Navigating Compliance and Exclusion: A Deep Dive into the Direct Instruction Rule and the Alaska R&D Tax Credit

Direct Instruction, in the context of R&D tax credits, refers to time spent on training employees or educating others on research results, and these expenditures are strictly excluded from qualifying research expenses (QREs). This critical exclusion ensures that the credit incentivizes true experimental research activities aimed at resolving technological uncertainty, rather than general workforce development.

The accurate demarcation of creditable research time versus non-creditable instructional time is one of the most significant compliance hurdles under Internal Revenue Code (IRC) Section 41. Given that the Alaska R&D Tax Credit (AS 43.20.046) is a derivative incentive calculated as 18% of the apportioned federal credit, strict adherence to these federal definitions, particularly concerning the exclusion of instructional labor, is paramount for securing state tax benefits.1 Taxpayers operating in Alaska must integrate federal QRE calculation precision with the state’s mandated apportionment methodology via Alaska Form 6390, a process further complicated by the imminent statutory repeal of the state credit.

Section I: The Foundational Framework: Defining Qualified Research Expenditures (QREs)

1.1 The Federal Mandate: Internal Revenue Code Section 41

The Alaska R&D tax credit is not a standalone state program but rather a mechanism designed to leverage and amplify the federal incentive. Specifically, the Alaska credit equals 18% of the calculated federal R&D credit that is apportioned to Alaska.1 This foundational linkage dictates that the definitions of qualified research activities (QRAs) and the scope of qualified research expenditures (QREs) are governed entirely by federal law, principally IRC Section 41 and its accompanying Treasury Regulations.

QREs are generally categorized into three components: (1) wages paid or incurred for qualified services performed by an employee, (2) costs for supplies used in the conduct of research, and (3) certain payments made for contract research expenses.3 For the purpose of applying the Alaska credit, businesses must first successfully substantiate their QREs under federal guidelines, making the federal compliance audit standard the governing measure for the state benefit.

1.2 The Four-Part Test for Qualified Research Activity

To be eligible for the federal, and consequently the Alaska, R&D tax credit, activities must satisfy the four core requirements defining “qualified research.” These tests ensure that the activity is conducted “in the experimental or laboratory sense” for the purpose of discovering technological information that aims to develop a new or improved business component.4

The activity must: (1) meet the Permitted Purpose test (creation or improvement of a business component’s functionality, quality, reliability, or performance); (2) involve the resolution of Technological Uncertainty; and (3) include a Process of Experimentation. Crucially, IRC Section 41 includes specific statutory exclusions designed to narrow the scope of creditable activities. The exclusion of expenditures related to “Direct Instruction” is one of the limitations that defines the boundary between incentivized research and generalized business or education expenses.

1.3 Categories of QREs: Wages and Qualified Services

The wage component of QREs is subject to stringent rules. Wages paid to an employee are creditable only to the extent they are paid for “qualified services” performed by that employee.3 The definition of “qualified services” is strictly limited to services consisting of (i) engaging in qualified research, (ii) directly supervising qualified research, or (iii) directly supporting qualified research.3

This limitation requires taxpayers to meticulously track and substantiate the activities performed by key personnel. The term “wages” includes all taxable wages reported on Form W-2, such as bonuses and stock option redemptions.5 However, simply paying a scientist a wage does not automatically qualify that expense; the service performed must meet one of the three criteria above.

Section II: The Critical Exclusion: Meaning and Context of Direct Instruction and Training

2.1 Statutory Basis and Regulatory Exclusion: The “Instruction/Training” Rule

The specific exclusion of instructional or training time from QREs is critical for compliance. Direct Instruction encompasses activities relating to training employees, whether they are new hires learning standard operating procedures (SOPs) or existing personnel being taught new skills that do not involve the active resolution of technological uncertainty.6 It also includes the dissemination of research findings—such as teaching a factory crew how to implement a newly developed process—which is viewed as a post-research application activity, not an experimental activity itself.

These expenditures are generally excluded because they fall outside the systematic process required to resolve technical uncertainties. They represent general workforce development or post-R&D implementation, and tax law dictates that the credit should focus solely on the costs directly incurred during the inventive phase.

2.2 Distinguishing Instruction from Qualified Service: The Role of the Researcher

For employees involved in research, the proper classification of their time is essential. The regulations draw sharp distinctions between activities that constitute qualified supervision and those that constitute non-qualified instruction or higher-level administration.

• Direct Supervision (Qualified): The regulations define “direct supervision” as the immediate supervision, or first-line management, of qualified research. An example is a research scientist who directly supervises laboratory experiments, even if they do not personally perform the experiments.7
• Higher-Level Management (Non-Qualified): Time spent by managers to whom first-line supervisors report, regardless of the manager’s technical qualifications, is explicitly excluded from “direct supervision”.7
• Support Services (Qualified vs. Non-Qualified): Services performed in direct support of research (e.g., maintaining research equipment) can qualify. However, general support services, such as the time spent by an accountant preparing general corporate tax returns or payroll, even for research staff, does not constitute qualified research or qualified services.7

2.3 Nuances in Wage Allocation and Compliance Burden

For many qualified personnel, time is split between hands-on research, direct supervision, and non-qualifying activities, including training or administrative tasks. When an employee performs both qualifying and non-qualifying services, the taxpayer must exclude the portion of wages corresponding to the non-qualifying time. This allocation must be made on a “just and reasonable basis” and, ideally, should be supported by contemporaneous records.8

The practical challenge lies in maintaining verifiable documentation. Implementing a robust time and expense tracking system is crucial, especially for activities that blur the line, such as training new staff on equipment or protocols.6 Without clear demarcation, a substantial compliance risk arises. If documentation fails to adequately separate research activities from instructional activities during an audit, the entire wage claim for that employee may be disallowed at the federal level. Because the Alaska tax credit is derived directly from the federal calculation, a deficiency in the foundational federal QREs automatically results in a proportional reduction of the available 18% Alaska credit, effectively exposing the state benefit to federal audit risk.8

To aid in understanding the distinction between labor categories, the following table summarizes the federal classification rules:

Table 1: Federal Classification of Research Labor (IRC §41)

Section III: The Alaska R&D Tax Credit (AS 43.20.046): Mechanism, Apportionment, and Repeal

3.1 Legislative Context and Credit Rate

The Alaska R&D Tax Credit, governed by AS 43.20.046, is a significant incentive for businesses subject to the state’s corporate income tax. The credit provides a dollar-for-dollar offset against tax liabilities and is set at 18% of the apportioned federal R&D credit.1 Eligibility generally mirrors the federal standards under IRC §41, focusing on businesses that incur QREs demonstrating technological uncertainty and innovation.1 The credit is available to various entity types, including C-Corporations, S-Corporations, LLCs, and Partnerships.1

3.2 The Requirement for Apportionment

A unique feature of the Alaska credit is that it requires apportionment to determine the allowable state amount, even if the underlying research activities are conducted outside Alaska.11 The credit applies only to the portion of the federal credit that is appropriately sourced to Alaska.

The Alaska Department of Revenue (DOR) mandates that the federal credit base must be apportioned using the state’s corporate income tax apportionment factor, which is determined based on the company’s property, payroll, and sales attributable to Alaska, as established under AS 43.20.021.1 For example, if a company calculates a $100,000 federal R&D credit and determines its Alaska apportionment factor is 20%, the state credit is calculated on a base of $20,000 (20% of $100,000), resulting in an Alaska credit of $3,600 (18% of $20,000).1 This process is formalized through Alaska Form 6390.

3.3 Credit Utilization and the Critical Sunset Clause

Historically, unused federal-based credits in Alaska could be carried back one year and carried forward for up to 20 years.1 This long carryforward period was designed to benefit corporations with long research cycles or fluctuating profitability, allowing them to monetize the credit over time.

However, a critical legislative change severely limits the future applicability of this incentive. AS 43.20.046 is statutorily scheduled to be repealed on January 1, 2025.12

Furthermore, while any unused portion of the credit acquired before the repeal may be carried forward, the utilization window has been significantly truncated. The unused credit may not be carried forward to tax years beginning after December 31, 2025.12

This combination of a statutory repeal and a severely compressed carryforward period transforms the R&D incentive from a long-term strategic asset into an immediate tax planning urgency. Companies with substantial accrued but unused R&D credits must aggressively manage their tax profiles for the 2024 and 2025 tax years. Failure to generate sufficient Alaska corporate income tax liability by the end of 2025 means any remaining unused credit will be permanently forfeited.

The following table summarizes the mathematical calculation mechanics inherent in the Alaska credit:

Table 2: Calculation Mechanics of the Alaska R&D Tax Credit

Section IV: Compliance Requirements and Alaska Department of Revenue (DOR) Guidance

4.1 Filing Requirements and Alaska Form 6390

The Alaska Department of Revenue (DOR) administers the R&D tax credit and provides specific procedural requirements for claiming the benefit. To apply for the credit, a business must file Alaska Form 6390 – Alaska Federal-Based Credits.1

Form 6390 must be submitted as an attachment to the relevant Alaska corporate income tax return, typically Form 6000, or Forms 6100/6150 for filers in the oil and gas industry.1 Furthermore, the taxpayer must include a copy of the Federal Form 6765 (Credit for Increasing Research Activities) and Federal Form 3800 (General Business Credit) to substantiate the underlying qualified research expenses and the calculated federal credit amount.1

4.2 Applying Apportionment on Form 6390

Alaska Form 6390 is structured to guide the taxpayer through the required state adjustments and apportionment process.9

• The process begins by transferring the calculated federal general business credit (which includes the R&D credit) from Federal Form 3800 to Line 1 of Form 6390.
• Line 3 establishes the federal general business credit amount applicable to Alaska after accounting for federal investment credits or other general business credits not allowable by the state.
• Line 6 then requires the taxpayer to input the specific Alaska Apportionment Factor.
• Line 7 calculates the apportioned federal credit base.
• The final state credit is calculated on Line 8 by multiplying the apportioned base (Line 7) by the 18% statutory credit rate.9

4.3 The Indirect Oversight of the Instruction Exclusion

Although Form 6390 itself focuses on the state-level mechanical calculation of apportionment, the accuracy of the foundational figures entered (derived from Federal Form 6765) is crucial. The state’s ability to administer its credit relies entirely on the initial federal compliance, including the proper exclusion of non-qualifying activities like Direct Instruction.

A failure by the taxpayer to properly exclude instructional labor when generating the federal QREs will result in an overstated federal credit. If this oversight is later corrected by the IRS through an audit, the taxpayer must retroactively adjust their Alaska corporate returns, leading to potential underpayment penalties and exposure to state audit findings. Therefore, taxpayers must prioritize their documentation regarding the instruction exclusion at the federal level to ensure the integrity of the figures flowing into Form 6390.

Section V: Case Study: Allocating Instructional Labor and Calculating the Alaska Credit

5.1 Scenario Setup: Arctic Innovations Manufacturing (AIM)

Arctic Innovations Manufacturing (AIM), a company operating as a C-Corporation, designs and produces components for specialized industrial equipment used in the energy sector. In 2024, the company engaged in qualified research aimed at improving the efficiency of its manufacturing process.

The data gathered for the year is as follows:

• Total QREs before all labor exclusions (including non-qualifying time): $2,500,000.
• Final Federal R&D Credit calculated using the Alternative Simplified Credit (ASC) method (after all adjustments): $175,000.
• AIM’s Alaska Apportionment Factor: 40%.

5.2 Applying the Instruction Exclusion: Calculating Eligible Wages

The company employs Ms. R. Smith, a Lead Research Engineer (LRE), with total annual W-2 wages of $150,000. AIM’s time-tracking system is utilized to allocate her time across various duties, a necessary step for compliance that avoids claiming wages for excluded activities such as training.6

Table 3 details the LRE’s activities and the necessary classification for QRE calculation:

Table 3: Example Allocation of Lead Research Engineer Wages (LRE $150,000)

The rigorous adherence to documentation and the application of the instruction exclusion demonstrates the integrity of AIM’s QRE calculation. Specifically, 300 hours (15%) spent on training new hires on standard operating procedures (SOPs)—a classic example of Direct Instruction—must be strictly excluded from QREs, along with the 10% dedicated to higher-level administrative reviews, as these do not constitute qualified services.7 By excluding 25% of the LRE’s time, AIM properly includes only $112,500 of her wages in the total QRE base that generates the $175,000 federal credit.

5.3 Final Alaska Credit Calculation

Using the final, compliance-validated federal credit amount, the calculation for the Alaska tax benefit proceeds as follows, mirroring the steps on Form 6390:

1. Start with Final Federal Credit: $175,000. (This figure is substantiated by Federal Form 6765, reflecting the exclusion of instructional labor).
2. Apply Apportionment Factor (Form 6390, Line 6): $175,000 (Federal Credit) $\times$ 40% (Alaska Factor) = $70,000 (Apportioned Federal Base).
3. Calculate Alaska Credit (Form 6390, Line 8): $70,000 (Apportioned Base) $\times$ 18% (Alaska Statutory Rate) = $12,600.

AIM can apply this $12,600 as a dollar-for-dollar offset against its Alaska corporate income tax liability, provided the liability is not subject to Alaska alternative minimum tax or other tax exceptions.10

Conclusion and Strategic Recommendations

The Alaska R&D Tax Credit, set at 18% of the apportioned federal credit, provides a powerful incentive for innovation but demands technical precision in compliance. The single most common technical challenge is the correct exclusion of expenditures related to Direct Instruction and training from the underlying Qualified Research Expenses. Since the Alaska credit is directly dependent on the accuracy of the federal QRE determination, any failure to properly track and exclude non-qualifying instructional time compromises the integrity of the entire claim at both the federal and state levels.

Furthermore, the tax environment surrounding this credit requires immediate, aggressive action due to the statutory repeal. The combination of AS 43.20.046 being repealed on January 1, 2025, and the hard cutoff for credit carryforward utilization on December 31, 2025, necessitates a fundamental shift in tax strategy. Companies can no longer rely on the long-term 20-year carryforward provision to utilize accumulated credits; instead, they must ensure sufficient corporate tax liability is realized within the 2024 and 2025 tax years to absorb any accrued credit balances.12

Strategic Recommendations for Alaskan Taxpayers

1. Mandate Meticulous Documentation: Implement or upgrade contemporaneous time-tracking systems to precisely segregate qualifying research activities (Direct Research, Direct Supervision) from non-qualifying excluded activities, especially Direct Instruction and higher-level administrative oversight.6 This compliance step provides the required evidentiary basis for defending QREs against both federal and state audits.
2. Accelerate Credit Utilization and Liability Forecasting: Due to the severe limitation imposed by the 2025 sunset date on carryforwards, businesses must immediately maximize QRE generation in 2024 and conduct rigorous forecasts of their Alaska corporate income tax liability for 2024 and 2025. Strategic tax planning is required to avoid the forfeiture of unused credits after the deadline.12
3. Validate Supervision Hierarchy: Conduct organizational and activity reviews to confirm that only first-line managers performing immediate, tactical supervision of research are included in QREs. Managerial time related to general oversight, strategic planning, or training must be identified and excluded according to Treasury Regulation section 1.41-2.7

Integrated Compliance Filing: Ensure that the filing of Alaska Form 6390 is fully supported by an accurate, audit-ready Federal Form 6765. The state’s reliance on the federal determination means that the documentation standards for the instruction exclusion must be met before the state claim is finalized.1

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