Can You Claim R&D Tax Credits for Employees Hired Through an EOR?

What Is an EOR, and Why Does This Question Keep Coming Up?

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An Employer of Record (EOR) is a third party that formally employs workers on your behalf. Though your company directs the employees’ day-to-day work, the EOR issues the paycheck, handles payroll tax withholding, and takes on the compliance burden that comes with employment laws.

Companies generally use EORs to hire employees quickly, bring on workers in states or countries where they don’t have a legal entity, or to avoid setting up payroll infrastructure. This is seen often in SaaS companies when hiring engineering teams, manufacturing companies when bringing in specialized contractors, or for many growing businesses that want the flexibility of hiring in other geographical locations.

Using an EOR also raises a question when companies are calculating their R&D tax credits under IRC §41: if the EOR is technically the employer on paper, can the wages paid to the worker still be claimed as qualified research expenses (QREs)?

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The Real Question: Who Is the Employer for R&D Credit Purposes?

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§41(b)(2)(D) defines wages for R&D credit purposes by referencing §3401(a), the same wage definition used for federal income tax withholding. Neither §41 nor §3401 defines the employer as the party who cuts the check. The IRS looks to the common law employer, meaning whoever has the right to direct and control how the work gets done, not who processes payroll.

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That is a facts-and-circumstances test. Relevant facts include:

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- Who trains the worker

- Who supervises the work day-to-day

- Whose equipment and systems the worker uses

- How integrated the worker is into your team

- Who sets the worker’s hours, assigns their projects, and ends the arrangement

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In an EOR relationship, the business that utilizes the EOR is generally making those decisions, while the EOR remains a merely administrative entity. That means your company, not the EOR, is likely the true employer of the worker for tax purposes. That said, the final determination is based on the specific facts of each arrangement.

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Certified PEOs Get a Clear Statutory Answer

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Congress has provided a clear rule for one category of payroll provider: Certified Professional Employer Organizations (CPEOs). IRS-certified under IRC §7705, CPEOs are specifically addressed in the tax code. Under IRC §3511(d) and Treas. Reg. §31.3511-1(e), the R&D tax credit belongs to the customer, not the CPEO. Although the CPEO issues payroll and remits employment taxes, the customer is treated as having paid those wages and taxes for purposes of claiming the credit. That statutory certainty applies to CPEOs, but not to other employment arrangements, such as most Employer of Record (EOR) providers, which require a separate legal analysis.

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In summary, if your EOR or PEO holds IRS CPEO certification, the statute already answers the employer question for you. You can generally treat the wages the CPEO pays your work-site employees as your own for R&D credit purposes, subject to the usual qualified services and substantially-all rules under IRC §41(b)(2) and Treas. Reg. 1.41-2.

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This clear-cut rule only applies to CPEOs. Not every company that markets itself as a PEO or an EOR has gone through IRS certification under §7705, and if your provider is not certified, you’re back to the common law employer analysis.

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Where EOR Arrangements Get Complicated

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Many EOR providers, especially ones used for hiring across state lines or internationally, are not certified PEOs. For these arrangements, there is no statute that will give you a clear-cut answer. You need to be able to provide documentation that shows your company functions as the common law employer, assigning and supervising work, hiring and terminating relationships, and how the worker is integrated into your existing team and processes.

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The Big Question: Where Was the Work Performed?

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Under IRC §41(d)(4)(F), qualified research does not include any research done outside of the United States, the Commonwealth of Puerto Rico, or any US possession. This exclusion applies regardless of who is treated as the employer, no matter how vital the work was to your product.

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While an international EOR can simplify hiring and payroll administration, it does not change where the research is performed. If the employee performs the work outside the United States, Puerto Rico, or a U.S. possession, those research activities are generally excluded from the federal R&D tax credit under IRC §41(d)(4)(F), regardless of whether the worker is employed directly or through an Employer of Record.

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Where work is split between the US and other countries, Treas. Reg. 1.41-4(c)(7) requires apportionment. Only the wages attributable to the work done within the US, Puerto Rico, or US possessions are eligible to be treated as QREs. The requirement applies to in-house research wages as well as contract research expenses.

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What to Document If You Use an EOR or PEO

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- Confirm in writing whether your provider is a certified CPEO or a non-certified PEO/EOR to confirm which analysis will apply.

- If not certified, keep records showing who directs and controls the work. This may include org charts, project assignments, performance reviews, and/or who the workers report to internally.

- Track where each worker physically performs work, separating US-based work from work performed offshore.

- Keep the service agreement/contract with the EOR/PEO provider to verify control and supervision responsibilities.

- Maintain documentation relating to specific business components that any qualified research activity requires, regardless of who issues the paycheck.

- Keep invoices and payment records paid by the EOR to specific individuals working on projects you are claiming   to ensure they are categorized properly