AZ R&D Tax Insight
The 10-Year Carryover Rule
"For taxable years beginning after December 31, 2021, unused Arizona R&D tax credits expire after 10 years, a reduction from the previous 15-year period."
Context & Background
Arizona offers a Research and Development (R&D) tax credit intended to stimulate innovation within the state. Historically, if a company could not use the full credit amount in the year it was generated (due to insufficient tax liability), they could carry the remainder forward for 15 consecutive taxable years.
However, recent legislative updates have tightened this window for newer credits. Understanding this change is critical for long-term tax planning and deferred asset valuation. This report analyzes the Post-2021 landscape.
Key Changes at a Glance
- ● Effective Date: Taxable years beginning from & after Dec 31, 2021.
- ● Old Rule: 15-Year Carryover (Pre-2022).
- ● New Rule: 10-Year Carryover (Post-2021).
- ● Impact: Acceleration of credit utilization is now required to avoid forfeiture.
Carryover Risk Simulator
Visualize the impact of the 10-year rule on your business. Use the sliders to estimate a generated credit amount and your projected annual tax liability. The chart will show the credit drawdown and highlight any amount at risk of expiration under the new law.
Input Parameters
Assumes constant annual liability for simplicity.
Credit Balance Projection (15 Year Timeline)
Statutory Guidance & Authority
Reviewing the specific laws and revenue office citations.
A.R.S. § 43-1168 (Corporate) & § 43-1074.01 (Individual)
The primary authority governing the Arizona Research and Development tax credit is found in the Arizona Revised Statutes. The carryover provision modification is the critical legal update.
*Note: This specific 10-year language applies to taxable years beginning from and after December 31, 2021. Credits generated prior to this date generally retain their original 15-year carryover status under the statutes active at that time.
Comparative Analysis
How does the new Arizona 10-year rule stack up against Federal rules and other major R&D jurisdictions?
While Arizona has shortened its carryover, it remains competitive compared to states with no carryover or 5-year limits. However, the disparity with the Federal 20-year period creates a "deferred tax asset mismatch" that requires careful accounting.
Strategic Conclusion
The reduction of the carryover period to 10 years for post-2021 credits signifies a policy shift emphasizing immediate utilization.
- ➜ Action Item: Review current carryover schedules. Ensure your tax software is correctly segregating 2022+ credits.
- ➜ Planning: If your simulator results show a loss at Year 10, consider accelerating income recognition or exploring refundability options if you qualify as a small business under A.R.S. § 41-1512.
- ➜ Documentation: Maintain rigorous records. With a shorter window, the ability to substantiate credits during an audit before they expire is more time-sensitive.
Real World Example
TechStart AZ Inc. generates $100,000 in credits in 2022. Due to heavy reinvestment, they pay $0 tax until 2028. From 2028-2032, they use $15,000/year.
Result: By Year 10 (2032), they have used $75,000. The remaining $25,000 expires. Under the old 15-year rule, they would have had 5 more years to use the balance.
The Arizona R&D Tax Credit: Analyzing the 10-Year Carryover Period (Post-2021) and Required Compliance
The 10-Year Carryover Period refers to the maximum duration—ten consecutive taxable years—that unused Arizona Research and Development (R&D) tax credits generated in taxable years beginning after December 31, 2021, may be carried forward to offset future state income tax liability.
This statutory change establishes a bifurcated tracking requirement for taxpayers, as credits generated in earlier taxable years retain their original fifteen-year carryover term.
This regulatory shift necessitates a significant adjustment in tax planning and compliance for businesses investing in research within Arizona. The reduction of the carryover period from 15 years to 10 years places a higher premium on future profitability and tax capacity, increasing the risk of credit expiration for companies with uncertain long-term revenue projections. Furthermore, the application of this new limit must be carefully managed alongside the provisions for refundable R&D credits administered by the Arizona Commerce Authority (ACA).
Section I: Foundation of the Arizona R&D Tax Credit (A.R.S. § 43-1168)
1.1 Program Eligibility and Scope
The Arizona Credit for Increased Research Activities is established under Arizona Revised Statutes (A.R.S.) § 43-1168.1 This nonrefundable credit is allowed against the taxes imposed by Title 43 (Arizona Income Tax) and is designed to incentivize qualified research activities conducted within the state.2
The structure of the Arizona R&D credit is based largely on Section 41 of the Internal Revenue Code (IRC), but critical exceptions apply.1 Notably, qualified research for the purpose of the Arizona tax credit is strictly limited to research conducted only in Arizona.1 This includes basic research payments made to a university under the jurisdiction of the Arizona Board of Regents.1 The termination provisions of IRC § 41, which govern the federal credit’s sunset (where applicable), do not apply to the Arizona credit, ensuring its continued availability.1
The credit is available to a broad spectrum of entity types. This includes corporate taxpayers (C corporations), corporate partners, S corporation shareholders (who may receive a pass-through election), partners in a partnership, and exempt organizations that generate Unrelated Business Taxable Income (UBTI).3 If multiple taxpayers share in the eligible expenses, each is eligible to claim a proportionate share of the credit.1
1.2 Calculation Mechanics and Tiered Credit Rates
Taxpayers are permitted to compute the Arizona R&D credit using either the Regular Method or the Alternative Simplified Credit (ASC) method, calculating the base amount and excess qualified research expenses (QREs) using only Arizona-sourced expenses.3
The allowable current taxable year credit is based on tiered percentage rates applied to the excess QREs above the base amount, as determined under IRC § 41(c). These rates are statutorily set to provide enhanced incentives through 2030.1
Current Tiered Rate Structure (Taxable Years before December 31, 2030):
- If the sum of excess QREs and basic research payments is $2,500,000 or less, the credit is equal to 24% of that amount.1
- If the sum exceeds $2,500,000, the credit is equal to $600,000 plus 15% of any amount exceeding $2,500,000.1
It is important for long-term tax modeling that taxpayers recognize the scheduled reduction in these rates. For taxable years beginning from and after December 31, 2030, the rates are set to decrease to 20% and 11% (applied after the initial $500,000 threshold, down from $600,000).1
1.3 Administration: Roles of ADOR and ACA
The administration of the Arizona R&D credit is split between two key state agencies:
- Arizona Department of Revenue (ADOR): ADOR administers the nonrefundable portion of the credit, which includes the calculation and tracking of carryover balances.7 Corporate taxpayers and partnerships use Form 308, while individual taxpayers use Form 308-I.3 ADOR is the central authority for processing the nonrefundable credit claims and ensuring accurate application of the carryover rules.
- Arizona Commerce Authority (ACA): The ACA administers the refundable portion of the R&D credit.9 To receive a refund, taxpayers must apply to the ACA for certification and receive a Certificate of Qualification.8 The ACA also oversees the Unused Credit Reinvestment Program, providing an alternative path for utilizing excess nonrefundable balances.10
Section II: The Legislative Mandate for the 10-Year Carryover Period
2.1 Statutory Enactment and Effective Date
The most significant recent change affecting the long-term planning of the Arizona R&D credit is the modification of the statutory carryover period. Prior to the legislative change, unused credits were subject to a generous carryforward period. For taxable years beginning before January 1, 2022, the credit that was not used to offset taxes could be carried forward for the next fifteen consecutive taxable years.7
The law was subsequently amended, establishing a shortened period. For taxable years beginning from and after December 31, 2021, any R&D credit claimed that is not used to offset taxes may only be carried forward for ten consecutive taxable years.7 This reduction creates a definitive legal distinction between credit assets generated in 2021 (and earlier) and those generated in 2022 and subsequent years.
2.2 Policy Context: Carryover Reduction and Liquidity Enhancement
The legislative decision to reduce the carryover period from 15 years to 10 years did not occur in isolation. This change was enacted alongside policy measures designed to offer greater near-term monetization and liquidity options for eligible businesses.
The state government simultaneously increased the aggregate annual cap on the refundable portion of the R&D Credit from $5,000,000 to $10,000,000.9 Additionally, mechanisms were established, such as the Unused Credit Reinvestment Program, directing the ACA to evaluate and certify taxpayers who carry forward unused credit balances to qualify a portion of that balance for specific reinvestments within Arizona.9
This concurrent legislative action reveals an important policy direction. By shortening the nonrefundable carryover duration, the state inherently limits its long-term contingent liability and encourages businesses to utilize the tax asset more rapidly. By enhancing the refundable component and creating the reinvestment avenue, the legislature provided alternative, accelerated means for businesses to derive immediate financial value from their R&D investments. The net effect is a legislative preference for either immediate cash realization or faster utilization of nonrefundable credits against taxable income, rather than maintaining large, long-dated balances on corporate balance sheets. This dynamic puts operational pressure on taxpayers to generate sufficient Arizona taxable income within the new, shorter 10-year window.
Section III: Navigating the Bifurcated Carryover System (The Transition Rule)
3.1 The Dual Carryover Requirement
The implementation of the 10-year carryover rule requires sophisticated tracking due to the statutory transition rule. Taxpayers cannot simply treat all unused R&D credits as a single pool. They must manage two distinct categories of carryover balances based on the year the credit was established:
- 15-Year Pool: Credits generated for taxable years beginning before January 1, 2022.16
- 10-Year Pool: Credits generated for taxable years beginning from and after December 31, 2021.16
For example, a credit generated in the 2021 tax year enjoys 15 years of carryforward potential, expiring in 2036 (assuming a calendar year taxpayer). A credit generated in the 2022 tax year, however, is limited to a 10-year carryforward, expiring in 2032. This mandates rigorous compliance and distinct financial modeling for each “vintage” of credit carryover, as each is subject to a different expiration clock.
3.2 ADOR Compliance Guidance and Administrative Procedures
The Arizona Department of Revenue (ADOR) has incorporated this dual requirement directly into the tax forms and instructions. The instructions for Form 308-I (Individuals), for instance, explicitly require separate computations for carryovers based on the generation year.16
- The form uses specific sections (such as Part 8 in the 2023 instructions) to compute and track carryover amounts generated prior to 01/01/2022, subject to the 15-year carryover period.16
- Separate sections (such as Part 9 in the 2023 instructions) are dedicated to computing and tracking carryovers generated after 12/31/2021, subject to the new 10-year period.16
ADOR guidance confirms that any carryover amounts from previous taxable years must be carried over to the next taxable year, subject precisely to their statutory carryover period.16 This mandate for separated tracking is critical, as aggregating the credits would make it impossible to enforce the correct expiration date for post-2021 credits.
3.3 Strategic Utilization of Carryover Vintages
Given that credit vintages are subject to different expiration dates, taxpayers must adopt a systematic approach to utilization to minimize asset forfeiture. Although the ADOR forms mandate the tracking of all available carryovers, maximizing the benefit requires a strategy focused on credit longevity.
When a taxpayer’s Arizona income tax liability exceeds the current year’s R&D credit generation, they must strategically deploy their carryover pool. This strategic deployment dictates that the taxpayer should utilize the credits that are closest to expiration first, regardless of whether they belong to the older 15-year pool or the newer 10-year pool. The 10-year credits, by their nature, have a shorter life span than the remaining life of the 15-year credits that were generated just before the transition date. By employing a “First-In, First-Out” (FIFO) principle based on expiration risk, the company ensures that tax assets that are nearing their sunset date are utilized before longer-lived assets, thereby preserving the total value of the R&D investment.
Section IV: The Impact of Refundable Elections on Carryover Balances
4.1 Qualification and Mechanism of the Refundable Credit
The Arizona R&D credit offers a partial refund option for certain qualified small businesses. To be eligible for this option, a company must qualify for the general R&D credit and employ fewer than 150 full-time employees.8
The refundable credit is equal to up to 75% of the excess credit amount—that is, the amount by which the calculated credit exceeds the taxpayer’s income tax liability for that year.8 As noted, this program is administered by the ACA, not ADOR, and is subject to a strict annual statewide cap, recently increased to $10,000,000.9 The ACA processes applications on a first-come, first-served basis, meaning prompt application following the close of the taxable year is necessary to secure the refund.8
4.2 The 75% Refund/100% Carryover Forfeiture Rule
The election to take the partial refund is subject to a critical statutory condition that directly affects the carryover period. If a taxpayer receives a refund of 75% of the excess credit for a specific taxable year, the taxpayer does not have any excess amount to carry forward for that year.7 Furthermore, the remaining 25% of the excess credit is automatically forfeited (waived).8
This rule establishes a non-negotiable trade-off: a company can choose immediate liquidity (75% cash back) for the credit generated in that specific year, but it forfeits the entire potential carryover balance (the full 100% of the nonrefundable credit) for that vintage.
The existence of the 10-year carryover period amplifies the necessity of careful evaluation when deciding between cash today and future tax relief. A shorter carryover period inherently makes the nonrefundable asset more volatile, increasing the utility of the immediate, albeit partial, refund for companies that do not foresee stable, high Arizona tax liability within the next decade. Conversely, a company with strong expectations of high future taxable income may find the Net Present Value (NPV) of carrying forward the full 100% credit for up to 10 years to be greater than the NPV of the immediate 75% cash injection.
4.3 Preservation of Prior Carryover Balances
It is crucial to differentiate the treatment of the current year’s credit from that of prior years’ carryovers. Electing and receiving the 75% refund only nullifies the carryover amount associated with the specific year for which the refund was claimed.15 Any remaining carryover balances established in previous taxable years—whether they are subject to the 15-year or 10-year rule—must still be carried over to the next taxable year, subject to their original statutory expiration periods.7
Section V: Comprehensive Example: Multi-Year Credit Carryover Tracking
The following example illustrates the operational mechanics of tracking R&D tax credit carryovers in a scenario involving both pre-2022 and post-2021 credit vintages. This demonstrates the critical importance of segregated tracking on ADOR forms (Form 308 or 308-I).
Scenario Setup: AZ Advanced Robotics (AZAR) is a calendar year C-Corporation that consistently generates Arizona R&D credits. AZAR projects high future tax liability and elects to carry forward all unused credits, never claiming the refundable portion.
Table: R&D Credit Carryover Tracking (15-Year vs. 10-Year Vintages)
| Tax Year | Credit Generated (A) | Statutory Carryover Period | Expiration Year | AZ Tax Liability (D) | Total Credit Available (A + C/O) | Credit Used (E) | Ending Carryover Balance (F) |
| 2021 | $500,000 | 15 Years (Pre-2022) | 2036 | $100,000 | $500,000 | $100,000 | $400,000 (Vintage 2021) |
| 2022 | $400,000 | 10 Years (Post-2021) | 2032 | $300,000 | $400,000 (New) + $400,000 (C/O 2021) = $800,000 | $300,000 | $400,000 (Vintage 2021) + $300,000 (Vintage 2022) |
| 2023 | $600,000 | 10 Years (Post-2021) | 2033 | $900,000 | $600,000 (New) + $700,000 (C/O Total) = $1,300,000 | $900,000 | $100,000 (Vintage 2021) + $0 (Vintage 2022) + $300,000 (Vintage 2023) = $400,000 |
| 2024 | $0 | N/A | N/A | $500,000 | $400,000 | $400,000 | $0 |
Detailed Application of Credits in 2023:
In 2023, AZAR has a substantial tax liability of $900,000. It has three pools of available credit:
- New Credit (Vintage 2023): $600,000 (Expires 2033).
- Carryover (Vintage 2021): $400,000 (Expires 2036, 15 years remaining).
- Carryover (Vintage 2022): $300,000 (Expires 2032, 10 years remaining).
The company must use $900,000 of credit to fully offset the liability. To minimize the risk of expiration, the company prioritizes the utilization of the shortest-lived carryover first.
Utilization Sequence:
- Utilize Vintage 2022 Carryover: Use $300,000 (Expires 2032). Remaining Liability: $600,000. Remaining Carryovers: $400,000 (2021).
- Utilize Vintage 2021 Carryover: Use $400,000 (Expires 2036). Remaining Liability: $200,000. Remaining Carryovers: $0.
- Utilize Vintage 2023 New Credit: Use $200,000. Remaining Liability: $0.
Resulting Carryover Balance to 2024:
- $400,000 ($600,000 new credit minus $200,000 used) from the 2023 vintage (10-year period, expires 2033).
- Zero balance remains for the 2021 and 2022 vintages.
This example highlights the complexity introduced by the 10-year carryover rule, forcing tax professionals to manage distinct expiration calendars and document the utilization sequence precisely across the multi-year carryover tables required by ADOR.20
Section VI: Strategic Tax Planning and Compliance Recommendations
6.1 Record Keeping and Documentation Integrity
The dual-system of 15-year and 10-year carryovers demands heightened precision in documentation and compliance. Taxpayers must maintain detailed, segmented records that clearly link the original tax year of generation, the amount of the nonrefundable credit established, the statutory carryover period assigned (15 or 10 years), and the annual amount utilized against Arizona tax liability.16
This record-keeping necessity extends beyond the mere calculation of the credit. While the statute of limitations for amending a return for the year a credit was generated may lapse (typically three years), the carryover period itself lasts for 10 or 15 years. The validity of the credit may be audited by ADOR in the year it is finally claimed to offset tax liability. Therefore, documentation supporting the underlying Qualified Research Expenses (QREs) for a credit generated in 2022 must be preserved for the entire 10-year utilization period, potentially extending the total documentation requirement beyond a decade.
6.2 Modeling the 10-Year Sunset in Financial Forecasts
For tax planning, the 10-year carryover period must be explicitly factored into deferred tax asset projections. Credits generated post-2021 carry a substantially increased risk of expiration compared to the pre-2022 15-year credits, particularly for early-stage companies or those in emerging markets where sustained profitability may take longer to achieve.
Financial modeling must project Arizona taxable income with sufficient certainty to utilize the 10-year credits before their mandated sunset. If the utilization of these shorter-lived credits is not probable within the statutory window, companies may be required to establish valuation allowances against the deferred tax asset on their financial statements, reducing reported book earnings. This increased urgency in tax asset realization makes the decision to pursue the 75% partial refund, despite the forfeiture of the remaining 25% and the carryover, a more attractive option for businesses facing uncertainty in long-term income generation.
6.3 Interplay with the Unused Credit Reinvestment Program
For taxpayers with large nonrefundable carryover balances that may be at risk of expiring—especially those subject to the new 10-year limit—Arizona provides an alternative monetization avenue through the Unused Credit Reinvestment Program, administered by the ACA.10
This program authorizes the ACA to certify a portion of a taxpayer’s unused credit balance for reinvestment in specified investments within Arizona.9 The purpose of this mechanism is to convert a static tax asset (the nonrefundable carryover) into immediate economic activity within the state. The establishment of this program, alongside the reduction of the carryover period, reinforces the legislative strategy to encourage the timely deployment or monetization of R&D tax assets, rather than allowing them to remain on tax returns for the maximum allowable period. Taxpayers should strategically evaluate whether this reinvestment program offers a more immediate and controlled value realization mechanism than relying solely on the 10-year carryover against uncertain future tax liabilities.
Conclusion: Key Takeaways
The enactment of the 10-Year Carryover Period for Arizona R&D tax credits generated after December 31, 2021, represents a structural modification that necessitates immediate adjustment in tax compliance and strategic financial planning.
The primary implication is the mandate for a bifurcated accounting system, requiring taxpayers to manage two distinct pools of credit based on their generation year—the 15-year pool (pre-2022) and the 10-year pool (post-2021). ADOR’s required forms reflect this structure, demanding that credits be tracked separately to enforce the correct expiration dates.
Furthermore, the shortened 10-year window increases the financial risk associated with nonrefundable credits, making accurate long-term income forecasting essential. This heightened risk compels taxpayers to adopt utilization strategies, such as prioritizing the use of credits closest to their expiration date. Finally, the critical interaction with the refundable credit provision demands a rigorous NPV analysis, as the election of a 75% refund for a given year results in the immediate and permanent forfeiture of that year’s entire carryover balance. Effective management of the Arizona R&D credit now relies on meticulous multi-year tracking and strategic decisions regarding utilization versus monetization through the refundable or reinvestment programs.
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What is the R&D Tax Credit?
The Research & Experimentation Tax Credit (or R&D Tax Credit), is a general business tax credit under Internal Revenue Code section 41 for companies that incur research and development (R&D) costs in the United States. The credits are a tax incentive for performing qualified research in the United States, resulting in a credit to a tax return. For the first three years of R&D claims, 6% of the total qualified research expenses (QRE) form the gross credit. In the 4th year of claims and beyond, a base amount is calculated, and an adjusted expense line is multiplied times 14%. Click here to learn more.
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