Directly Supporting Research

Directly supporting research refers to services that facilitate the active conduct or supervision of qualified research, such as machining experimental models, cleaning laboratory equipment, or compiling technical data. In the Ohio context, these services must be performed within state borders to qualify as eligible expenses against the Commercial Activity Tax.

The intersection of state and federal tax law creates a complex regulatory environment for companies seeking to leverage the Ohio Research and Development Investment Tax Credit. Authorized under Ohio Revised Code (R.C.) Section 5751.51, this credit is a nonrefundable incentive designed to stimulate technological innovation within the state. For an activity to qualify, it must generally meet the rigorous standards established by the Internal Revenue Code (IRC) Section 41, which Ohio has adopted by reference. Central to this framework is the concept of “qualified services,” which encompasses three distinct categories of activity: the direct conduct of research, the direct supervision of research, and the direct support of research. While the direct conduct of research is often the most intuitive to identify, the classification of “direct support” requires a nuanced understanding of Treasury regulations, administrative guidance from the Ohio Department of Taxation (ODT), and evolving case law from both federal courts and the Ohio Board of Tax Appeals (BTA).

The historical evolution of Ohio’s tax structure underscores the importance of this credit. Historically, research incentives were tied to the Corporation Franchise Tax under R.C. 5733.351. However, with the phase-out of the franchise tax and the introduction of the Commercial Activity Tax (CAT) in 2005, the credit was transitioned to apply against the CAT for tax periods beginning on or after January 1, 2008. This shift necessitated a re-evaluation of how research expenses are “sitused” or geographically attributed to Ohio. Under the CAT, which is a gross receipts tax imposed on the privilege of doing business in Ohio, the credit serves as a vital offset to the 0.26% tax rate applied to Ohio taxable gross receipts. To maintain compliance, taxpayers must navigate not only the technical scientific requirements of the IRC but also the specific jurisdictional constraints imposed by the ODT.

The Statutory Integration of Ohio and Federal Law

The Ohio R&D tax credit does not exist in a vacuum; it is explicitly tethered to federal definitions. R.C. 5751.51(A) states that “qualified research expenses” has the same meaning as defined in Section 41 of the Internal Revenue Code. This conformity ensures that the four-part test used by the Internal Revenue Service (IRS) is also the standard used by the ODT to determine whether a project constitutes “qualified research.” For an expenditure to be considered a qualified research expense (QRE), it must first pass through the gateway of the Section 174 test, which requires that the costs be research and development costs in the experimental or laboratory sense. Furthermore, the research must be undertaken to discover information that is technological in nature, intended for use in developing a new or improved business component, and substantially all of the activities must constitute a process of experimentation.

Once a project is deemed qualified research, the taxpayer must identify the specific costs associated with it. IRC Section 41(b)(1) divides these into in-house research expenses and contract research expenses. In-house expenses include wages for qualified services and the cost of supplies. “Direct support” is a critical subset of these qualified services. The following table provides a high-level comparison of the jurisdictional requirements for these expenses between federal and Ohio law.

The requirement that expenses be “incurred in this state” is perhaps the most significant hurdle for Ohio taxpayers. In the final determination of Cristal USA, the Tax Commissioner emphasized that while R.C. 5751.51 adopts the federal definition of QREs, meeting the federal definition alone is insufficient. A taxpayer must demonstrate that the activities giving rise to the expenses were physically conducted in Ohio. This creates a rigorous documentation requirement for support staff, who may be located at different facilities than the primary research scientists.

Defining Directly Supporting Research under Treasury Regulation 1.41-2

Because Ohio law relies on federal definitions, Treasury Regulation Section 1.41-2(c)(3) provides the authoritative definition of “direct support.” According to this regulation, direct support consists of services performed in the direct support of either persons engaged in the actual conduct of qualified research or persons directly supervising such research. This definition creates a pyramid of eligibility: at the top is the direct conduct (the scientist), in the middle is direct supervision (the first-line manager), and surrounding them is the support infrastructure (the technician, machinist, or clerk).

Eligible Support Activities and Technical Functions

The ODT and the IRS recognize several specific activities as qualifying for direct support. These tasks are typically technical or administrative in nature but are characterized by their direct relationship to the research process.

The fabrication of experimental models or prototypes is a quintessential direct support activity. A machinist who machines a part of an experimental model used in qualified research is providing a service that directly facilitates the process of experimentation. Even if the machinist is not an engineer and does not understand the scientific uncertainty being resolved, their physical labor is essential to the creation of the business component being tested. Similarly, the setup and calibration of specialized testing equipment are considered direct support. This includes laboratory workers who clean equipment used in qualified research, as the maintenance of a sterile or functional research environment is direct support of the experimental process.

Data management also falls under this umbrella. A clerk or technician who compiles research data derived from experiments is performing a direct support function. This activity is distinguished from general data entry by its context; it must involve the recordation and organization of the results of the research itself. Furthermore, the documentation of these results is eligible. A secretary who types reports describing laboratory results or technical findings is engaged in direct support. However, the scope of this eligibility is narrow; the documentation must be of the research results, not general departmental communications.

The Boundary of Indirect and Administrative Services

The term “direct” serves as a restrictive modifier that excludes general and administrative (G&A) services. The ODT strictly enforces this boundary, as shown in administrative guidance and audit results. Services that only indirectly benefit research activities are categorically excluded, regardless of whether the personnel are located within the R&D department or report to the Chief Technology Officer.

This distinction often creates friction during audits. For example, while cleaning a specialized vacuum chamber used for testing is “direct support,” cleaning the floor of the room where the vacuum chamber is located might be viewed as “general janitorial” and thus excluded. Taxpayers are encouraged to use a functional analysis rather than a job-title analysis to determine eligibility. A manager who spends 20% of their time on technical supervision and 80% on general HR and budgeting can only include 20% of their wages in the QRE calculation, unless the “substantially all” rule applies.

The “Substantially All” Rule for Personnel

A vital provision for maximizing the Ohio R&D credit is the “substantially all” rule, found in IRC Section 41(b)(2)(B) and adopted by Ohio. This rule serves as a simplified accounting mechanism for employees who spend the vast majority of their time on qualified activities. If at least 80% of the services performed by an individual for the taxpayer during a given tax year consist of qualified services—meaning any combination of direct conduct, direct supervision, or direct support—then 100% of the wages paid to that individual for that year are considered qualified research expenses.

Mathematically, this is represented by the formula:

If Qualified_Hours / Total_Hours >= 0.80, then Qualified_Wages = 100%.

If the individual’s time falls below the 80% threshold, only the actual percentage of time spent on qualified activities may be claimed. In the context of “direct support,” this is particularly beneficial for dedicated laboratory technicians or prototype machinists. If a machinist spends 85% of their time machining experimental parts and 15% on general production maintenance, all of their Ohio-based wages qualify for the 7% credit. This rule incentivizes companies to dedicate specific staff to research and development functions rather than rotating them frequently between production and R&D.

Ohio Revenue Office Guidance: The ODT Audit Perspective

The Ohio Department of Taxation provides guidance primarily through Information Releases and the instructions for the “CAT CS” (Credit Schedule) form. Information Release CAT 2007-03 provides the foundational explanation of the R&D credit, noting that there is no separate certificate or approval process required to claim the credit. Instead, the credit is “computed by the taxpayer based on expenses incurred during the calendar year”. This self-reporting mechanism places a heavy burden of substantiation on the taxpayer.

The CAT CS and Substantiation Requirements

To claim the credit, a taxpayer must file a return and submit the “CAT CS” form, which requires a year-over-year comparison of Ohio QREs. The ODT requires that for each business component, the taxpayer must be able to identify the research activities performed, the individuals who performed those activities (including support staff), and the information sought to be discovered.

According to the instructions for Form CAT CS and related ODT training materials, a valid credit claim should be supported by:

• A state-by-state breakdown of sales and expenses to prove the Ohio nexus.
• A copy of federal Form 6765 to show consistency with the federal claim.
• The specific address(es) where the qualified research was conducted.
• Detailed time-tracking or project-level wage allocations.

A common point of failure in Ohio R&D audits is the reliance on “high-level” studies or estimates. In the Ecolab final determination, the ODT rejected a claim because the taxpayer provided only summary spreadsheets and failed to produce a detailed description of the actual tasks performed by support staff. The Department emphasized that the language of R.C. 5751.51 is “strictly construed against the taxpayer,” who must demonstrate a clear entitlement to the credit.

The Geographic “Situsing” of Support Services

In Ohio, the “situsing” of gross receipts and expenses is paramount. Under R.C. 5751.51(B)(1), only those QREs incurred in Ohio are eligible. For “direct support” wages, this means the employee must physically perform the support activity within Ohio’s borders.

Consider a scenario where a company has its primary R&D laboratory in Cleveland but utilizes a specialized data-processing center in Indiana to compile research results. Even though the Indiana-based activity qualifies as “direct support” under federal rules, those wages are ineligible for the Ohio credit. Conversely, if a company is headquartered in New York but conducts all of its experimental machining at a facility in Columbus, the wages of those Columbus-based machinists are eligible for the Ohio credit, provided they support a project that meets the four-part test.

Analyzing Judicial and Administrative Precedents

Case law and administrative final determinations provide the most granular insights into how “direct support” is treated in practice. Two key federal cases, Little Sandy Coal and Suder v. Commissioner, have significantly influenced the ODT’s approach.

The Impact of Little Sandy Coal on Production and Support

The 7th Circuit’s decision in Little Sandy Coal Co. v. Commissioner addressed the eligibility of production-line activities as research expenses. The court upheld the Tax Court’s denial of the credit but provided essential clarification: “direct support” and “direct supervision” activities can indeed be elements of a process of experimentation. However, the court rejected the “categorical exclusion” of production employees, stating that their activities must be measured against the 80% “substantially all” test.

For Ohio manufacturers, this implies that if a production team assists in a “plant trial” to test a new manufacturing process, their wages may be qualifying support expenses if the trial itself is intended to resolve a technical uncertainty. However, the taxpayer must substantiate that the production activities were not merely “routine testing” or “quality control,” which are explicitly excluded under IRC Section 41(d)(4).

The Suder Decision and First-Line Supervision

The Suder case clarified the definition of “direct supervision” and “direct support” for high-level executives. The court held that while purely administrative supervision is excluded, technical leaders who are heavily involved in brainstorming, technical problem-solving, and the direct oversight of lab experiments are engaged in qualified services. In the Ohio context, this means that a VP of Engineering in Dayton who actively reviews the technical results of daily experiments and directs the next steps of the experimentation process can have a portion of their wages included as “direct supervision” or “direct support”.

The Cristal USA Determination: The “Incurred in Ohio” Bar

The Cristal USA case is one of the most cited ODT final determinations regarding the R&D credit. The petitioner argued that because it received federal R&D credits for plant trial activities, it should automatically qualify for the Ohio credit. The Tax Commissioner disagreed, noting that the audit staff could not confirm the expenses were “incurred at either of Cristal USA’s Ohio plants”.

This case highlights a critical trap: federal approval is a necessary, but not sufficient, condition for the Ohio credit. The taxpayer must affirmatively demonstrate the local performance of the work. For support staff, this means the records must show that the machining, data compilation, or laboratory cleaning actually happened in an Ohio facility.

Calculation Mechanics: The 7% Incremental Credit

The Ohio R&D credit is an incremental credit, meaning it rewards businesses for increasing their investment in Ohio research over time. The credit amount is 7% of the “excess” qualified research expenses.

Determining the Base Amount

The “base amount” for the Ohio credit is the average annual qualified research expenses incurred in Ohio for the three preceding calendar years. This is a simpler calculation than the federal “Standard” method, which often involves historical gross receipts from the 1980s.

If a taxpayer has no prior research history in Ohio, the base amount is zero, allowing for a credit on the full 7% of current-year expenses. Any unused credit may be carried forward for up to seven years to offset future CAT liability.

Coordination with Other Programs

The R&D Investment Tax Credit is often paired with other state incentives. For example, businesses participating in the JobsOhio Research and Development Investment Loan program can claim a separate loan repayment credit in addition to the standard R&D credit. However, the “order of credits” specified in R.C. 5751.98 must be followed; nonrefundable credits like the R&D credit are applied before refundable credits like the Jobs Creation Credit.

Comprehensive Industry Example: Advanced Polymer Development

To synthesize these concepts, consider “Buckeye Polymers,” a specialty chemical manufacturer located in Akron, Ohio. The company is developing a new biodegradable polymer for use in medical sutures, a project that requires significant technical experimentation to achieve the necessary tensile strength and degradation rate.

Personnel Classification and Ohio Eligibility

The project involves a diverse team of employees. Their roles and the eligibility of their wages for the Ohio R&D credit are analyzed below.

Applying the “Substantially All” Rule

In this example, Mr. Miller (the machinist) spends 75% of his time on the medical suture project and 25% on routine production equipment maintenance. Because his qualified time (75%) is less than 80%, Buckeye Polymers can only include 75% of his Ohio wages in the QRE calculation. However, Ms. Davis (the lab tech) spends 90% of her time on the research project. Under the “substantially all” rule, 100% of her Ohio wages are included in the QRE pool.

Audit Preparation and Documentation

If the ODT audits Buckeye Polymers, the company must be prepared to show that Mr. Miller and Ms. Davis were physically working in Akron. They would need:

• Personnel files verifying the Akron facility as their primary work location.
• Time logs or project summaries showing the 75% and 90% allocations to the suture project.
• A technical narrative describing how Mr. Miller’s molds and Ms. Davis’s stress tests were used to resolve the technical uncertainties of the polymer design.

Procedural Safeguards and Future Regulatory Trends

The regulatory landscape in Ohio is currently undergoing significant shifts. House Bill 33, enacted in 2023, introduced major changes to the Commercial Activity Tax, including a substantial increase in the exclusion amount.

Increasing CAT Exclusions and Filing Changes

Starting in 2024, the CAT exclusion amount increased from $1 million to $3 million. In 2025, it will rise further to $6 million.

For small-to-medium enterprises in Ohio, these changes may reduce or eliminate their CAT liability entirely, making the nonrefundable R&D credit less useful in the short term. However, because the credit has a seven-year carryforward, companies should continue to document their “direct support” activities and calculate their QREs. If the company’s gross receipts grow to exceed the $6 million threshold in the future, the carried-forward credits will be available to offset the 0.26% tax.

The Evolving Refund Claim Standard

The ODT’s approach to refund claims is also becoming more rigorous, mirroring the IRS’s “no-consideration” policy discussed in the Park-Ohio case. When a taxpayer files an amended return or a refund claim (Form CAT REF) to claim the R&D credit, they are now expected to provide “sufficient facts” at the time of filing to apprise the Tax Commissioner of the exact basis of the claim. For “direct support” expenses, this means that merely providing a list of titles is no longer sufficient; the narrative must be present from the outset to avoid an immediate denial.

The Role of the Board of Tax Appeals (BTA)

The BTA remains the primary forum for resolving disputes between taxpayers and the ODT. Recent BTA decisions, such as the one regarding pharmaceutical chargebacks in Perrigo Sales Corp. v. Harris, demonstrate that the Board is willing to scrutinize the Tax Commissioner’s definitions of “gross receipts” and “expenses”. For R&D credits, the BTA consistently upholds the principle that “direct support” must be technically grounded. Taxpayers who can present a coherent story of how their support staff enabled a process of experimentation are far more likely to prevail than those relying on generic administrative classifications.

Final Synthesis: Best Practices for Direct Support Compliance

To successfully navigate the Ohio R&D tax credit, professional practitioners must treat “direct support” as a technical designation rather than an administrative one. The following principles summarize the optimal strategy for capturing and defending these expenses.

The documentation of direct support must be contemporaneous. Retrospective “studies” that rely on interviews conducted years after the research occurred are increasingly vulnerable to ODT audits. Companies should implement time-tracking systems that allow technicians, machinists, and technical writers to attribute their hours to specific business components as they occur.

Geographic nexus must be verified. For every employee included in the support wage pool, the taxpayer must be able to prove that the work was performed in Ohio. This is particularly critical for companies with multi-state operations or those utilizing remote or satellite support staff.

The distinction between “direct” and “indirect” must be strictly maintained. Practitioners should proactively exclude G&A functions like payroll, HR, and general accounting, even if those individuals report to the R&D director. Instead, the focus should remain on those who physically interact with the research (machining, cleaning specialized equipment) or those who manage the research data (compiling results, typing laboratory reports).

Finally, the “substantially all” rule should be utilized strategically. By ensuring that dedicated support staff spend at least 80% of their time on qualified activities, companies can maximize the 7% credit without the need for minute-by-minute time allocations for every person. This proactive management of personnel time not only increases the credit’s value but also creates a more resilient audit trail. In an environment of rising CAT exclusions and heightened regulatory scrutiny, these robust compliance practices are essential for any Ohio business seeking to turn its technical support infrastructure into a sustainable tax advantage.