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Rising Tech Salaries and the R&D Tax Credit: What Businesses Need to Know

By Archita Roy, Tax Staff Accountant

The competition for highly skilled technology professionals has never been more extreme. Professionals across industries such as Software engineers, AI specialists and cybersecurity professionals are commanding record salaries. While rising payroll costs create budget challenges, they also present an opportunity many businesses overlook: the federal Research and Development (R&D) Tax Credit.
Under Internal Revenue Code (IRC) Section 41, businesses that perform qualified research activities may be able to recover a portion of their research costs through the R&D tax credit. Because employee wages often represent the largest category of Qualified Research Expenses (QREs), increasing compensation can have a meaningful impact on the value of the credit—provided the work performed meets IRS requirements.

Why Salaries Matter for the R&D Tax Credit

For many technology companies, employee wages contribute the largest share of their R&D expenditures. Developers, engineers, architects, and other software personnel spend a lot of their time designing new software, improving existing products and systems, solving technical challenges, and testing innovative solutions. When these activities qualify under the tax law, a portion of their wages may be included as Qualified Research Expenses.
Qualified wage expenses generally include employees who do the following:
  • Design and develop new software, products or processes
  • Improve existing technology through technical problem-solving and experimentation
  • Perform testing, validation, or prototype development
  • Directly supervise or provide direct support to qualified research activities
For many software businesses, engineering payroll represents the single largest driver of the R&D tax credit calculation.

Higher Salaries Has the Potential to Increase Credit

As salaries continue to rise across the technology sector, the potential value of the R&D credit may increase as well.

For instance, consider a software engineer earning $140,000 annually who spends approximately 80% of their time performing qualified research activities. Approximately $112,000 of that employee’s wages may be considered qualified for purposes of the credit. If the employee’s salary later increases to $170,000 while continuing to perform the same qualifying work, the amount of qualified wages increases to roughly $136,000.

When similar increases occur across an entire engineering team, the impact on total Qualified Research Expenses can be significant, that leads to higher research expenses.
However, it is important to remember that higher salaries do not automatically translate into larger tax credits.

Salary Alone Does Not Determine Eligibility

A common misconception is that all engineering or developer salaries automatically qualify for the R&D tax credit. This is not the case. In reality, the IRS focuses only on the nature of the work performed—not an employee’s job title or compensation level.

To qualify, the activities generally must meet the Four-Part Test i.e. the Permitted Purpose, Technological in Nature, Elimination Uncertainty, and Process of Experimentation.

Good Documentation is Essential

Even when research activities qualify, businesses must be able to support their claims with adequate and contemporaneous documentation. Recent IRS examinations and court decisions have continued to emphasize the importance of maintaining timely records rather than attempting to recreate documentation years later.
Useful documentation may include the following:
  • Project plans and technical design and drawing documents
  • Functional and system specifications
  • Jira or Azure DevOps work items
  • Source code repositories and version histories
  • Testing results and validation reports
  • Engineering meeting notes
  • Employee time-tracking records, when available
Maintaining the above records throughout the year makes it much easier to substantiate both the qualified activities as well as the wage allocations used in the credit calculation.

Don’t Overlook Supporting Employees

The R&D tax credit is not limited to software developers and engineers. Somehow companies tend to forget to add employees who directly supervise or support qualified research activities may also generate eligible wage expenses.

Depending on their responsibilities, qualifying employees may include:
  • Engineering managers overseeing technical development
  • Quality assurance professionals conducting experimental testing
  • DevOps engineers supporting development and prototype environments
  • Systems architects designing technical solutions
The key is understanding each employee’s actual responsibilities rather than relying solely on their job title.

Common Mistakes Companies Make

Many companies unintentionally reduce the value of their R&D tax credit by making avoidable mistakes. Some of the most common mistakes include:
  • Assuming all engineering or software payroll automatically qualifies
  • Failing to document research activities as projects progress
  • Including routine maintenance, customer support, administrative tasks or other non-qualifying work
  • Overlooking employees who directly supervise or support the qualified research
  • Waiting until an IRS examination to gather documentation
Developing a documentation process throughout the year is significantly more effective than trying to reconstruct project details after the fact.

Practical Tips for Software Technology Companies

Technology companies can strengthen both the value and defensibility of their R&D tax credit by adopting a proactive approach. Businesses should consider the following practices:
  • Review engineering projects annually to identify qualifying research activities
  • Track employee time spent on research projects whenever practical
  • Maintain technical documentation throughout the development process
  • Review customer contracts to determine whether research may be considered funded research
  • Encourage collaboration among engineering, finance and tax teams during the R&D credit study
These practices not only help maximize available credits but also improve readiness in the event of an IRS examination.

Final Thoughts

Technology companies continue to invest heavily in innovation, and rising salaries often reflect that investment. While increasing payroll costs can create financial pressure, they may also increase the value of the federal R&D tax credit when employees are engaged in qualified research activities.

The key is not how much employees are paid, but what they are doing. Businesses that identify qualifying activities early, maintain strong technical documentation, and properly evaluate employee roles are in a much stronger position to maximize available tax incentives while reducing audit risk.

Please contact us for additional information and to start maximizing your innovative investments.

Related Services

R&D Tax Credit Business Tax

Related Industries

Technology Manufacturing & Distribution

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