R&D Tax Credits for Aerospace and Defense Contractors

Key Takeaways

• Aerospace companies are among the highest-qualified R&D credit claimants — industry estimates suggest 47% or more of typical expenses may qualify as QREs
• Government contracts must be analyzed individually for the funded research exclusion — FAR data rights clauses (particularly DFARS 252.227-7013 and 7014) determine whether you retain substantial rights
• IRAD (Independent R&D) and B&P (Bid & Proposal) costs are typically the cleanest qualifying expenses because they’re not funded by a specific contract
• Fixed-price contracts generally provide a stronger basis for credit eligibility than cost-reimbursable contracts — but even cost-plus work can qualify depending on data rights and risk allocation

Activity Category	Specific Examples
Structural design and analysis	Airframe design, composite structure development, finite element analysis, fatigue and damage tolerance analysis, stress analysis on new configurations, landing gear design iterations.
Avionics and electronics	Flight control system development, radar and sensor design, communication systems engineering, electronic warfare systems, embedded software development for mission-critical applications.
Propulsion engineering	Turbine blade design, combustion chamber engineering, nozzle optimization, fuel system development, thermal management for propulsion components, engine testing and performance characterization.
Materials and processes	Qualifying new alloys and composites, developing heat treatment processes, surface finishing engineering, additive manufacturing process development (metal 3D printing for flight hardware), NDI/NDT method development.
Test and qualification	Environmental testing (thermal, vibration, shock, humidity), qualification testing for new materials or processes, flight test engineering, wind tunnel testing, structural test article design and instrumentation.
Manufacturing engineering	Developing fabrication processes for new designs, tooling engineering, production line design for new programs, automated assembly development, first-article inspection engineering, process parameter optimization.
Systems engineering	Requirements analysis and trade studies, system architecture development, interface design, integration and verification planning, modeling and simulation for system performance prediction.

Quotable fact: Industry estimates suggest that 47% or more of a typical federal defense contractor’s expenses may qualify as R&D research expenditures — making aerospace and defense among the highest-yield industries for R&D credit studies. The combination of engineering-intensive work, high-salary technical staff, and significant supply and testing costs creates a large QRE base.

💡
The data rights analysis is non-negotiable: In aerospace R&D credit work, the DFARS data rights clauses — particularly 252.227-7013 (technical data) and 252.227-7014 (computer software) — determine whether the contractor retains “substantial rights” to the research. The three tiers — unlimited, government purpose, and limited/restricted — each have different implications. A contractor with “limited rights” or “restricted rights” generally retains substantial rights. A contractor that has granted “unlimited rights” has effectively transferred the technology to the government. Every contract must be analyzed individually.

Important nuance: While IRAD costs are allowable under FAR 31.205-18 as indirect costs recoverable through overhead rates, this does not make them “funded” for IRC §41 purposes. The IRS treats IRAD as contractor-funded research because the costs are incurred at the contractor’s discretion and risk — the government doesn’t direct or specifically pay for IRAD activities.

💡
From our practice: A precision machining shop developing CNC processes for flight-critical hardware. A composites manufacturer qualifying new layup techniques for structural components. An electronics assembler designing custom test fixtures for avionics boards. A heat treatment facility qualifying new processes for aerospace alloys. Each of these is a potential R&D credit claimant performing qualifying activities every day. If you’re a manufacturer supplying the aerospace industry, your process development work likely qualifies — and the funded research exclusion is often less of an issue at the supplier level because suppliers typically work under fixed-price purchase orders where they bear the process development risk.

Activities that don’t qualify:

✕	Funded research where the contractor doesn’t bear financial risk or retain substantial rights — the most common disqualifier in this industry
✕	Production manufacturing to established specs — once a process is qualified and production is running to documented parameters, the manufacturing itself doesn’t qualify
✕	Routine quality inspections — standard incoming/in-process/final inspection to established criteria (but developing new inspection methods or investigating anomalies can qualify)
✕	Administrative program management — cost tracking, schedule management, contract administration, and compliance paperwork
✕	Foreign research — any R&D performed outside the U.S., including work by foreign subsidiaries or offshore engineering teams

Aerospace or Defense Contractor? Let’s Analyze Your Contracts.

We start every aerospace engagement with a contract-by-contract funded research analysis — because that’s what determines credit eligibility. We’ll evaluate your IRAD, B&P, and contract-funded work and give you a clear picture of your qualifying activities.

Schedule a Free Consultation

Can government contractors claim the R&D credit?

Yes — but with caveats. The funded research exclusion doesn’t automatically disqualify all government contract work. It depends on the specific contract type, data rights provisions, and whether the contractor bears financial risk. IRAD and B&P costs are generally the safest qualifying expenses. Fixed-price contract work may also qualify depending on data rights. Each contract must be analyzed individually.

What about SBIR/STTR grants — do those qualify?

SBIR and STTR awards are generally considered funded research because the government provides the funding. However, the contractor typically retains data rights under these programs, which means the “substantial rights” test may be met. The financial risk analysis is the critical factor — and it depends on whether the award is structured as a contract, grant, or cooperative agreement. Consult with a specialist before including SBIR/STTR costs in a credit claim.

We’re a small machine shop making aerospace parts — do we qualify?

Very likely. If you’re developing processes for new part geometries, qualifying new materials, designing custom tooling, or solving engineering challenges on production parts — especially flight-critical hardware — those activities frequently qualify. Tier 2 and Tier 3 aerospace suppliers are among the most underserved R&D credit claimants. See our manufacturing R&D guide for more detail on shop-floor qualifying activities.

Does additive manufacturing (3D printing) qualify?

Yes — when it involves genuine technical uncertainty and experimentation. Developing print parameters for new alloys, qualifying AM processes for flight hardware, designing parts for AM that can’t be made traditionally, and solving post-processing challenges all involve technical uncertainty. The process development and qualification work is often more credit-intensive than the design work itself.

How much is the R&D credit typically worth for an aerospace company?

It depends on the mix of IRAD vs. contract-funded work, contract types, and overall R&D spending. A mid-size aerospace company with $10M in qualifying expenses might generate $600,000-$1,000,000 in annual federal credits, plus applicable state credits. The key variable is how much of the total R&D activity survives the funded research analysis. Read our complete R&D tax credit guide for calculation methodology.