Direct Conduct of Research

Analysis of Direct Conduct of Research within the New York State R&D Tax Credit Framework

Direct conduct of research in the context of the New York Research and Development (R&D) tax credit refers to the active, hands-on performance of technical activities by internal employees to resolve technological uncertainties. It encompasses the “doing” of research—such as engineering, biological testing, and software programming—specifically aimed at developing or improving a business component through a process of experimentation.

The legislative and administrative landscape governing these incentives in New York is characterized by a high degree of specificity, often diverging from federal standards to prioritize local job creation and sector-specific growth. While the federal government allows for the inclusion of a significant portion of contract research costs, New York’s targeted programs, such as the Life Sciences Research and Development Tax Credit, place a premium on in-house innovation. This distinction shifts the burden of proof toward the taxpayer to demonstrate that the personnel claimed are directly engaged in the “experimental or laboratory sense” of research. This requirement is anchored in New York Tax Law Section 210-B.22 and is further refined by the Technical Services Bureau (TSB) of the New York State Department of Taxation and Finance (DTF) and the regulations of Empire State Development (ESD). Understanding the nuances of direct conduct is essential for businesses seeking to maximize their return on investment, as it dictates the eligibility of the most substantial portion of R&D spend: employee wages and the direct use of tangible property.

The Legislative Evolution of New York’s Innovation Policy

To understand the current application of “direct conduct,” one must examine the state’s shift from a legacy manufacturing economy to a high-technology and life-sciences powerhouse. New York’s tax code has evolved to provide tiered incentives that reward varying levels of technical engagement. The initial framework was largely designed around the Investment Tax Credit (ITC) and the Employment Incentive Credit (EIC), which primarily benefited the physical production of goods. However, as global competition for intellectual capital intensified, the state legislature introduced targeted amendments to specifically address research and development as a distinct category of economic activity.

The pivotal 1982 amendments, detailed in TSB-M-82(18)C, began to separate R&D property from general manufacturing assets, introducing formulas for the recapture of credits if property ceased to be used in a “qualified sense” before the end of its useful life. This established the precedent that “direct use” was not a permanent status but a functional one that must be maintained throughout the asset’s lifecycle. More recently, the introduction of the Life Sciences Research and Development Tax Credit Program and the Excelsior Jobs Program R&D Credit has further refined this, focusing on “new businesses” and “green projects” to align tax relief with modern environmental and economic goals.

Deconstructing “Direct Conduct” under Section 210-B.22

The core of the R&D credit lies in the definition of “qualified services,” which is split into three categories: direct conduct, direct supervision, and direct support. Of these, direct conduct is the most “common sense” wage category but also the one subject to the highest level of audit scrutiny.

The Technical Threshold of Direct Conduct

For an activity to qualify as direct conduct, the individual must be personally involved in the technical resolution of a project’s uncertainties. In a laboratory setting, this involves the actual scientists who handle chemical compounds or biological samples. In the software industry, it refers to the engineers who architect new algorithms or write code to solve performance latencies that cannot be addressed through existing public knowledge. This category excludes personnel who are merely present in the lab or office but are not contributing to the technical “process of experimentation.”

Under the “experimental or laboratory sense” standard mandated by NY law, the research must be undertaken for a permitted purpose—improving the function, performance, reliability, or quality of a business component. This is where many claims fail during state audits; if an employee is “doing” research that relates to marketing, management studies, or routine quality control, they are not engaged in the direct conduct of research in the eyes of the DTF.

Distinguishing Supervision and Support

Direct supervision and direct support are often conflated with direct conduct, but they have distinct legal definitions that affect the calculation of qualified research expenses (QREs). Direct supervision refers to the “first-line” management of those engaging in direct conduct. This includes a lead engineer who reviews the technical designs of a junior team or a research scientist who oversees laboratory experiments but may not handle the samples themselves. NY guidance is clear that this does not extend to upper-level management or C-suite executives whose involvement is primarily strategic or financial.

Direct support, conversely, involves the “ancillary” tasks that enable research. A machinist who creates a part for an experimental prototype is providing direct support, as is a lab worker who cleans specialized equipment used in experiments. These individuals are not resolving the uncertainty themselves, nor are they managing the process, but their services are indispensable to the technical activity.

Service Category	Standard of Involvement	Typical Job Titles	Qualifying Examples
Direct Conduct	Hands-on performance of experimentation.	Software Engineer, Research Scientist, Chemist.	Writing code for a new neural network; performing chemical assays.
Direct Supervision	Immediate management of technical staff and results.	Lead Engineer, Lab Manager, CTO (if first-line).	Reviewing technical protocols; validating experimental data.
Direct Support	Tasks directly enabling the research process.	Machinist, Lab Assistant, Data Entry Clerk.	Machining prototype parts; cleaning experimental equipment.

The Administrative Hierarchy: DTF vs. ESD Guidance

In New York, R&D tax incentives are managed through a dual-agency structure. The Department of Taxation and Finance (DTF) handles the tax returns and audits, while Empire State Development (ESD) manages the certification and allocation of credits for programs like Life Sciences and Excelsior. This split requires taxpayers to satisfy two different sets of guidance that, while overlapping, emphasize different aspects of “direct conduct.”

Department of Taxation and Finance (DTF) Standards

The DTF focuses on the “direct use” and “predominant use” of assets and services. Their guidance, particularly in Technical Reports and Bulletins (like TB-ST-770), is rooted in the “experimental or laboratory sense” of the work. The DTF interprets “direct use” to mean that materials or equipment are used to perform the actual research work. This is a rigorous standard; for example, if a company builds an apparatus for experiments, the materials for the apparatus are exempt (direct use), but the tools used to build the apparatus are not (indirect use).

The DTF also applies a “predominant use” test for sales tax exemptions on R&D property. To qualify, the property must be used more than 50% of the time directly in R&D. For utilities like electricity or gas, the standard is even stricter: “exclusive use,” or 100% usage in the R&D process, which often necessitates separate metering or a detailed engineering survey.

Empire State Development (ESD) Regulations

ESD is more concerned with the economic outcome and the “new business” status of the claimant. For the Life Sciences credit, ESD requires a company to prove it is a “qualified life sciences company” through a formal application process. Their definition of “qualified research expenses” follows IRC Section 41(b) but explicitly excises contract research. ESD’s role is to verify that the “direct conduct” is happening within New York State, ensuring that the tax benefits are tied to local payroll and facility investment.

The Life Sciences Research and Development Credit

The Life Sciences Research and Development Tax Credit is New York’s flagship incentive for biotechnology and pharmaceutical startups. It is a fully refundable credit, meaning that if the credit amount exceeds the taxpayer’s liability, the state issues a cash refund.

Refundability and Rates

The credit offers two tiers based on the size of the company’s workforce:

• 20% of QREs for companies with fewer than 10 employees.
• 15% of QREs for companies with 10 or more employees.

The credit is limited to $500,000 per year and a lifetime cap of $1.5 million per company. The “fewer than 10 employees” tier is particularly beneficial for seed-stage startups, as it allows them to monetize their R&D spend long before they have a commercialized product or taxable income.

The Strategic Exclusion of Contract Research

One of the most significant departures from federal law is the exclusion of contract research expenses from the Life Sciences credit. Federal law allows companies to claim 65% of payments to outside contractors as QREs. New York’s exclusion is a deliberate policy choice to incentivize the “direct conduct” of research by employees of the New York-based entity. This prevents companies from acting as “pass-through” entities that receive state funding only to outsource the technical work to laboratories in other states or countries. For a startup to maximize this credit, it must build its internal technical team rather than relying on a Contract Research Organization (CRO).

The “New Business” Hurdle

To qualify, a company must pass a “new business” test under NY Tax Law Section 210-B.1(f). The company cannot be “substantially similar” in ownership or operation to a previously existing NY taxpayer. This is designed to prevent established firms from spinning off R&D departments into “new” entities simply to harvest the credit. The “direct conduct” must be a truly new economic effort within the state.

The Excelsior Jobs Program: R&D as a Performance Metric

For businesses that are not “new” or are outside the life sciences sector, the Excelsior Jobs Program provides a broader suite of incentives. The Excelsior R&D tax credit is performance-based, meaning it is awarded only after the business has met its job and investment targets.

Calculation and Green Projects

The Excelsior R&D credit is capped at 6% of the QREs conducted in the state. However, the state has recently prioritized sustainability, offering an increased cap of 8% for “qualified green projects”. These are defined as projects in industries like manufacturing, software development, or scientific R&D that aim to reduce greenhouse gases or create clean energy solutions.

In this program, “direct conduct” is viewed through the lens of job creation. The state calculates the credit based on the “NY payroll fraction” for wages, ensuring that only the portion of work performed within state lines is rewarded. This prevents “leakage” of the tax benefit to out-of-state remote workers, even if they are engaging in direct conduct of research for a New York firm.

Program Feature	Life Sciences R&D Credit	Excelsior R&D Credit
Credit Rate	15% – 20% flat rate.	6% (or 8% for Green Projects).
Refundability	Fully Refundable.	Fully Refundable.
Contract Research	Excluded.	Included (per Federal IRC 41).
Annual Limit	$500,000.	Subject to ESD discretionary allocation.
Statewide Cap	$10 Million rolling annual pool.	Part of a larger $200M+ Excelsior budget.

Direct Use of Tangible Property and Utilities: Sales Tax Implications

Beyond income tax credits, “direct conduct” is the gatekeeper for significant sales and use tax exemptions. In a high-cost environment like New York City, where the combined sales tax rate is 8.875%, these exemptions provide immediate cash flow relief.

Machinery and Equipment

Purchases of machinery and equipment used “directly and predominantly” in R&D in the experimental or laboratory sense are exempt. DTF guidance provides a list of examples, such as laboratory tables and paper used to record test results. The distinction between “direct” and “indirect” is often a matter of physical proximity to the R&D activity. A desk used by a scientist in the lab to record findings is exempt; a desk used by a clerical person in the front office is not.

Computer Software and Hardware

New York has been proactive in classifying CAD/CAM systems as property used directly in R&D. Furthermore, “hosting costs” for off-premise computers (such as cloud computing services used for technical simulations) can be included as QREs for income tax purposes, provided the taxpayer is not the primary owner and the computers are used for the conduct of qualified research. This recognition of virtual “direct conduct” is essential for software and AI startups that do not maintain physical servers.

Utilities: The “Exclusive” Standard

The exemption for gas, electricity, and steam is one of the most difficult to obtain due to the “direct and exclusive” (100%) requirement. A biological laboratory that develops vaccines might use an electric autoclave and a refrigerator for storage. Because these are critical to the R&D process, the electricity consumed by them is exempt. However, because most buildings have a single electric bill that includes general lighting and HVAC for office areas, companies must often perform an engineering survey to isolate the R&D-specific consumption.

Audit and Compliance: Documenting the “Experimental Sense”

The greatest risk to any R&D claim in New York is the lack of contemporaneous documentation. The DTF and ESD both require proof that the work was documented as it occurred, highlighting the specific technical challenges faced and the methods used to overcome them.

The “Nexus” Requirement

For wages to qualify, there must be a clear nexus between the employee’s time and the “direct conduct” of a specific project. This is typically established through time-tracking software or detailed activity logs. In the event of an audit, a company must be able to show that a software engineer’s 2,000 hours were not just for “working,” but were specifically allocated to resolving a technical uncertainty.

Proving the “Experimental Sense”

The DTF looks for a systematic process of trial and error. This means that project notes should reflect not just the successful outcomes, but the failed attempts and the iterations that characterize true R&D. If a project log only shows the final, working product, an auditor may argue that the solution was obvious and that no “technological uncertainty” existed at the outset.

Documentation Checklist for NY R&D Audits:

1. Project Descriptions: Narrative summaries of the technical goals and uncertainties for each project.

2. Contemporaneous Records: Lab notebooks, GitHub commit logs, or design review meeting minutes.

3. Payroll Allocation: Detailed records linking employee W-2 wages to specific R&D projects.

4. Vendor Agreements: (For non-Life Science credits) Contracts and invoices for qualified research expenses.

5. Certification Documents: A copy of the Certificate of Completion (for Brownfield-related R&D) or the ESD Certificate of Tax Credit.

Economic Landscape: Fiscal Impact and Tax Expenditure Analysis

The scale of New York’s commitment to R&D is evident in its tax expenditure reports. In fiscal year 2022, state and local governments spent approximately $10.7 billion on economic development, including both direct spending and foregone tax revenue.

Sector Distribution

A significant portion of this spending is targeted at high-value sectors. The Excelsior program, for instance, has seen a steady increase in utilization, reaching $163 million in tax expenditures in 2022. Furthermore, New York’s Green CHIPS program, enacted in 2022, represents a massive forward-looking commitment, with an annual cap of $500 million per year through 2041 to attract semiconductor manufacturers and their associated R&D pipelines.

The Life Sciences Corridor

The Life Sciences R&D credit, though capped at $10 million annually, has seen high utilization in New York City’s burgeoning biotech corridor. Since its inception in 2018, over $50 million has been allocated to new businesses. The concentration of this activity in the NYC metro area is reflected in the city’s business income tax collections, which have outpaced all other revenue sources since 2019, growing by more than 50%.

Fiscal Metric	Impact Value	Growth Period
NY Business Income Tax Revenue Growth	+ 50%	FY 2019 – FY 2024.
Manufacturing/R&D Sales Tax Benefits	$933 Million	Tax Year 2022.
Excelsior Tax Expenditure	$163 Million	Tax Year 2022.
Green CHIPS Annual Cap	$500 Million	Projected through 2041.
Life Sciences Credit Utilization (NYC)	> $50 Million	Since 2018.

Comparative Analysis: New York vs. Federal and Peer States

New York’s R&D tax credit landscape is often described as “generous but rigid.” When compared to the federal credit and programs in peer states like Massachusetts or California, New York’s focus on the “direct conduct” of research stands out.

The Federal Contrast

The federal R&D tax credit (IRC Section 41) is incremental, meaning it only rewards companies that increase their R&D spend relative to a historical base amount. This can be difficult for established firms that have high but flat R&D budgets. New York’s Life Sciences credit, by contrast, is a flat-rate credit on total QREs, making it significantly easier to calculate and often more valuable for early-stage companies. However, the federal credit’s inclusion of 65% of contract research makes it more flexible for virtual companies that do not have their own lab facilities—a flexibility New York consciously avoids to encourage physical infrastructure growth.

Peer State Comparison: Massachusetts

Massachusetts, a primary competitor for biotech investment, offers a refundable R&D credit for life science companies, but its program is integrated into a larger “Life Sciences Initiative” that often requires more rigorous job creation commitments than New York’s “new business” test. New York’s 20% rate for small teams is one of the highest in the country, specifically designed to poach talent from Boston and San Francisco by lowering the effective cost of a technical hire.

Direct Conduct as a Tool for Reshoring

The emphasis on direct conduct also serves a “reshoring” function. By excluding contract research and requiring a “NY payroll fraction,” the state encourages companies to bring technical roles back to New York that might otherwise be outsourced to lower-cost jurisdictions. In the semiconductor and Green CHIPS sectors, this is explicitly tied to national security and supply chain resilience.

Example: Application of Direct Conduct in a Biotech Startup

To illustrate the practical application of these rules, consider “Solstice Therapeutics,” a hypothetical New York-based startup with 8 employees, developing a new gene-editing therapy.

Company Profile:

• Total NY Payroll: $1,200,000.
• R&D Supplies: $300,000.
• Contract Research (External Lab): $500,000.
• Computer Rentals (AWS for data processing): $100,000.

Step 1: Identifying Qualified Personnel (Wages)

The CEO (who is also the Lead Scientist) spends 80% of her time on “direct conduct” (designing experiments and analyzing data). Three junior researchers spend 100% of their time on “direct conduct” (performing the experiments). One lab assistant spends 100% of his time on “direct support” (cleaning equipment). The HR manager and the CFO spend 0% of their time on R&D.

• Qualified Wages (Direct Conduct/Support): $900,000.

Step 2: Identifying Qualified Expenses

• Supplies: $300,000 (fully qualifying).
• Cloud Computing: $100,000 (qualifying as a computer rental).
• Contract Research: $0 (excluded under NY Life Sciences rules).

Total New York QREs: $1,300,000.

Step 3: Calculating the Life Sciences Credit

Since Solstice has < 10 employees, the rate is 20%.

• Credit Amount: $1,300,000 x 0.20 = $260,000.

Because the credit is fully refundable, Solstice will receive a check for $260,000 from the New York State DTF, even if they had zero revenue and zero tax liability for the year.

Step 4: Federal Stacking

Solstice would also claim the Federal R&D credit. Because the federal credit includes the $500,000 in contract research (at 65%, or $325,000), their federal QRE base would be higher ($1,300,000 + $325,000 = $1,625,000). This demonstrates how the two credits complement each other: the federal credit provides breadth (including contractors), while the New York credit provides depth (higher rate for internal direct conduct).

Final Thoughts

The “direct conduct of research” is the functional heart of the New York State R&D tax credit system. By defining qualified activity through a lens of technical personal involvement and physical presence within the state, New York has created an incentive structure that rewards “doing” over “delegating.” For the life sciences and high-tech sectors, this requirement translates into a mandate for internal team building and facility investment.

While the administrative burden of documenting this activity is significant—requiring meticulous time-tracking and technical narratives—the rewards are unparalleled. The ability for a pre-revenue startup to receive hundreds of thousands of dollars in cash refunds based on their internal payroll is a powerful driver of the state’s innovation economy. As New York continues to expand its “Green CHIPS” and sustainability initiatives, the definition of direct conduct will likely broaden to include new technical frontiers, but the core requirement will remain: to receive the credit, the research must be hands-on, technologically uncertain, and performed by the people who call New York home. In the competitive landscape of global innovation, New York’s message is clear: the state values the scientist in the lab and the coder at the screen above all else.