Supplies Used in Research

Supplies used in research are defined as non-depreciable tangible personal property, such as raw materials and laboratory consumables, that are directly consumed or utilized during a process of experimentation. Within the New York State tax landscape, these expenditures must be geographically linked to New York-based activities and meet rigorous federal and state criteria to qualify for various refundable credits and sales tax exemptions.

Fundamental Definitions and Legal Foundations

The classification of supplies within the research and development (R&D) sector requires a nuanced understanding of the intersection between federal tax code and New York State statutory provisions. New York’s primary R&D incentives—most notably the Excelsior Jobs Program, the Life Sciences Research and Development Tax Credit, and the Qualified Emerging Technology Company (QETC) credit—rely on the federal definition of Qualified Research Expenses (QREs) as established under Internal Revenue Code (IRC) § 41. To a tax professional, the term “supplies” carries a specific, restricted meaning that excludes large categories of business property that a layperson might otherwise include in the definition.

According to IRC § 41(b)(2)(C), the term “supplies” refers to any tangible property other than land or improvements to land and property of a character subject to the allowance for depreciation. This definition creates a sharp boundary: an item is a supply only if it is physical, movable, and not treated as a capital asset. Property that is subject to depreciation under IRC § 167 or § 168, which generally includes assets with a useful life exceeding one year that suffer from wear and tear, exhaustion, or functional obsolescence, is strictly disqualified from being treated as a supply QRE. Consequently, while the raw silicon consumed in developing a semi-conductor prototype is a qualifying supply, the clean-room equipment and machinery used to manufacture that prototype are capital assets and must be depreciated, thus remaining ineligible for the supply-based portion of the R&D credit.

Furthermore, for these expenditures to qualify for New York’s specific state-level credits, there is a strict geographic nexus requirement. Only expenses paid or incurred for research conducted within New York State are eligible for the New York credits. This necessitates that supplies be used or consumed at a New York-based facility and that the associated “qualified services”—the labor that consumes these supplies—also be performed within the state’s borders.

Federal vs. New York State Supply Classification

While the federal definitions provide the baseline, New York’s application involves distinct administrative layers. The following table summarizes the key distinctions and alignments between federal and state classifications of research supplies.

The Four-Part Test as Applied to Research Supplies

For supplies to be “used in the conduct of qualified research,” the underlying activity must satisfy the rigorous “Four-Part Test” mandated by the IRS and adopted by the New York State Department of Taxation and Finance (DTF). This test serves as the gatekeeper for all QREs, including wages and contractor fees, but its application to supplies is particularly focused on how the materials are physically integrated into the experimental process.

The first hurdle is the Permitted Purpose Test, which dictates that the research must be intended to develop a new or improved “business component”. In this context, supplies must be used to improve the functionality, performance, reliability, or quality of a product, process, formula, or software. If a company uses materials to make purely aesthetic changes—such as testing different colors for a casing without changing its durability—those supplies are disqualified.

The second hurdle is the Elimination of Uncertainty Test. The taxpayer must demonstrate that the supplies were used to discover information that would eliminate uncertainty concerning the capability or method for developing or improving the business component, or the appropriate design of that component. For example, if a chemical manufacturer is unsure whether a new catalyst will increase yield, the chemicals used in trials to resolve this uncertainty are qualifying supplies.

The third hurdle, the Process of Experimentation Test, requires that substantially all of the activities constitute a systematic process of evaluating alternatives. This often involves the construction and testing of prototypes, the performance of simulations, or a rigorous trial-and-error methodology. Supplies consumed in these iterative cycles are at the core of the R&D credit.

Finally, the Technological in Nature Test mandates that the research fundamentally rely on principles of physical science, biological science, engineering, or computer science. Supplies used in non-technical research, such as consumer surveys, management studies, or efficiency surveys, are explicitly excluded by both federal and New York law.

Identifying Qualifying Research Supplies

The identifying characteristic of a qualifying supply is its consumption during the performance of “qualified services.” Qualified services encompass the activities of employees who are either engaging in the actual research, directly supervising the research, or directly supporting the research. To be an eligible expense, the supply item must be directly tied to the delivery and performance of these specific services.

Common Categories of Qualifying Supplies

In the manufacturing, technology, and life sciences sectors, supply expenses often represent a significant portion of total research expenditures. Taxpayers should focus on the following categories:

• Raw Materials for Prototyping: This includes metals, polymers, resins, and electronic components used to build physical models. Even if a prototype is ultimately sold, the materials used to create it can qualify as supplies if the prototype was built for experimental purposes.
• Laboratory Consumables: Reagents, chemicals, disposable pipettes, test tubes, slides, and filters used in a scientific environment are quintessential research supplies.
• Testing Media and Fuels: New York guidance specifically mentions that fuel and parts used during function and reliability tests for prototype aircraft are exempt as research supplies.
• Extraordinary Utilities: Standard building utilities like general lighting are considered non-qualifying indirect expenses. However, if a research project requires “extraordinary” expenditures—such as high-voltage electricity for a particle accelerator or specialized gases for a fabrication chamber—these specific costs may be treated as supplies.

Ineligible and Excluded Costs

Revenue office guidance emphasizes that general and administrative (G&A) functions do not meet the criteria for supply QREs. This strictness extends to activities that may support research but are “collateral” to the actual experimentation.

New York State R&D Credit Programs: Eligibility and Mechanics

New York offers a multi-tiered approach to R&D incentives, each with its own rules regarding the treatment of supplies. These programs are generally refundable, meaning that if the credit exceeds the company’s tax liability, the state will issue a cash refund—a vital feature for pre-revenue startups.

The Excelsior Jobs Program

The Excelsior Jobs Program is New York’s primary vehicle for encouraging job growth and investment in strategic industries like biotechnology, pharmaceuticals, high-tech, and manufacturing. The program provides five different credits, including an R&D tax credit.

The Excelsior R&D Tax Credit is calculated as 50% of the portion of the Federal R&D tax credit that relates specifically to expenditures in New York State. However, the state imposes a secondary cap on this credit based on the total New York research expenditures:

• Standard Projects: Capped at 6% of New York research expenditures.
• Semiconductor Supply Chain Projects: Capped at 7% of New York research expenditures.
• Green Projects / Green CHIPS: Capped at 8% of New York research expenditures.

To qualify, companies must be certified by Empire State Development (ESD) and meet job creation or capital investment targets. For scientific R&D firms, the minimum threshold is the creation of at least 5 net new jobs.

Life Sciences Research and Development Tax Credit

In contrast to the Excelsior program, which is linked to the federal credit calculation, the Life Sciences R&D Tax Credit is a standalone program for new life sciences businesses. This program is particularly generous to small startups and focuses exclusively on in-house research.

The credit is a flat percentage of the total New York QREs, including wages and supplies:

• 10 or more employees: 15% of New York QREs.
• Fewer than 10 employees: 20% of New York QREs.

The program is limited to a maximum of $500,000 per year for three consecutive years, with a lifetime cap of $1.5 million. Importantly, this credit excludes contract research expenses, meaning that supplies and labor must be managed internally to be counted.

Qualified Emerging Technology Company (QETC) Credit

The QETC R&D credit is designed for technology companies with total annual product sales of $10 million or less. Eligibility is also contingent on the company maintaining a specific ratio of R&D expenses to net sales, typically 6% or higher.

The credit is calculated as 18% of research and development property, costs, and fees incurred in connection with emerging technology activities, capped at $250,000 per year. Supplies are a key component of these costs. This credit can be carried forward for up to 15 years if it cannot be fully utilized in the current year.

State Revenue Office Guidance on Sales Tax Exemptions

A critical but often overlooked benefit for New York researchers is the sales and use tax exemption for tangible personal property and utilities. This exemption provides immediate cash flow relief by allowing businesses to make purchases without paying the 4% state sales tax (plus local rates).

The “Direct and Predominant” Standard

Under New York Tax Law §§ 1115(a)(10) and 1115(b)(ii), tangible personal property—including supplies—purchased for use or consumption directly and predominantly in research and development in the experimental or laboratory sense is exempt from sales tax.

• Direct Use: The property must be used in the actual R&D operation. This includes materials worked on and supplies used to perform the research work.
• Predominant Use: The property must be used directly in R&D more than 50% of the time.

For example, a company constructing an experimental apparatus in its own machine shop can purchase the materials tax-free. However, the specialized tools and dies needed to build the apparatus are not exempt, as they are used to build the research equipment, not consumed in the research itself.

Utility Exemptions: The “Direct and Exclusive” Standard

New York revenue office guidance imposes a stricter standard for the exemption of utilities like electricity and gas. To be exempt, these services must be used or consumed “directly and exclusively” (100%) in research and development.

Because utilities are typically received in bulk through a single meter, the user must maintain adequate records to allocate the portion used directly and exclusively for R&D. This usually requires an engineering survey or a detailed mathematical formula to compute the exempt amount. A biological laboratory might use electricity for an autoclave or a vaccine-storage refrigerator; the portion of the bill attributable to these devices is exempt, while the portion for general lighting is taxable.

Administrative Procedures: Forms ST-121 and AU-11

To claim the sales tax exemption at the time of purchase, a business must provide its supplier with a completed Form ST-121 (Exempt Use Certificate).

• For supplies and materials, the purchaser marks an “X” in Box K for property used directly and predominantly in R&D.
• For utilities, the purchaser marks an “X” in the appropriate boxes under Item L for utilities used directly and exclusively in R&D.

If a company has already paid sales tax on qualifying supplies, it can apply for a refund using Form AU-11 (Application for Credit or Refund of Sales or Use Tax). For businesses, this can be done through the DTF’s Online Services account, while individuals must file a paper form.

Comprehensive Example: Innovative Aerospace Prototype Development

To illustrate the application of these rules, consider “Long Island Aerospace Systems,” a mid-sized firm developing a high-efficiency prototype engine for zero-emission flight.

Analysis of Expenditures

During the current fiscal year, the firm incurs the following costs at its Farmingdale, NY facility:

• Wages: $1,200,000 for engineers and lab technicians.
• Titanium Alloy: $200,000 for raw materials used to cast the prototype engine blades.
• Fuel for Testing: $50,000 in specialized aviation fuel consumed during high-stress reliability testing.
• Lab Consumables: $20,000 for sensors, lubricants, and disposable filters used during trials.
• High-Intensity Furnace: $300,000 for a new furnace to heat-treat the alloys (depreciable).
• Rent and Utilities: $100,000 for the facility, with $10,000 of the electric bill verified by an engineering survey as used exclusively for the R&D furnace and testing equipment.

Classification for the New York R&D Tax Credit

The titanium alloy, fuel, and lab consumables are all non-depreciable tangible property used directly in the process of experimentation. These qualify as “supplies” under IRC § 41 and the Excelsior Jobs Program.

The high-intensity furnace is a depreciable asset and must be excluded from supply QREs. However, it may qualify for the separate Excelsior Investment Tax Credit (ITC), which is valued at 2% to 5% of qualified investments.

The general facility rent and the majority of the electric bill are indirect or administrative costs and are excluded from the R&D credit.

Sales Tax Treatment

Long Island Aerospace Systems can use Form ST-121 to purchase the titanium alloy, fuel, and lab consumables tax-free. For the furnace, although it is a depreciable research asset, New York law allows for its tax-free purchase because it is used directly and predominantly in research. Finally, the firm can claim a refund for the $10,000 portion of the electric bill used exclusively for R&D activities.

Audit Risks and Legal Precedents

The definition of supplies has been a point of significant litigation. A landmark case in federal law—which heavily influences New York audits—is Union Carbide Corp. (UCC) v. Commissioner.

The “Indirect Research Expense” Challenge

In the UCC case, the company attempted to claim the entire cost of materials used in “plant-scale” tests as research supplies. The IRS and the courts disagreed, ruling that if the supplies would have been purchased for ordinary production regardless of the research, they are “indirect research expenses” and ineligible for the credit. The court argued that allowing a credit for supplies that the taxpayer would have incurred anyway would create an “unintended windfall”.

This creates a high burden of proof for New York companies engaging in “first-run” production or large-scale testing. Examiners will look to see if the supplies were “extraordinary” or if they were diverted from normal production solely for experimentation.

Audit Guidance and Substantiation

New York DTF auditors look for contemporaneous documentation to support research supply claims. “Contemporaneous” means the records were created while the research was being performed, not reconstructed years later.

Failure to maintain these records can lead to the “disallowance” of the credit during an audit. Research shows that while tax credits stimulate R&D spending—with a 10% reduction in user cost leading to an 11% increase in research intensity—the effectiveness of the incentive relies on the company’s ability to defend its claims under audit.

Economic Context and Budgetary Considerations

New York’s commitment to R&D is reflected in its fiscal planning. In State Fiscal Year 2024-25, business tax receipts reached $117.5 billion, with significant portions of state funds allocated to economic development programs like Excelsior and Life Sciences. However, New York faces budgetary pressures, with projected gaps of over $10 billion in coming years, which may lead to tighter scrutiny of tax expenditure programs.

The annual report on New York State tax expenditures notes that R&D credits are a major “Cross-Article” expenditure, appearing across various tax types (Article 9-A for corporations, Article 22 for individuals and partnerships). The state’s unemployment rate recently hit a four-year high of 4.6%, heightening the political importance of these “activity-based” jobs credits to drive high-tech employment.

Statistical Insights into R&D Credit Utilization

The utilization of R&D credits varies significantly by industry and company size. Historically, New York’s tech and manufacturing sectors have been the primary beneficiaries of these incentives.

These statistics suggest that while the programs are robust, they are also “capped” or subject to competition for funding. Businesses must be proactive in their applications, particularly for programs like the Life Sciences credit, which are disbursed on a first-come, first-served basis.

Final Thoughts

The meaning of “supplies used in research” is a critical pivot point for New York businesses looking to maximize their R&D tax incentives. By strictly defining these as non-depreciable tangible property consumed directly in experimentation, both federal and state laws aim to reward companies for the physical “burn rate” of innovation. However, the path to compliance is fraught with regulatory nuance, from the “direct and predominant” requirements of sales tax law to the geographically restrictive “New York nexus” rules of the Excelsior and Life Sciences programs.

For a business to succeed in this domain, it must move beyond simple accounting and adopt a project-based approach to expenditure tracking. This involves not only identifying which chemicals or components were purchased but also documenting the specific technical uncertainties they were used to resolve. As New York faces a complex fiscal future, the integrity of these credit claims—backed by contemporaneous records and a deep understanding of revenue office guidance—will be the deciding factor in whether a company realizes the full value of its innovative efforts or falls victim to the stringent disallowances of a state tax audit. The synergy between income tax credits and sales tax exemptions provides a powerful toolkit for growth, but it is a toolkit that requires professional precision to operate effectively.