[GLOS86_code]

Exclusionary Principles: An Expert Analysis of General and Administrative (G&A) Functions in U.S. Research and Development Tax Law

I. Executive Summary: The Exclusionary Role of General and Administrative (G&A) Costs in the R&D Tax Credit (IRC § 41)

A. Meaning and Importance of G&A Exclusion

General and Administrative (G&A) expenses represent the indirect operating costs necessary for the overall functioning and governance of an enterprise, but which lack a direct, causal linkage to the creation, production, or technical experimentation associated with research and development (R&D).1 These costs are foundational to business operations and typically include fixed employee salaries for corporate service functions such as human resources (HR), accounting, and legal departments, as well as general facility rent, office supplies, and executive salaries for non-technical leadership.2 The strategic importance of classifying G&A stems from the fundamental structure of the R&D Tax Credit, defined under Internal Revenue Code (IRC) Section 41. This section mandates that the credit is calculated exclusively based on Qualified Research Expenditures (QREs), which are limited to specific, direct costs: wages for qualified services (direct performance, direct supervision, or direct support of research), supplies consumed in experimentation, and contract research expenses.3 IRS regulations strictly enforce this limitation by explicitly excluding expenditures that are indirectly related to R&D, thereby categorizing general and administrative costs as inherently non-qualifying.5 This categorical exclusion is critical to the integrity of the tax incentive, ensuring that the credit exclusively rewards measurable, high-risk technological innovation rather than providing a general subsidy for common business overhead.

B. Compliance Implications and The Critical Distinction

The stringent regulatory framework dictates that compliance success hinges on the accurate separation of costs that perform “direct support” of qualified research (which may be included as a QRE) from those that constitute “indirect G&A” (which must be excluded).4 Indirect G&A encompasses administrative functions that benefit the company as a whole, irrespective of any specific research project, such as the processing of payroll for research staff, the general executive oversight of a technical department, or the accounting work related to the general ledger.6 This strict exclusionary principle is consistently applied across tax legislation. Recent, detailed guidance from the Internal Revenue Service (IRS), specifically Notice 2023-63, reinforces this posture by explicitly excluding costs from functional G&A departments—including payroll, HR, and accounting—from the pool of Specified Research and Experimental (SRE) costs that must be capitalized under IRC Section 174.8 Since qualifying research activities for the credit must align with the definition of research expenditures under Section 174 3, this ruling establishes a unified standard: these functional administrative costs are neither capitalizable nor creditable. The consequence of failing to implement robust cost allocation methodologies to separate and exclude these indirect costs represents a primary source of audit risk, frequently leading to the disallowance of claimed QREs.

Concrete Example of G&A Exclusion:

Consider a specialty manufacturing firm developing a complex, improved lightweight composite material for aircraft components. The qualified research expenditures (QREs) include the wages of the materials engineer conducting tensile strength testing and the direct cost of the raw chemical supplies consumed in mixing and curing the prototypes.4 However, the wages of the corporate accounting staff who manage the firm’s general ledger, the Human Resources (HR) department’s time spent administering employee benefit plans, and the interest paid on a secured loan used to finance the entire corporate facility are all fundamentally categorized as General and Administrative (G&A) expenses. These costs, although necessary for the business’s existence and operation, only indirectly support the underlying research activity. Consequently, under the explicit requirements of IRS regulations, these G&A expenditures must be strictly excluded from the calculation of the R&D tax credit.7

II. Foundational Tax Law: G&A as a Categorical Non-Qualifying Expenditure

A. Accounting and Financial Definition of G&A Expenses

From an accounting perspective, G&A expenses are indirect operating costs that are essential for supporting the company’s operations but are separate from the costs of production (Cost of Goods Sold, or COGS) and R&D activities.1 These expenditures are typically fixed costs and do not fluctuate directly based on revenue or sales volume. They cannot be directly attributed to the production, sales, or specific technical operations of the business.1 Standard examples of G&A expenses include non-technical executive compensation, corporate facility leases, general office supplies, utilities for non-manufacturing areas, and salaries for centralized administrative departments such as payroll, finance, legal, and general IT administration.2 The financial rule of thumb establishes that if an operating expense is not part of COGS or R&D, it is generally classified as G&A.1

B. Statutory and Regulatory Basis for Exclusion under IRC § 41

The limitation of QREs under IRC § 41 is established through a strict positive definition. IRC § 41(b)(1) defines QREs as the sum of specific in-house research expenses and contract research expenses incurred by the taxpayer.3 This narrowly defined scope inherently excludes expenses that do not meet the direct nexus criteria. The regulations explicitly state that expenditures for supplies that are merely indirectly related to R&D, which encompasses general and administrative costs, do not qualify for the R&D tax credit.5

This rigorous statutory distinction acts as a crucial gatekeeper, ensuring that the R&D credit remains focused on stimulating investment in technical uncertainty and technological advancement. If common operating overhead, such as routine payroll or general administrative labor, were included, the incentive would effectively subsidize standard business costs regardless of the level of innovation achieved. By demanding a direct, measurable link between the expenditure and the technical experimentation process—such as requiring direct labor and supplies consumption 4—the regulations restrict the benefit to the marginal cost incurred by the innovation activity itself. This approach reinforces the core legislative purpose that the subsidy should be narrowly targeted to encourage high-risk research activities.

C. Categorical Exclusions from Qualified Research Activities (QRA)

Beyond the general exclusion of indirect G&A costs, the Internal Revenue Code also provides specific exclusions for non-technical activities that align with G&A functions. IRC § 41(d)(4) excludes activities relating to “management functions or techniques,” which explicitly includes efficiency surveys, management studies, the preparation of financial data and analysis, and the development of general employee training programs or management organization plans.12

These exclusions confirm the principle that non-technical, strategic, or efficiency-oriented administrative activities are outside the scope of incentivized research and development.12 For instance, a management-based change in a production process, such as merely rearranging work stations on an assembly line, is excluded, even if it follows qualified R&D activity.12 This regulatory detail demonstrates that the focus of the credit is strictly on the development of technological information and the application of a process of experimentation, not on routine or administrative improvements.

III. The Definitional Conflict: Direct Technical Support vs. Indirect Functional Overhead

A. The Legal Standard: Qualified Services

Personnel costs are often the largest component of QREs and are subject to the most intense scrutiny regarding the distinction between qualified and excluded work. Wages are considered QREs only if the individual performs “qualified services,” which are defined in one of three ways: (i) engaging in qualified research, (ii) engaging in the direct supervision of qualified research, or (iii) engaging in the direct support of qualified research.4

The standard for “direct support” is highly restrictive. Direct support activities must have an immediate, traceable link to the technological experimentation. The regulations specify that direct support explicitly does not include general and administrative services or any other services that only indirectly benefit research activities.6 For example, a technician performing maintenance on specialized lab equipment used solely for experimentation qualifies as direct support, whereas a corporate secretary organizing travel for the research team likely does not.

B. Explicit Exclusion of Administrative Functions

The IRS has provided explicit guidance clarifying which administrative functions are definitively excluded from QREs because they constitute indirect G&A. The focus is on services rendered by G&A departments that only indirectly support or benefit the technical research activities.7

Specific functions identified as non-qualifying G&A include:

• Payroll Services: The work performed by payroll personnel in preparing salary checks for research staff.7
• Human Resources (HR): The time spent by HR staff in recruiting or administering benefits for research employees.7
• Accounting/Finance: The services of accounting personnel dedicated to tracking and reporting general financial data or accounting for research expenses.7
• Interest Expenses: Interest paid on debt incurred to finance R&D activities is also uniformly excluded as an indirect financial cost.7

C. The Nuance of Executive and Supervisory Roles: The Suder Rule

The exclusion of G&A extends to general executive oversight. Supervisory time qualifies only if it meets the test of “direct supervision” of qualified research, meaning general administrative or strategic executive planning is excluded.6

The landmark Tax Court case Suder v. Commissioner (2014) provided important clarification, establishing that credit eligibility is based entirely on the activity performed, regardless of the employee’s job title.6 High-level executives, including a CEO, who possess technical expertise and actively perform or directly supervise qualified research activities, may include those specific wages as QREs.6 However, this ruling simultaneously affirmed a strict check: even when the activity qualifies, the executive compensation must satisfy the separate reasonableness test for Section 174 purposes. If the salary claimed for the research role is found to be excessive compared to industry standards for the actual hours worked on technical activities, the qualified wages must be reduced accordingly.13

The convergence of the strict G&A exclusion and the function-over-title standard established in Suder imposes an extremely high bar for documentation, particularly for employees with hybrid technical and administrative responsibilities, such as Chief Technology Officers or technical Vice Presidents. Since all general executive oversight is classified as G&A 6, and since high salaries must be allocated between qualified research supervision and excluded administrative work, taxpayers are required to substantiate the precise technical nature and reasonableness of every hour claimed. This converts what might otherwise be a simple accounting task into a complex, function-based legal substantiation requirement, demanding detailed, contemporaneous records that clearly distinguish qualified technical activity from non-qualifying G&A activities (e.g., separating time spent reviewing technical experimentation protocols from time spent preparing general corporate shareholder reports).

Matrix of Qualified Research Activities (QREs) vs. Excluded General and Administrative (G&A) Functions

IV. Regulatory Consistency: G&A Treatment Under IRC Section 174 (TCJA Implications)

A. The Shift to Capitalization of Specified R&E (SRE) Expenditures

The Tax Cuts and Jobs Act (TCJA) introduced a significant change requiring all expenditures defined under IRC § 174 as Specified Research or Experimental (SRE) costs to be capitalized and amortized over five years (for domestic research) or fifteen years (for foreign research), effective for taxable years beginning after December 31, 2021.8 This legislative change heightened the focus on accurately defining and measuring the universe of R&D expenditures. Because qualified research activities under IRC § 41(d)(1)(A) must fundamentally be expenses treated as research or experimental under Section 174 3, the definition of SRE costs dictates the maximum scope of potentially qualified research expenditures for the credit.

B. IRS Notice 2023-63 and the Unification of G&A Exclusion

In 2023, the IRS issued interim guidance via Notice 2023-63 to clarify SRE capitalization requirements. This guidance definitively reinforced the exclusionary principle regarding administrative costs.10 The Notice explicitly states that costs that only indirectly support or benefit SRE activities are not SRE expenditures.

The Notice specifically mandates the exclusion of G&A costs, stating that: “Costs paid or incurred by general and administrative (G&A) services departments or functions that only indirectly support or benefit SRE activities (e.g., payroll, HR, accounting, etc.)” are not SRE expenditures.8 Furthermore, interest on debt incurred to finance SRE activities is also excluded.7 The Notice clarifies a subtle distinction concerning facility overhead, noting that costs such as rent, utilities, and insurance (operational and management costs) can be SRE/QRE if they are incurred in the direct support of the SRE activity 8, whereas the costs of the G&A departments themselves remain inherently indirect and excluded.9

The explicit exclusion of indirect G&A costs in Notice 2023-63 is highly consequential, establishing a unified regulatory standard for defining a “research expenditure” for the purposes of both capitalization under Section 174 and the credit under Section 41. Prior to this guidance, some ambiguity existed regarding the treatment of shared administrative services. By unequivocally classifying costs from functional G&A departments (HR, payroll, accounting) as excluded for SRE purposes 8, the IRS confirms that these corporate costs are permanently outside the scope of any specialized tax benefit directed toward R&D activity. This consistency simplifies the compliance landscape by setting one clear, high standard emphasizing direct causality between the expenditure and the technical activity.

G&A Cost Treatment under Section 41 (Credit) and Section 174 (Capitalization)

V. Compliance Strategy: Advanced Allocation Methodology and Documentation Requirements

A. The Allocation Mandate

To comply with the categorical exclusion of G&A, taxpayers must adhere to stringent cost allocation rules. The IRS requires that costs be allocated to SRE/QRE activities on the basis of a “cause-and-effect relationship” between the costs and the R&D activities.15 If a clear cause-and-effect relationship cannot be established, an alternative relationship that “reasonably relates the costs to the benefits provided” must be utilized, requiring the taxpayer to apply the chosen method consistently.16

This methodological requirement, which aligns conceptually with the facts-and-circumstances approach found in Uniform Capitalization (UNICAP) regulations (Section 263A), necessitates detailed justification for the allocation basis used.9 The challenge is significant because indirect G&A costs (excluded) and qualified operational support costs (included) often originate from the same centralized service departments, such as shared IT infrastructure or general facility maintenance. Without the benefit of simplified allocation methods or safe harbors—which Notice 2023-63 notably failed to provide 9—taxpayers face the administrative complexity of conducting detailed, bespoke functional studies for every shared service cost pool to prove that G&A has been properly stripped out.

B. Documentation Best Practices

Audit defense against challenges regarding G&A exclusion is fundamentally reliant upon robust documentation. The core principle is that qualification hinges on the documented activity, not merely on the job title or organizational chart.6

For supplies, required documentation includes retaining invoices that demonstrate the purchase of prototype materials or lab consumables and, crucially, linking these purchases to specific R&D projects or experiments.17 Non-qualifying items, such as equipment or software subject to depreciation, must be formally separated from consumable supplies in expense records.17

For labor, detailed, contemporaneous time-tracking records are mandatory, especially for hybrid or supervisory personnel, to substantiate the specific split between qualified technical work and excluded G&A or general executive time.13 This level of substantiation must survive the reasonableness scrutiny applied in case law such as Suder.

The combination of the stringent G&A exclusion and the absence of simplified allocation methodologies in recent regulatory guidance imposes a substantial hidden compliance cost, particularly upon mid-sized taxpayers. While the principle of exclusion (G&A is out) is unambiguous, the administrative process required to prove that the remaining QREs are not G&A demands expensive, specialized allocation studies. This structural complexity, arising from the need to justify highly granular cost splits based on specific functional use, can effectively erode the net benefit of the R&D tax credit for companies with highly integrated administrative and technical operations, turning regulatory compliance into a disproportionately high administrative burden.

VI. Strategic Recommendations for Future Regulatory Clarification (Next Steps)

To enhance regulatory predictability, minimize audit disputes, and improve the administrative feasibility of compliance with the G&A exclusion rules under IRC § 41 and § 174, the following strategic next steps are recommended for policymakers and tax administrators:

A. Proposing Regulatory Safe Harbors and Simplified Allocation Methods

The current regulatory landscape relies entirely on complex, factual “cause-and-effect” allocation studies for shared administrative services, which imposes a disproportionate burden on compliance.9 To address this, tax policy experts should advocate for the development of Simplified G&A Allocation Safe Harbors (SGASH). These safe harbors could permit a standardized, low-percentage allocation of costs from clearly indirect service departments (such as HR, payroll, and accounting) to be automatically excluded from the QRE base calculation, provided the company meets established criteria, such as gross receipts thresholds. The implementation of such safe harbors would significantly streamline compliance by eliminating the requirement for complex, UNICAP-style functional reviews for purely administrative cost centers.

B. Advocating for Treasury Regulation Updates Delineating Hybrid Technical/Administrative Roles

While judicial precedent (Suder) confirmed that executive technical activity qualifies, official regulations lack clear, prescriptive criteria for differentiating includible qualified technical supervision from excludible general executive oversight (G&A).6 To provide necessary clarity, the IRS and Treasury should issue new Treasury Regulations under Section 41 (or formal guidance cross-referencing Section 174) that establish non-exhaustive examples and objective criteria for high-level personnel. This essential guidance should formally define which executive responsibilities constitute non-qualifying “management functions” (e.g., general corporate finance budgeting or non-technical strategic acquisitions) 12 and which tasks unequivocally qualify as “direct supervision” (e.g., direct technical specification sign-off or detailed review of experimental results).4

C. Formal Integration of Section 174 G&A Exclusions into Section 41 Regulations

The current detailed understanding of the G&A exclusion relies predominantly on the definitions provided in IRS Notice 2023-63, which formally addresses IRC § 174 capitalization.10 Relying on Notice 2023-63 for § 41 credit claims creates a risk of legal instability, as proposed regulations may change or be contested. To achieve statutory certainty, the IRS and Treasury must publish updated or new regulations under IRC § 41 that explicitly incorporate and cross-reference the stringent G&A exclusion definitions promulgated in the Section 174 guidance. This formal legislative action is necessary to unify the G&A exclusion standard across both R&D tax provisions, ensuring consistent regulatory authority and enforcement across both capitalization and credit methodologies.

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/