Before You Start

This guide assumes you have a foundational understanding of what qualifies as an R&D expense and administrator access to your accounting software (QuickBooks, Xero, etc.) with class or tag functionality enabled.

Overview

30 min
Setup Time
Advanced
Difficulty
Quarterly
Review Frequency

What You’ll Learn

  • Strategies for identifying eligible R&D activities and expenses
  • Configuring classes or tags in your GL for precise tracking
  • Mapping payroll, contractor, and supply costs for R&D
  • Best practices for documentation and audit readiness

1. Preparation Steps

Before setting up tracking, ensure these elements are considered in your GL:

Required for R&D Tracking

  • Dedicated R&D ‘Class’ or ‘Tag’ (e.g., “R&D Project X”)
  • Specific GL Accounts for R&D Payroll
  • Specific GL Accounts for R&D Contractor Services
  • Specific GL Accounts for R&D Supplies/Materials

Optional (but recommended)

  • R&D Fixed Asset tracking (e.g., Equipment Used in R&D)
  • R&D Software Expenses
  • R&D Overhead Allocations

2. Choosing Your Tracking Method

You have primary methods for tracking R&D expenses, each with distinct advantages.

Method A: Class/Department Tracking

This leverages your accounting software’s class or department feature.

Pros:
  • Robust reporting capabilities.
  • Good for detailed project costing.
  • Integrates well with financial statements.
Cons:
  • Can be rigid if projects change often.
  • Requires consistent data entry.
  • May require separate departmental setup.

Method B: Tag/Location Tracking

This uses custom fields or tags for flexible expense categorization.

Expert Tip: For businesses with multiple, concurrent R&D projects or a need for highly flexible reporting, combining both Class (for core R&D department) and Tag (for specific projects or activities) can offer the most granular and defensible tracking system.

3. Step-by-Step: Implementing Your System

Here is the high-level workflow for setting up an R&D tracking system.

Visualizing the flow: Start with identifying R&D activities, then assign expenses (payroll, contractors, supplies) to a specific R&D class/tag in your accounting system. Finally, generate reports to aggregate eligible expenses for tax credit calculations.

Here is a sample entry to illustrate how an R&D expense might be structured in your GL.

{
  "transaction_id": "EXP-7890",
  "date": "2025-09-15",
  "account": "Payroll Expenses",
  "amount": 5500.00,
  "memo": "Salary for Dr. Evelyn Reed - Project Alpha",
  "class_tag": "R&D - Project Alpha",
  "employee_id": "ER001"
}

4. Setting Up Your Accounting Software

  1. 1

    Define R&D Classes/Tags

    Create a new ‘Class’ or ‘Tag’ (e.g., “R&D - Product Development”) within your accounting software for each distinct R&D project or department.

  2. 2

    Map R&D Payroll

    Ensure that all payroll entries for employees involved in R&D activities are tagged with the appropriate R&D class/tag.

  3. 3

    Track Contractor & Supply Costs

    For invoices from contractors or purchases of supplies directly used in R&D, apply the designated R&D class/tag during entry.

Common Error: Inconsistent Tagging

Inconsistent application of R&D classes/tags can lead to underreporting or disallowed expenses during an audit. Implement clear guidelines and regular reviews.

5. Testing Your Setup

Quarterly Review Checklist

  • Generate an R&D expense report for the last quarter
  • Verify that all eligible expenses are correctly tagged
  • Cross-reference with project documentation
  • Confirm total R&D expenses align with expectations

Need Help?

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Struggling to identify eligible activities or optimize your R&D tax credit claim? Our specialists are here to help.

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