Supplies Used in Research

Supplies used in research comprise tangible personal property, excluding land or depreciable assets, that is consumed or destroyed during the performance of qualified research activities within the State of Ohio. In the context of the Ohio Research and Development Investment Tax Credit, these expenditures function as a 7% nonrefundable credit against Commercial Activity Tax liability to the extent they exceed a taxpayer’s three-year historical average of Ohio-based research spending.

The definition and application of “supplies” within the Ohio tax landscape represent a sophisticated intersection of state statutory construction and federal regulatory adoption. Under Ohio Revised Code (ORC) Section 5751.51, the state explicitly tethers its definition of “qualified research expenses” to the standards established under Section 41 of the Internal Revenue Code (IRC). This deliberate “piggyback” mechanism ensures that taxpayers can utilize their federal calculations as a baseline for state-level incentives, yet the transition from federal to state reporting introduces a complex layer of jurisdictional and geographic requirements that demand rigorous substantiation. While federal law considers research conducted anywhere in the United States, Ohio’s mandate requires that these supplies be “incurred in this state,” a requirement that has been the focal point of numerous administrative determinations and audits by the Ohio Department of Taxation. Consequently, a supply that qualifies for the federal 20% credit may not necessarily qualify for the Ohio 7% credit unless the taxpayer can demonstrate a clear physical and economic nexus to an Ohio-based research facility or project.

The Statutory Evolution and Framework of the Ohio R&D Credit

The legal architecture of research incentives in Ohio has undergone a significant transformation since the early 2000s, moving from a credit against the now-repealed Corporation Franchise Tax to a centerpiece of the Commercial Activity Tax (CAT) regime. Originally authorized under ORC 5733.351, the credit was designed to encourage capital-intensive technology firms to remain in the state during the phase-out of traditional corporate income taxes. With the enactment of the CAT in 2005, the credit was transitioned to ORC 5751.51, maintaining the same 7% incremental rate but applying it against a gross receipts tax rather than a net income tax.

This structural shift is critical for understanding the value of research supplies. Because the CAT is imposed on the “privilege of doing business in Ohio” and is measured by gross receipts, the credit serves as one of the few mechanisms available to manufacturers and technology firms to reduce their tax burden regardless of their profitability. The 7% credit rate is applied to the excess of the current year’s qualified research expenses (QREs) over the average of the prior three years. For many high-growth Ohio companies, this incremental structure means that the purchase of research supplies—such as raw materials for prototypes or chemical reagents—can generate significant tax savings during phases of rapid scaling.

Comparative Statutory Structure of Ohio Research Credits

The following table delineates the various statutory provisions currently governing research and development incentives in Ohio across different tax types:

Definitional Boundaries of Supplies Used in Research

To be classified as a “supply” under ORC 5751.51, an item must first meet the federal definition found in IRC Section 41(b)(2)(C). The federal regulations define supplies as any tangible property other than land, improvements to land, and property of a character subject to the allowance for depreciation. This negative definition—defining what a supply is not—creates a strict boundary between the R&D Tax Credit and other capital investment incentives.

The Exclusion of Depreciable Property

The most significant hurdle in identifying qualifying supplies is the exclusion of depreciable property. If an item is of a character that is subject to depreciation under IRC Section 167, it is legally barred from being considered a supply for the R&D credit. This includes laboratory equipment, computers, furniture, and long-term machinery. While these items may be essential for research, their cost cannot be included in the QRE calculation for the 7% credit. However, Ohio offers a complementary incentive: the Sales Tax Exemption under ORC 5739.02(B)(42)(i), which specifically covers the purchase of such machinery and equipment.

The distinction often hinges on the “useful life” of the item and its intended purpose. If a manufacturer in Cleveland purchases 500 pounds of specialized alloy to build a one-time experimental prototype that will be stress-tested to destruction, the alloy constitutes a “supply”. If that same manufacturer purchases a laser cutter to fabricate that prototype, the laser cutter is a depreciable asset and is excluded from the R&D credit, though it may be exempt from sales tax at the time of purchase.

Consumables, Prototypes, and Pilot Models

In the industrial context of Ohio manufacturing, supplies typically fall into three broad sub-categories: consumables, prototype components, and pilot model inputs.

1. Consumables: These are materials that are physically used up during the research process. Common examples include chemical reagents used in bioscience labs, gases used in aerospace wind tunnel testing, and lubricants utilized during high-speed machining trials.
2. Prototype Components: These are materials that become part of an experimental version of a product. In the automotive sector, this might include the sensors, wiring harnesses, and custom-molded plastic parts used to build a “test mule” for a new electric vehicle platform.
3. Pilot Model Inputs: A pilot model is defined under federal regulations as a fully functional version of a product produced to resolve uncertainty regarding the appropriate design. The materials used to construct these models—even if they are eventually sold to a customer—may qualify as research supplies provided that the primary purpose of their construction was to eliminate technical uncertainty.

Navigating the Four-Part Test for Supply Inclusion

The mere fact that an item is a non-depreciable consumable does not automatically grant it “supply” status for the credit. Every expenditure must be linked to an activity that satisfies the “Four-Part Test” mandated by federal law and adopted by the Ohio Department of Taxation.

Section 174 Test: The Elimination of Uncertainty

The supply must be used in research where the expenditures may be treated as expenses under IRC Section 174. This requires that the research be intended to discover information that would eliminate uncertainty concerning the development or improvement of a “business component”. Uncertainty is present if the information available to the taxpayer does not establish the capability or method for developing the component or the appropriate design of the component. In Ohio’s manufacturing heartland, this often applies to “plant trials,” where raw materials are used to test a new production process on a factory floor. If the trial is merely a “run-through” of an established process, the supplies do not qualify; if the trial is to determine if a new polymer will properly bond with a substrate under specific heat conditions, the supplies satisfy the Section 174 test.

Technological Information Test: The Hard Science Requirement

The research activity must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science. Ohio auditors strictly enforce this “hard science” requirement. Supplies used in market research, consumer surveys, or aesthetic design do not qualify. For instance, the cost of fabric used to test the aerodynamic drag of a new racing suit for a Columbus-based sports tech firm would qualify as it relies on physics and engineering; the cost of the same fabric used to test which color is more appealing to consumers would be disqualified.

Business Component Test: The Functional Target

The taxpayer must intend to use the information discovered to develop a new or improved product, process, software, technique, formula, or invention to be held for sale or used in the taxpayer’s trade or business. In many Ohio audits, the Department of Taxation requires the taxpayer to identify the specific business component to which the supplies relate. General “slush funds” for lab supplies that cannot be traced to a specific project are frequently disallowed.

Process of Experimentation Test: The Evaluation of Alternatives

Substantially all of the activities (generally 80% or more) must constitute a process of experimentation. This involves a systematic evaluation of alternatives, such as trial-and-error, modeling, or simulation. Supplies used in routine testing or quality control are explicitly excluded. If an Ohio-based medical device company uses 100 titanium screws to test three different attachment methods for a spinal implant, the screws are qualifying supplies. If they use those same screws to perform standard quality-assurance checks on a finished batch of implants, those costs are non-qualifying.

Local State Revenue Office Guidance: The Ohio Department of Taxation Perspective

The Ohio Department of Taxation (ODT) has provided critical guidance on the R&D credit through a series of Information Releases and Final Determinations. These documents reveal the state’s aggressive stance on geographic nexus and substantiation.

Information Release CAT 2007-03

Issued during the infancy of the Commercial Activity Tax, Information Release CAT 2007-03 established the administrative rules (specifically Ohio Administrative Code 5703-29-22) for claiming the credit. The release clarified that taxpayers must complete a specific schedule (CAT CS) to claim the credit and that the credit must be claimed in a specific order against other nonrefundable credits under ORC 5751.98. Importantly, the release noted that while the credit is nonrefundable, it allows for a seven-year carryforward of any unused portion.

The “Incurred in This State” Mandate

ORC 5751.51(B)(1) contains the most critical jurisdictional distinction from federal law: the expenses must be “incurred in this state by the taxpayer”. In Cristal USA, Inc. v. Harris (2020), the Tax Commissioner addressed a petition for reassessment where a taxpayer claimed QREs for plant trials. The ODT audit staff denied the credits because they could not confirm the expenses were incurred at the company’s Ohio plants in Ashtabula. The Commissioner’s ruling emphasized that even if a taxpayer receives a federal R&D credit, Ohio maintains the right to independently review the facts to ensure the activity—and the consumption of supplies—actually occurred within Ohio’s borders.

Audit Sampling and Records Retention

With the passage of Am. Sub. House Bill 33 in 2023, the Ohio General Assembly formalized the Tax Commissioner’s authority to use “representative sampling” during R&D audits. This means that if a manufacturer claims $1 million in supplies across 50 different research projects, the auditor may select five projects as a sample. If 20% of the supplies in those five projects are found to be non-qualifying, the ODT may disallow 20% of the entire $1 million claim. Taxpayers are now statutorily required to maintain records substantiating the credit for four years from the date the return was filed or the tax was due, whichever is later.

Interaction with the Ohio R&D Sales Tax Exemption

A common area of professional confusion involves the overlap between the CAT-based R&D Investment Tax Credit and the Sales and Use Tax Exemption for R&D equipment. While the CAT credit focuses on wages and “supplies” (consumables), the Sales Tax Exemption focuses on capital assets.

ORC 5739.02(B)(42)(i): The Machinery Exemption

Ohio law provides an exemption from the 5.75% state sales tax (plus local piggyback taxes) for the purchase of machinery and equipment used “primarily” for research and development. This is a “point-of-sale” benefit; a company provides a “Blanket Exemption Certificate” (Form STEC B) to their vendor, and no tax is charged.

The “primarily” standard requires that the equipment be used for R&D activities more than 50% of the time. This creates a powerful dual-incentive:

• For the CAT Credit: Use the cost of the materials (supplies) transformed by the machine.
• For the Sales Tax Exemption: Use the cost of the machine itself.

Consumables as “Things Transferred”

In some instances, supplies used in R&D might also qualify for the “Manufacturing Exemption” under ORC 5739.02(B)(42)(g). Ohio law exempts “things transferred” to a manufacturer for use in a manufacturing operation. If an Ohio steel fabricator uses a specific chemical solvent during the R&D phase of a new galvanizing process, that solvent might be exempt from sales tax as a manufacturing consumable and qualify as a supply for the R&D credit. However, the taxpayer must be careful to avoid “double-dipping” in a way that violates the specific definitions of each chapter.

The 2024 and 2025 CAT Reforms: Implications for Research Entities

The Ohio 2024-2025 biennial budget bill introduced the most significant changes to the Commercial Activity Tax since its inception, which fundamentally altered the landscape for small and mid-sized R&D firms.

Expansion of the Exclusion Amount

Historically, the first $1 million in Ohio taxable gross receipts were excluded from the CAT. Under the new law, this exclusion increased to $3 million in 2024 and will increase to $6 million in 2025. For many innovative startups in the “pre-revenue” or “early-revenue” stage, this change effectively eliminates their CAT liability.

This creates a “use-it-or-lose-it” scenario for the R&D credit. Because the credit is nonrefundable, it can only offset a tax liability that actually exists. If a Columbus-based software developer has $4 million in receipts in 2025, they will only owe tax on the $1 million that exceeds the $3 million exclusion. If they have generated a massive R&D credit through their supply and wage spending, they may have more credit than they can use. Fortunately, the seven-year carryforward remains in place, allowing these firms to “bank” their credits until their revenue exceeds the new, higher thresholds.

Elimination of the Annual Minimum Tax (AMT)

The elimination of the AMT in 2024 removes the $150 to $2,600 “floor” that businesses previously had to pay regardless of their receipts. While this is a tax cut, it also means that the R&D credit no longer has a minimum liability to offset for the smallest businesses.

Consolidated and Combined Group Nuances

The ODT now requires that each member of a consolidated elected or combined taxpayer group calculate the credit separately on a member-by-member basis. This is a strategic trap for entities that centralize their R&D supply purchasing. If an Ohio-based parent company buys all the supplies but the research is actually performed by a subsidiary entity, the subsidiary must be the one to claim the credit, and it must have the documentation to prove it incurred those expenses.

Detailed Example: Aerospace Prototyping in Dayton

To synthesize these complex rules, consider “Dayton Aero-Structures, Inc.” (DAS), a manufacturer specializing in experimental airframes. In 2024, DAS embarked on a project to develop a new “Bird-Strike Resistant” canopy using a proprietary transparent ceramic composite.

The Research Activity

The project involves significant “uncertainty” because transparent ceramics have never been successfully integrated into flexible airframe mounts. The DAS engineering team must evaluate three different bonding agents and two different ceramic thicknesses to achieve the required impact resistance without compromising optical clarity. This is a “process of experimentation” fundamentally based on materials science and aerospace engineering.

The Supply Expenditures (All Incurred in Ohio)

1. Transparent Ceramic Sheets: $400,000. These are the primary materials for the prototypes. They are destroyed during “bird-strike” impact testing.
2. Experimental Bonding Resins: $50,000. These are consumables used to attach the ceramic to the frame during testing.
3. High-Speed Cameras: $120,000. Purchased to film the impact tests at 10,000 frames per second.
4. Custom Mounting Brackets: $30,000. Fabricated in-house using aluminum scrap solely for use in the test rig; these brackets are not of a character subject to depreciation because they have no use beyond this specific 6-month test series.
5. Nitrogen Gas: $10,000. Used to maintain a pressurized environment in the testing chamber.

Analysis of QREs for the CAT R&D Credit

• Ceramic Sheets ($400,000): These qualify as “supplies.” They are tangible personal property, non-depreciable (consumed in testing), and linked to the resolution of design uncertainty.
• Bonding Resins ($50,000): These are “supplies” (consumables) used in the performance of qualified research.
• High-Speed Cameras ($120,000): These are EXCLUDED from the R&D Credit. They are depreciable equipment. However, DAS should have claimed the Ohio R&D Sales Tax Exemption at the time of purchase, saving approximately $9,000 in sales tax.
• Mounting Brackets ($30,000): Because these are specific to the research project and do not have a “useful life” in the traditional sense of a capital asset, they can be treated as “supplies”.
• Nitrogen Gas ($10,000): This is a qualifying “supply” (consumable).

Total Supply QREs: $490,000.

Calculation of the Ohio Tax Credit

DAS must now look at its historical Ohio QREs to determine the “incremental” portion.

Calculation:

Excess QREs = $1,400,000 (Current) – $1,000,000 (Average) = $400,000

Ohio R&D Credit = 7% x $400,000 = $28,000

DAS can now take this $28,000 credit to offset its 2024 CAT liability. If DAS has $10 million in Ohio taxable gross receipts, its CAT liability (at 0.26% on the $7 million exceeding the $3 million exclusion) would be $18,200. The $28,000 credit would wipe out the entire $18,200 liability, and the remaining $9,800 would carry forward for use in 2025.

Strategic Challenges and Future Outlook

The landscape of research supply taxation in Ohio is currently facing two major exogenous shocks: the federal Section 174 amortization requirement and the Park-Ohio litigation regarding refund claims.

The Section 174 Conflict

Starting in 2022, the Tax Cuts and Jobs Act (TCJA) required that all R&D expenses be capitalized and amortized over five years (domestic) or 15 years (foreign). Previously, these could be immediately deducted. While Ohio’s R&D credit is based on “expenses paid or incurred” (a cash/accrual concept) and not the “deduction” taken on the tax return, the federal change has complicated the accounting. If a company is forced to amortize the cost of research supplies at the federal level, Ohio auditors may question whether the taxpayer is properly identifying these as current-year QREs for the state credit. There is significant legislative pressure in Congress to retroactively restore full expensing, which would resolve this administrative mismatch.

The Park-Ohio Case and Refund Claims

The case of Park-Ohio Holdings Corp. v. United States is currently a “wakeup call” for tax professionals. The IRS has raised the bar on documentation for R&D refund claims, demanding a “line-by-line, person-by-person” explanation of the research behind every claimed dollar. Because Ohio piggybacks on federal definitions and has now adopted its own “representative sampling” audit power, Ohio taxpayers should assume that the ODT will adopt similarly aggressive documentation standards for supply expenditures. Vague descriptions like “Miscellaneous Lab Supplies” are no longer sufficient; taxpayers must be prepared to defend the technical uncertainty resolved by each category of material.

The “Shrink-back” Defense

In response to these aggressive audits, taxpayers should rely on the “shrink-back” rule. If the ODT argues that an entire prototype project was “routine,” the taxpayer can “shrink back” the claim to the specific experimental sub-components where supplies were truly used for experimentation. For example, if a Cleveland company builds a new industrial furnace, and the furnace itself is a standard design, the ODT might deny the credit for all supplies. However, if the company “shrinks back” to the unique, experimental ceramic lining that was the true focus of the R&D, they may successfully salvage the credit for the supplies related to that specific component.

Final Thoughts

The Ohio Research and Development Investment Tax Credit provides a vital incentive for businesses to purchase and consume research supplies within the state. However, the successful capture of this 7% credit requires more than simple expense tracking. It necessitates a deep understanding of the exclusionary definition of supplies, which forbids the inclusion of depreciable property, and a rigorous application of the Four-Part Test to ensure that every material is used in a process of experimentation to resolve technological uncertainty. With the 2024 and 2025 CAT reforms drastically increasing exclusion amounts, the credit has become a long-term strategic asset that must be “banked” through careful carryforward management. Ultimately, the burden of proof rests on the taxpayer to navigate the “incurred in this state” mandate and survive the Department of Taxation’s sampling-based audits through meticulous, project-level documentation of every reagent, resin, and prototype component consumed in the pursuit of Ohio-based innovation.