware is the substantially enhanced credit rate available to “small businesses,” defined as those with average annual gross receipts not exceeding the $\$20,000,000$ threshold.5

For these qualified small businesses, the enhanced rates apply:

• Method A provides 20% of excess QREs (double the standard rate).6
• Method B provides 100% of Delaware’s apportioned federal ASC (double the standard rate).6

This enhanced refundable rate structure underscores the financial significance of accurately capturing every dollar of qualified supplies. Businesses in high-consumption sectors, such as biotechnology or specialized manufacturing, often utilize high volumes of consumables during early development phases. For small businesses, an aggressive yet compliant approach to documenting supply QREs ensures maximum leverage of the state’s 20% refundable cash benefit.

Table 2: Delaware R&D Tax Credit Calculation Rates (Del. Code Ann. tit. 30, § 2070)

6. Case Study and Practical Example: Maximizing Supply QREs in Advanced Manufacturing

This case study illustrates the substantial financial impact of correctly classifying supply expenses in a high-tech R&D scenario.

6.1. Scenario: InnovateDE Manufacturing

InnovateDE, a Delaware-based advanced manufacturer, is engaged in qualified research to develop and test custom tooling designed to automate part of its production line.16 The R&D phase involves repeated experimental trials using specialized materials to test durability and structural failure points, activities that qualify under the federal four-part test.1

6.2. Supply Expense Tracking and Allocation

InnovateDE incurred the following costs at its Delaware R&D facility over the tax year:

By implementing a disciplined expense segregation system, InnovateDE correctly identified and claimed $\$222,000$ in qualified supplies, excluding the $\$55,000$ related to capital expenditures and routine costs.

6.3. Quantification of Credit Impact

Assume InnovateDE is a small business eligible for the enhanced 20% rate (Method A). Their total QREs, including the $\$222,000$ in supplies, equal $\$2,500,000$. The Delaware Base Amount is calculated at $\$1,500,000$.

• Credit Calculation with Supplies: The Excess QREs amount to $\$1,000,000$ $(\$2,500,000 – \$1,500,000)$. Applying the small business rate results in a credit of $\$200,000$ $(20\% \times \$1,000,000)$.
• Impact of Supply Disallowance: If the $\$222,000$ in supply QREs were disallowed due to insufficient documentation, the Total QREs would fall to $\$2,278,000$. The new Excess QREs would be $\$778,000$ $(\$2,278,000 – \$1,500,000)$. The resulting credit would be $\$155,600$.

The failure to properly substantiate the supply costs would lead to a direct reduction of $\$44,400$ in the company’s refundable cash credit, demonstrating that the effort expended on documenting supply consumption provides a direct, measurable return.

7. Conclusion and Strategic Recommendations for Compliance

The rigorous classification and documentation of Supplies Used in Qualified Research are essential to maximizing the valuable, fully refundable Delaware R&D tax credit. Delaware’s statute fully integrates the federal definition of QREs under IRC $\S 41(\text{b})$, making federal compliance the gateway to state benefits. Supplies must be defined as tangible, non-depreciable property directly consumed in the qualified research process performed within Delaware.

To effectively manage audit risk and optimize the credit, particularly for small businesses utilizing the enhanced 20% rate, the following strategic steps are recommended:

1. Mandatory Expense Segmentation and Consumption Tracking: Taxpayers must move beyond simple general ledger reporting by implementing project-level tracking. This system should meticulously segregate consumable supplies from capitalized assets, tracking materials from inventory receipt to their definitive consumption in a qualified experiment. Maintaining detailed records of disposal or destruction proves the non-depreciable nature of the expense, which is critical for compliance.
2. Centralized Documentation Strategy: The entire state claim rests upon the substantiation prepared for Federal Form 6765, which is required by the Delaware DOR on Form 2070AC.14 Therefore, all documentation relating to supplies must be prepared to federal audit standards, linking the expenditure to the four-part test, specific R&D personnel, and the in-state performance of the research activity.
3. Annual Calculation Method Review: Taxpayers must annually evaluate the two calculation methods (Traditional and ASC) to determine which yields the highest credit.5 For small businesses, the enhanced 20% and 100% rates mean that aggressive, compliant supply tracking can significantly enhance liquidity through the refundable credit mechanism.5

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/