Is R&D an operating expense?

What are R&D expenses?

R&D expenses include the costs of researching, designing, testing, and improving products or systems. These expenses are often incurred before a product is fully developed or brought to market. They reflect the business’s investment in innovation and competitiveness, even though they may not result in immediate revenue.

How to categorize R&D expenses

• Record as Operating Expenses in your income statement.
• Use a dedicated “Research and Development” or “Product Development” account in your chart of accounts.
• Include both direct costs (e.g., materials, equipment use, testing) and indirect costs (e.g., salaries of R&D staff).
• Capitalize only certain development costs if they create long-term assets or meet specific accounting standards (e.g., software development).
• Track R&D separately from other operating costs to identify eligible tax credits or incentives.

Examples of R&D expenses

• Prototype development and testing.
• Laboratory supplies and technical equipment.
• Salaries and benefits for engineers, scientists, or developers.
• Contract research or third-party lab services.
• Market or feasibility studies for new products.
• Software or tools used exclusively for R&D activities.

Tax implications for R&D expenses

• R&D expenses are typically fully deductible as ordinary business costs, but some may qualify for R&D tax credits that reduce taxable income further.
• The IRS allows immediate expensing of certain R&D costs under Section 174, though some must now be amortized over multiple years.
• Keep thorough documentation( project descriptions, payroll records, and invoices) to support any R&D credit claims.
• Expenses that lead to the creation of intangible assets (like software) may need to be capitalized and amortized instead of deducted immediately.
• Consult your accountant to determine which R&D costs are eligible for credits or accelerated deductions.