Expert Report on In-House Research Wages in the Context of the Idaho R&D Tax Credit

In-House Research Wages (IHRW) represent the compensation paid to employees for directly performing, supervising, or supporting qualified research activities. For the Idaho Research Activities Credit, these wages only qualify as eligible expenditures if the related research is physically conducted within the state of Idaho.

This report provides a detailed analysis of In-House Research Wages (IHRW) as defined under Internal Revenue Code (IRC) Section 41, which is adopted by the Idaho State Tax Commission (ISTC) for the purposes of the Idaho Research Activities Credit (Idaho Code §63-3029G). This analysis focuses on the specific requirements for identifying, allocating, and documenting these wages to ensure compliance with Idaho revenue guidance.

I. The Idaho R&D Tax Credit: Foundational Principles and Federal Alignment

The Idaho R&D Tax Credit serves as a mechanism to incentivize businesses to invest in technological advancements within the state’s borders. Established under Idaho Code §63-3029G, the credit is a valuable, though complex, tax strategy.

A. Overview: The 5% Incremental Credit and Statutory Basis

The Idaho R&D Tax Credit provides a financial incentive calculated at 5% of the incremental Qualified Research Expenses (QREs) that exceed a calculated base amount.1 The base amount calculation typically involves multiplying a fixed base percentage by the average annual gross receipts from the four preceding years, aligning closely with the federal formula.2

Key administrative features of the Idaho credit offer substantial long-term relief:

• Nonrefundable Nature: The credit is nonrefundable, meaning it can only offset Idaho income tax liabilities, but it cannot generate a cash refund.1
• Carryforward Provision: Unused credits are granted a generous 14-year carryforward period, allowing businesses to maximize the benefit of their research investments over time.1
• Start-Up Election: Taxpayers may elect start-up treatment on Form 67, utilizing the federal formula but constrained by Idaho data and capped at 16%.1

B. The Mandate of Idaho Nexus: Locality as the Governing Constraint

A foundational principle governing the Idaho R&D tax credit is the requirement that all claimed QREs must be related to research that is conducted in Idaho.1

While Idaho adopts the comprehensive definitions found in the Internal Revenue Code (IRC) Section 41, this adoption is explicitly qualified by the geographic constraint. This requirement necessitates meticulous tracking of where research activities are performed, regardless of the employee’s primary residence or reporting location.

For multi-state employers, compliance requires a sophisticated two-step allocation methodology. First, the employee’s time must be allocated to qualified research activities according to federal standards (e.g., the 80% rule discussed below). Second, that qualified time must be geographically sourced only to the activities physically performed within Idaho. This layered allocation requirement significantly increases the documentation complexity compared to calculating the federal credit alone.

C. The Federal Pillar: Incorporation of Internal Revenue Code (IRC) Section 41

Idaho Admin. Code r. 35.01.01.720 explicitly confirms that the Idaho credit computation utilizes the same definitions for qualified research expenses, qualified research, basic research payments, and basic research as those detailed in IRC Section 41.3

This mandate makes a clear understanding of the federal rules—particularly those defining QREs—essential for claiming the state credit. IRC §41(b)(1) defines QREs as the sum of three types of expenditures:

1. In-House Research Expenses: This includes wages for employees working on qualified research, costs paid or incurred for supplies, and certain rental/lease payments.4
2. Contract Research Expenses: Generally, 65% of amounts paid to third parties (non-employees) for qualified research.4
3. Basic Research Payments: For basic research conducted in Idaho, in excess of the base period amount.1

D. Contextual Note: Federal R&D Amortization Impact

For tax years beginning on or after January 1, 2022, the federal Tax Cuts and Jobs Act (TCJA) requires R&D expenditures (governed by IRC §174) for domestic research to be amortized over five years.6

Idaho’s credit hinges on the definition of expenditures that are eligible for treatment under Section 174.4 Although the amortization affects the federal deduction rather than the state credit, classification consistency is paramount. Any attempt to classify an expenditure as R&D for the Idaho credit that is intentionally not treated as amortizable R&D for federal purposes (due to the amortization requirement) creates a substantial inconsistency that may trigger an audit red flag and challenge the claim’s foundational Section 174 test eligibility.4 Taxpayers must therefore ensure that their claimed QREs satisfy the underlying federal eligibility criteria, even when calculating the state credit.

II. Deconstructing “In-House Research Wages” (IHRW)

The largest component of In-House Research Expenses often involves wages paid for qualified services. Accurate determination requires strict adherence to both the definition of “wages” and the definition of “qualified services.”

A. Statutory Definition of Taxable Wages (IRC §3401(a) Standard)

For R&D tax credit purposes, the term “wages” is defined by IRC Section 3401(a).7 This definition is broad, encompassing all remuneration paid to an employee for services performed for their employer, including the cash value of all non-cash remuneration, provided these amounts are subject to federal income tax withholding. This includes regular salaries and bonuses directly tied to qualified services.

Specific provisions apply to certain individuals:

• Self-Employed and Owner-Employees: In the case of an employee defined under IRC §401(c)(1), which often includes owners of pass-through entities common in Idaho 4, the term “wages” includes the earned income of that employee, as defined in IRC §401(c)(2).7 This provision is vital for small and mid-sized businesses where owners are actively involved in research.
• Exclusions: The definition explicitly excludes any amount of wages already taken into account when determining the Work Opportunity Credit under IRC Section 51(a).7

B. The Three Components of In-House Research Expenses

IHRW is one of three categories comprising In-House Research Expenses:

1. Wages: As defined above, relating only to compensation for qualified services performed in Idaho.2
2. Supplies: This covers the cost of tangible property consumed during the research process. Supplies are defined as tangible property other than land, improvements to land, or property subject to the allowance for depreciation.5
3. Rental/Lease Payments: Amounts paid or incurred for the right to use computer systems used specifically in the conduct of qualified research.

III. Defining Qualified Services and the Allocation Rules

Wages are only includible in QREs to the extent they are paid for performing “qualified services.” The identification and allocation of time spent on these services are central to Idaho R&D compliance.

A. The Three Categories of Qualified Services (IRC §41(b)(2)(B))

Qualified services are strictly delineated into three activities, as adopted by Idaho 9:

1. Engaging in Qualified Research (Direct Research): Services that involve the actual execution of the research activity, such as operating specialized testing equipment, designing experimental software architecture, or developing prototypes.5
2. Direct Supervision: Services consisting of the immediate management, oversight, and control of employees who are directly performing qualified research. General administrative management is not included; the supervision must be tied specifically to the research activity.5
3. Direct Support: Services that provide integral, direct assistance to the researchers or supervisors, such as maintaining specialized research equipment, fabricating parts for an experiment, or compiling and processing research data. General administrative functions, such as human resources or sales activities, do not qualify.5

B. Deep Dive into the “Substantially All” Rule (The 80% Threshold)

A critical rule in wage calculation is the “substantially all” provision. If an individual employee performs qualified services (any combination of the three categories listed above) for 80% or more of their total time worked during the taxable year, then 100% of that individual’s wages are treated as qualified wages.5 This rule recognizes that core research personnel often engage in minor non-research tasks, simplifying compliance.

Conversely, if an employee fails to meet the 80% threshold, the “substantially all” rule does not apply. In this scenario, only the wages corresponding to the actual time spent on qualified services are included in QREs.5

The compliance structure dictates that the allocation must precisely verify both the qualified service percentage and the location. If an employee performs qualified research 60% of the time, but 10% of that qualified time was spent outside of Idaho, only 54% of their total wages (90% of 60%) would qualify for the Idaho credit, demonstrating the necessity of tracking geographic location alongside activity.

C. Reporting In-House Research Wages on Idaho Form 67

The final, calculated, and geographically sourced IHRW amount must be reported to the state. Taxpayers use Form 67, Credit for Idaho Research Activities.9 The calculated IHRW is specifically entered on:

• Form 67, Part I, Line 4: “Wages for qualified services performed in Idaho”.9

The instructions for Line 4 reiterate the state’s reliance on the federal standard for qualified services, confirming the requirement to track services consisting of engaging in qualified research, direct supervision, or direct support.9

IV. Idaho State Tax Commission (ISTC) Guidance on Wage Compliance

Idaho’s tax administration adopts a rigorous stance on R&D credit substantiation, relying heavily on federal audit standards and judicial precedent to validate claims, particularly those related to the largest QRE component—wages.

A. Mandatory Application of the Federal Four-Part Test in Idaho

The ISTC requires that, as a prerequisite to claiming any QRE, the underlying activity must satisfy the federal four-part test defined in IRC §41.1 This foundational compliance hurdle requires taxpayers to document that their research expenditures are:

1. Eligible for Section 174 Treatment: The expenses must be eligible for treatment as research or experimental expenditures.4
2. Technological Information Test: The activities must seek to discover information that relies on principles of physical or biological sciences, engineering, or computer science.6
3. Business Component Test: The discovered information must be intended to develop a new or improved business component (product, process, software, etc.).6
4. Process of Experimentation Test: The activity must involve a systematic process designed to eliminate technological uncertainty regarding the capability, method, or appropriate design of the improvement.4

B. The Critical Role of Documentation for Idaho Claims

The greatest risk faced by taxpayers claiming the Idaho R&D credit is inadequate documentation of employee time. ISTC audit guidance explicitly reinforces the high bar for substantiation. The ISTC has cited relevant federal tax court precedent, noting that “shortcut estimates of experimentation-related activities will not suffice” and emphasizing the necessity of “documentation of time spent on such [activities]”.6

Audit decisions frequently result in the disallowance of credits not due to a failure to perform the research, but due to the petitioner’s failure to provide “sufficient documentation to meet the four-part test”.10 Because IHRW represents a significant portion of QREs, a lack of verifiable time tracking directly invalidates the wages claimed. The state’s explicit reference to judicial standards regarding insufficient estimates confirms that reliance on general job descriptions or management opinions is inadequate.

To mitigate this high audit risk, Idaho taxpayers must implement precise, contemporaneous time-tracking systems (such as daily logs, project management software, or detailed periodic estimations supported by verifiable source data) that capture time at the project level, specific activity level, and, crucially, the in-state activity level.

V. Strategic Allocation and Example Case Study

Effective strategy for maximizing the Idaho R&D credit involves rigorous segmentation of the workforce and meticulous application of the 80% rule, integrated with the geographic sourcing constraint.

A. Employee Classification Strategy

Companies should categorize employees based on their primary function to streamline time tracking and optimize the claim:

• Core Research Personnel (e.g., Lead Engineers, Scientists): These employees are likely to meet or exceed the 80% threshold. If they do, 100% of their Idaho-sourced wages may be included.
• Direct Support Personnel (e.g., Technicians, Programmers, Quality Assurance): These individuals often spend significant, but not majority, time on qualified services. Detailed time tracking is essential here, as proportional allocation will apply.
• Indirect Personnel (e.g., Senior Management, Administrative Staff): Only specific project managers or executives who can quantitatively prove they engaged in direct supervision of qualified research activities should be tracked, typically resulting in proportional allocation.

B. Case Study: Allocation of In-House Research Wages

Consider a Boise-based technology company, Innovate ID, engaged in a qualified, multi-year software development project. The company must calculate the qualified wages for the following employees, assuming 100% of their qualified services were performed in Idaho:

Table Title

Calculation Breakdown:

1. Dr. Smith: Spends 90% of time on direct research (e.g., coding and testing new features). Since 90% exceeds the 80% threshold, the “substantially all” rule allows for 100% inclusion of the wages. ($120,000).
2. P. Jones: Spends 40% of time running specialized tests and compiling data specifically for the R&D team (Direct Support). Since 40% is below 80%, the time is proportionally allocated: $\$70,000 \times 40\% = \$28,000$.
3. A. Chen: Spends 75% of time directly supervising the R&D team’s activities and providing technical guidance (Direct Supervision). Since 75% is below 80%, the time is proportionally allocated: $\$95,000 \times 75\% = \$71,250$.

The total In-House Research Wages claimed on Form 67, Line 4, for this period is $219,250.

This example demonstrates the significant impact of the 80% rule. While core R&D staff wages are maximized through the 100% inclusion, failing to meticulously track time for employees who fall short of 80% but still contribute significantly (like A. Chen at 75%) would forfeit substantial QREs. Strategic compliance focuses on ensuring robust tracking for all levels of research engagement to accurately capture all qualifying proportional allocations.2

VI. Conclusion and Forward-Looking Compliance Strategy

The Idaho R&D Tax Credit is a vital mechanism offering long-term tax relief via a 14-year carryforward.1 However, claiming In-House Research Wages successfully requires navigating a complex compliance pathway that integrates strict federal definitions with specific Idaho geographic sourcing rules and rigorous documentation standards.

A. Summary of Key Compliance Requirements for Idaho IHRW

Successful Idaho R&D claims rely on addressing three simultaneous core challenges:

1. Federal Qualification: The underlying project must satisfy the stringent IRC §41 Four-Part Test, ensuring the expenditure is eligible for Section 174 treatment and involves a process of experimentation to resolve technological uncertainty.4
2. Idaho Sourcing: The calculated QREs, including IHRW, must be explicitly tied to research activities that were physically conducted within the state of Idaho, requiring geographical tracking for mobile or multi-state employees.3
3. Audit Substantiation: The ISTC requires granular, contemporaneous evidence of time allocation. Claims resting solely on high-level estimates are vulnerable to disallowance, as the ISTC strongly emphasizes verifiable documentation of employee time dedicated to qualified services.6

B. Audit Defense Best Practices

To successfully defend IHRW claims under ISTC examination, taxpayers must move beyond basic payroll records and implement robust internal controls:

• Implement Detailed Time Tracking: Utilize project management or specialized time-tracking systems that capture employee time based on the specific project, the type of qualified service performed (direct research, supervision, or support), and the location (Idaho versus non-Idaho).
• Establish Management Oversight: Require periodic management review and sign-off on time allocation logs to substantiate the claim that the time recorded accurately reflects qualified services and direct supervision activities.
• Document Technical Uncertainty: Time tracking alone is insufficient. All documentation supporting the “Process of Experimentation” and the underlying technological uncertainty—including meeting minutes, design specifications, and test reports—must be retained, as this provides the necessary context for the claimed employee time.6

By ensuring absolute consistency between federal eligibility (IRC §174/§41) and Idaho’s geographic sourcing requirements, and by maintaining auditable, contemporaneous documentation, Idaho businesses can sustainably maximize the financial benefit of the Research Activities Credit.

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/