R&D Tax Credits for Chemical Companies

Summary

Chemical companies consistently work through problems that have no established answers, which is a strong indicator of activities that qualify for the R&D tax credit under IRC §41. This article covers what qualifies, what doesn’t, and what documentation chemical companies need to keep to support their R&D tax credits.

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Why Chemical Companies Are a Strong Fit for R&D Tax Credits

Formulation work is built on trial and error. Chemists test ratios, run pilot batches, adjust for stability or shelf life, and repeat the process until something works reliably and at scale. Whether the end product is an industrial chemical, a specialty formula, or a coating, the processes and materials used to solve these technical unknowns may qualify for the credit.

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The Four-Part Test Applied to Chemical R&D

To qualify as research, the activity must meet all four parts, applied to each business component.

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• Permitted Purpose: The activity must be intended to develop or improve the functionality, performance, reliability, or quality of a business component.

• Technological in Nature: The work must rely on engineering, physical or biological science, or computer science principles.

• Technical Uncertainty: The activity must be undertaken to discover information intended to eliminate uncertainty about the capability, method, or appropriate design of the business component.  

• Process of Experimentation: Your team must have a process that evaluates alternatives through modeling, simulation, systematic trial and error, or other methods to eliminate uncertainty.

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A chemist adjusting a known formula to hit a performance target with no real uncertainty about how to achieve it is not enough on its own. The work must start with a genuine uncertainty that is resolved through testing.

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Examples of Qualified Activities

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• Developing new chemical formulations or improving existing ones for performance or reliability.

• Process development and scale-up work, moving from bench-scale to pilot batch to full production.

• Running pilot batches to test whether a formulation or process performs as expected at a larger scale.

• Experimentation aimed at improving a production process.

• Developing new methods of analysis or testing to evaluate a new formulation or process.

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What Typically Does Not Qualify

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• Routine quality control testing of a formula that is already established and unchanged.

• Market research, consumer preference testing, or focus groups.

• Cosmetic-only changes to color, scent, or packaging with no underlying technical uncertainty.

• Routine regulatory filing or paperwork that does not involve new technical work.

• Reproducing a known, published formula without any experimentation of your own.

• Contract research that is fully funded by a customer, where the company performing the work retains no substantial rights to the results of the research.

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Supplies

Wages are generally a large piece of an R&D tax credit, but for chemical companies, supply costs can also be a larger contributor. IRC §41(b)(2)(C) defines a supply as any tangible property other than land or improvements to land, and other than property of a character subject to depreciation. Under Treas. Reg. §1.41-2(b), a supply is a qualified research expense when it is used in the performance of qualified services by an employee working on the research, rather than in a general or administrative capacity.

For a chemical company, raw materials, reagents, and other inputs consumed while running pilot batches or experimental trials may all count toward the credit, regardless of whether the test was successful or not. Tax court precedent has recognized that consumed research material can qualify as a supply expense when it is genuinely used in the testing process, not only when the final result is a success, as long as the material was used in the experiment, and not in standard, repeatable manufacturing processes.

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Equipment that is capitalized and depreciated, such as permanent lab or plant equipment, will not qualify as a supply expense (even if used in research) due to depreciable property falling outside the statutory definition of a supply. Overhead, license fees, and the cost of leasing equipment are not tangible property either, so those also fall outside the supply category.

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Production Costs vs. Research Costs

There is an important differentiation to note in reference to production costs vs. research costs when calculating an R&D tax credit. Supply costs a company would have incurred to manufacture and sell its product regardless of the activity do not become research expenses simply because research is happening at the same time. IRC §41(d)(2)(C) treats the process used to produce a business component as a separate business component from the product itself. When a chemical company is testing a new production method rather than an improved product, only the incremental costs tied to evaluating that process, not the standard cost of running production, are eligible for the credit.

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This distinction was central to Union Carbide Corp. & Subsidiaries v. Commissioner (T.C. Memo 2009-50, aff'd 697 F.3d 104 (2d Cir. 2012)). Union Carbide sought credit for the full cost of raw materials used while evaluating an improved manufacturing process, materials it would have purchased and consumed regardless of the research. The Tax Court, affirmed by the Second Circuit, held that only the additional costs tied specifically to evaluating the process qualified. The routine cost of materials used to produce the product for sale remained a production expense, not a research expense.

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Agricultural cases have applied the same principle. J.G. Boswell Co. v. Commissioner (T.C. Memo 2022-127) and George v. Commissioner (T.C. Memo 2026-10) both distinguish work aimed at producing the same product more cheaply or in greater volume (process research) from work aimed at improving the product itself (product research). Only the latter, and the incremental process-evaluation costs within the former, generally support a full supply claim.

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For a chemical company, this would mean:

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• If a formulation change is intended to improve the product's performance, quality, or reliability, the related supply costs generally support the credit.

• If a process change is intended to produce the same product at lower cost or higher yield, only the supply costs above what standard production would have required are eligible. The baseline production cost is not.

• Careful, contemporaneous allocation between product-focused and process-focused testing is necessary to support a defensible claim.