Arizona R&D Tax Credit Report
The Meaning of the 24% Credit Rate
Executive Definition: The 24% rate applies strictly to the incremental increase of Qualified Research Expenses (QREs) over a calculated base amount, capped at the first $2.5 million of that excess.
This section provides a detailed breakdown of the 24% credit rate, distinguishing it from a flat tax credit and explaining its tiered structure under Arizona law.
1. The Incremental Logic
The 24% rate is not applied to every dollar of research spending. Instead, Arizona employs an incremental calculation method. The credit is designed to reward growth in R&D activity.
- ➤ Base Amount: A historical baseline of spending (usually based on a fixed-base percentage of gross receipts).
- ➤ The Excess: The 24% rate applies only to current year expenses that exceed this base amount.
2. The Tiered Structure ($2.5M Cap)
The 24% rate is finite. It applies to the first $2,500,000 of the excess expenses. Once the incremental spending surpasses this threshold, the rate drops.
Strategic Context: Why 24%?
Arizona's 24% rate is significantly more aggressive than the federal statutory rate (often effectively 6-10%) and many other states. This high rate is intended to attract high-tech manufacturing, aerospace, and biotech firms to the state. However, accurate calculation of the "Base Amount" is critical; an artificially low base calculation can lead to audit exposure, while an artificially high base results in missed credits.
Interactive R&D Calculator
Adjust the sliders below to see how the 24% rate is applied to your Qualified Research Expenses (QREs) versus the Base Amount.
The Base Amount is typically calculated using a Fixed Base Percentage of Gross Receipts. Expenses below this line generate $0 credit.
Estimated Credit
Credit Composition Analysis
Local Revenue Office Guidance & Statutes
Key excerpts from the Arizona Revised Statutes (A.R.S.) and Department of Revenue guidance governing the 24% rate.
A.R.S. § 43-1168(A)(1)(a)
The 24% Rate Definition
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"A credit is allowed... in an amount equal to:"
"If the excess qualified research expenses are two million five hundred thousand dollars or less, twenty-four per cent of the excess qualified research expenses."
Analysis: This is the statutory authority for the 24% rate. Note the specific language "excess qualified research expenses," confirming the incremental nature.
A.R.S. § 43-1168(A)(1)(b)
The 15% Rate (Tier 2)
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"If the excess qualified research expenses are over two million five hundred thousand dollars, six hundred thousand dollars [which is 24% of $2.5M] plus fifteen per cent of the amount of excess qualified research expenses over two million five hundred thousand dollars."
Analysis: This clause creates the tiered structure. It ensures the first $2.5M still gets the full 24%, and only the amount above that threshold drops to 15%.
ADOR Form 308
Calculation Method (Regular vs ASC)
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Arizona generally conforms to the Federal Internal Revenue Code (IRC) § 41 definition of "Qualified Research Expenses" (wages, supplies, contract research).
Taxpayers typically use Form 308 to claim the credit. Unlike Federal law which often encourages the Alternative Simplified Credit (ASC), Arizona's standard calculation (Regular Method) is often more beneficial due to the high 24% rate, provided the Base Amount doesn't negate the benefit.
Refundability: Turning Credit into Cash
The 24% rate is even more powerful for small businesses because it is partially refundable.
If a taxpayer has fewer than 150 full-time equivalent employees worldwide, and their R&D credit exceeds their Arizona tax liability, they can elect to receive a refund.
The 75% Rule
The refund is equal to 75% of the excess credit. The remaining 25% is forfeited if the refund is elected.
Example Calculation
- Total AZ Credit Generated: $100,000
- AZ Tax Liability: $0 (Pre-revenue startup)
- Refundable Amount: $100,000 × 75% = $75,000 Check from State
Cash Liquidity
For startups, the 24% rate acts closer to a grant than a tax offset.
Comprehensive Expert Report: Analysis of the 24% Credit Rate within the Arizona Research and Development Tax Incentive Program
I. Executive Summary: The Definition and Context of the Arizona R&D Credit Rate
The 24% credit rate serves as the foundational tier for the Arizona Research and Development (R&D) Tax Credit, established to maximize the financial return on initial, incremental research expenditures within the state. This premium rate is specifically applied to the first $2.5 million of qualified research expenses that surpass a calculated statutory base amount, yielding a maximum credit of $600,000 from this tier alone.
The administration of the Arizona R&D incentive requires navigating a unique two-pronged approach involving the Arizona Department of Revenue (DOR) for non-refundable credit calculation and carryforward management, and the Arizona Commerce Authority (ACA) for the high-value refundable tax credit program aimed at smaller enterprises.1 Success in utilizing the full potential of the 24% rate—particularly the ability to claim a cash refund—is dependent on strict adherence to the application sequencing mandated by both state agencies.
A. Dual Administration and Strategic Necessity
The division of administrative duties between the DOR and the ACA is a critical operational complexity for taxpayers. The non-refundable portion of the R&D credit, which taxpayers use to offset their Arizona income tax liability, is overseen by the DOR (pursuant to A.R.S. §§ 43-1074.01 and 43-1168).1 Conversely, the refundable portion, which allows certain smaller qualifying businesses to convert their excess credit into cash, is established under A.R.S. § 41-1507 and is exclusively administered by the ACA.1
This dual structure imposes a crucial, non-traditional compliance sequence for companies seeking the refundable benefit. Companies must obtain a Certificate of Qualification from the ACA prior to filing their original tax return with the DOR.3 Failure to adhere to this strict chronological requirement means the taxpayer forfeits the election to claim the partial refund for that tax year, demonstrating that successful Arizona tax planning must intrinsically integrate administrative coordination with economic development bodies.
II. Statutory and Legislative Foundation
A. Governing Statutes and Credit Purpose
The statutory authority for the Arizona R&D Tax Credit is found in A.R.S. §§ 43-1074.01 (for individual income taxpayers) and 43-1168 (for corporate income taxpayers).2 Enacted initially in 1994, the program supports innovation in critical Arizona sectors such as technology, aerospace, biotechnology, and manufacturing.4 The current high-incentive structure, which includes the 24% rate, has been updated and is authorized through the 2030 tax year.4 Arizona is one of 36 states nationwide that utilize R&D tax credits to encourage increased investment in local research activities.2
B. Defining Qualified Research Expenses (QREs)
The foundation of the 24% credit calculation rests on the definition and quantification of Arizona-sourced Qualified Research Expenses (QREs). Arizona statutes largely mirror the federal IRC Section 41 definition for determining what activities qualify as research.7
1. Integration of Federal Standards
Arizona utilizes the framework set forth in Internal Revenue Code (IRC) Section 41 for the definition of “Qualified Research” (IRC § 41(d)) and the applicable QREs (IRC § 41(b)).8 This federal nexus establishes eligible costs, including:
- In-house Research Expenses: Wages paid for qualified services, the cost of supplies consumed in the research process, and amounts paid for the right to use computers in conducting research.8
- Contract Research Expenses: 65% of amounts paid to non-employees (third parties) for qualified research.8
2. The Arizona Sourcing Requirement
A critical state-specific limitation is that the credit applies only to QREs that are Arizona-sourced.4 This constraint mandates rigorous documentation, particularly for multi-state or multi-national companies, to isolate and substantiate the portion of eligible federal QREs that were exclusively attributable to research conducted within the physical boundaries of Arizona. For global firms, the necessity of applying specialized allocation methodologies to pinpoint Arizona QREs introduces complexity beyond the scope of federal compliance.
III. Deconstructing the Tiered Credit Structure (24% and 15%)
The Arizona R&D credit employs a tiered structure to incentivize both moderate and extremely large increases in R&D spending, with the 24% rate serving as the highest marginal incentive. The credit amount is always based on the amount of QREs that exceed the calculated Base Amount (the “excess”).4
A. The Application of the 24% Rate (The First Tier)
The 24% rate is applied to the initial incremental expenditure, driving the largest portion of the overall credit value.
- Threshold: The premium 24% rate is strictly applied to the first $2,500,000 of the calculated excess QREs.1
- Fixed Value: This tier provides a fixed maximum credit yield of $600,000 (24% multiplied by $2.5 million).7
B. The Subsequent 15% Incremental Rate
To encourage continued significant investment beyond the initial $2.5 million, a secondary rate is applied:
- Rate: 15% is applied to all excess QREs that exceed the $2,500,000 threshold.1 This rate, while lower, remains a powerful incentive for large-scale research projects, ensuring that there are financial benefits for every dollar of excess QREs generated.
C. The Scheduled Sunset and Future Rate Reduction
Taxpayers must model their future R&D budgets against the program’s scheduled rate reduction, which takes effect in the next decade:
- 2031 Change: For taxable years beginning on or after January 1, 2031, the credit rates are legislatively set to decrease.5 The top tier will fall from 24% to 20% of the first $2.5 million in excess QREs. The subsequent tier will decrease from 15% to 11% of the excess over $2.5 million.7
This scheduled rate reduction means the potential financial return on R&D investment will decline substantially post-2030, lowering the maximum benefit derived from the initial incremental spending from $600,000 to $500,000. This planned degradation provides a clear financial imperative for businesses to maximize R&D utilization and credit generation during the current, higher-rate period.
Arizona R&D Tax Credit Tiered Rate Structure
| Excess QRE Amount | Current Rate (Through 2030) | Credit Value on $2.5M | Future Rate (Post 2030) | Credit Value on $2.5M |
| First $2,500,000 | 24% | $600,000 | 20% | $500,000 |
| Amount Exceeding $2,500,000 | 15% | N/A | 11% | N/A |
IV. Determining the Base Amount: The Cornerstone of the Calculation
The Base Amount calculation is fundamental to generating the 24% credit, as the credit is applicable only to the QREs that exceed this threshold. Arizona allows taxpayers to choose between two methods for calculating this Base Amount, both requiring the exclusive use of Arizona-sourced data.4
A. Method 1: The Regular (Incremental) Credit Calculation
The Regular Credit is based on the methodology used for the federal regular credit, but substitutes Arizona-specific figures for the federal ones.11
- Fixed-Base Percentage: This percentage is determined by the ratio of aggregate Arizona QREs incurred during the historic base period (taxable years beginning after 1983 and before 1989) to the aggregate Arizona gross receipts for those same years.11
- Base Amount Formula: This Fixed-Base Percentage is multiplied by the average annual Arizona Gross Receipts for the four preceding taxable years.11
- Minimum Threshold (Floor): Statutory requirements dictate that the calculated Base Amount must equal at least 50% of the current year’s Arizona QREs.4
The requirement for established firms to maintain and utilize historical Arizona-specific QRE and gross receipts data dating back to 1984–1988 presents a considerable challenge for compliance and recordkeeping, particularly for companies that have undergone mergers, acquisitions, or organizational changes since that period. This complex data requirement contributes significantly to the administrative burden associated with the R&D credit.6
B. Method 2: The Alternative Simplified Credit (ASC)
The ASC is an option designed to alleviate the complex data requirements of the Regular Method, simplifying the base calculation significantly:
- Base Amount Definition: Under the ASC, the base amount is defined as 50% of the average Arizona QREs incurred during the three preceding taxable years.4
- Start-up Provisions: If a company lacks Arizona QREs in the preceding three years, the base amount calculation defaults to zero.4
Taxpayers must perform a preliminary calculation under both the Regular Credit Method and the ASC to determine which yields the maximum credit. The optimal choice depends entirely on a company’s historical spending patterns: whether the historic fixed-base percentage is low (favoring the Regular Method) or whether the recent three-year average of QREs is low (favoring the ASC), thus ensuring maximum excess QREs are subject to the 24% and 15% tiered rates.
C. Enhanced Credit for University Research
Arizona provides an additional incentive for research collaboration with in-state academic institutions. Taxpayers can claim an additional credit equal to 10% of basic research payments made to a state university under the jurisdiction of the Arizona Board of Regents, provided these payments exceed a defined base amount.2
V. Detailed Application Example of the Tiered Rates
This example demonstrates how the tiered structure maximizes the credit value by applying the 24% rate to the first $2.5 million of incremental spending.
Assume a taxpayer determines the following Arizona-sourced figures using the ASC method:
- Current Year Arizona QREs: $4,500,000
- Calculated Base Amount: $1,000,000
The calculation proceeds as follows:
- Determine Excess QREs: The current year QREs are subtracted from the calculated Base Amount.
$$\$4,500,000 – \$1,000,000 = \$3,500,000 \text{ (Total Excess QREs)}$$ - Apply 24% Rate (Tier 1): The 24% rate is applied to the first $2,500,000 of the total excess.
$$\$2,500,000 \times 24\% = \$600,000 \text{ (Credit from 24\% tier)}$$ - Determine Remaining Excess QREs for Tier 2: The amount remaining above the initial threshold is calculated.
$$\$3,500,000 – \$2,500,000 = \$1,000,000 \text{ (Remaining Excess QREs)}$$ - Apply 15% Rate (Tier 2): The 15% rate is applied to the remaining excess.
$$\$1,000,000 \times 15\% = \$150,000 \text{ (Credit from 15\% tier)}$$ - Total Arizona R&D Credit:
$$\$600,000 + \$150,000 = \$750,000$$
In this scenario, the premium 24% rate is responsible for generating $600,000 of the total $750,000 credit, illustrating the enormous weight of this first tier in the overall incentive structure.
Illustrative Calculation: Arizona R&D Credit Tier Application
| Step Description | Amount | Calculation | Resulting Credit |
| 1. Current Year QREs | $4,500,000 | ||
| 2. Calculated Base Amount | -$1,000,000 | ||
| 3. Excess QREs (Line 1 – Line 2) | $3,500,000 | ||
| 4. Credit on First $2.5M (24% Rate) | $2,500,000 | 24% x $2.5M | $600,000 |
| 5. Credit on Excess over $2.5M (15% Rate) | $1,000,000 | 15% x $1.0M | $150,000 |
| 6. Total Arizona R&D Credit | $750,000 |
VI. Arizona Department of Revenue (DOR) Compliance and Carryforward Rules
The DOR administers the primary non-refundable usage of the R&D credit, which is utilized to offset Arizona income tax liability.1
A. DOR Reporting Requirements
All taxpayers claiming the credit must file Arizona Form 308, Credit for Increased Research Activities.12 Individuals must complete Form 308-I. For flow-through entities, the partnership or S corporation files Form 308, and then completes and distributes specific allocation forms (Form 308-P for partners or Form 308-S for shareholders) to ensure the proportionate share of the eligible expenses is correctly passed through to the owners.12
The credit is utilized only after the tax liability has been determined and after all other applicable non-refundable credits have been calculated and applied. Only the amount remaining after offsetting the current year’s tax liability constitutes the “excess credit” eligible for refund or carryforward.11
B. Managing Carryover Periods
The statutory changes enacted for the carryover of unused credits require meticulous tracking based on the year the credit was generated:
- Historical Credits (Pre-2022): For credits established in taxable years beginning before January 1, 2022, the unused amount may be carried forward for the next fifteen consecutive taxable years.11
- Current Credits (Post-2021): For credits established in taxable years beginning from and after December 31, 2021, the carryforward period is reduced to the next ten consecutive taxable years.11
This complexity necessitates sophisticated tracking of credit vintage to manage two separate expiration timelines (15-year versus 10-year). Proper inventory management of R&D credits is essential to avoid the forfeiture of valuable unused balances due to expired statutory limitations.
VII. Arizona Commerce Authority (ACA) Guidance: The Refundable Credit Program
The ACA administers the crucial partial refund component (A.R.S. § 41-1507), a program designed to provide immediate liquidity to small businesses that generate R&D credits but lack sufficient tax liability to utilize them immediately.2
A. Eligibility and Quantification
The refundable credit is highly restrictive in its eligibility criteria:
- Size Restriction: To qualify, a company must employ less than 150 full-time employees worldwide as of the last day of the taxable year.2
- Refundable Amount: The refund is calculated on the current year’s excess R&D credit (the amount remaining after offsetting tax liability).11 The amount of refund granted is the lesser of 75% of the excess credit or the maximum amount specified on the ACA-issued Certificate of Qualification.11
- Waiver: If the taxpayer elects the refund, the remaining 25% of the excess credit is waived and cannot be carried forward to offset future tax liabilities.11
B. Application Process and Critical Timing
The procedural steps for securing the refundable credit are mandatory and rigidly sequential, overseen by the ACA 13:
- Electronic Application: Applications must be submitted electronically through the Authority’s Electronic Application System.13 A fiscal year taxpayer may file their application on or after the first business day following the end of their fiscal year.3
- Certificate of Qualification: The taxpayer must secure the Certificate of Qualification from the ACA.11
- Mandatory Pre-Filing Requirement: The Certificate must be obtained prior to filing the original tax return with the DOR.3 The election to make the credit refundable must be made when the return is originally filed.11
The critical nature of securing ACA certification before DOR filing dictates that compliance strategy must prioritize the ACA application timeline, especially since the refundable pool is a competitive resource.
C. Program Caps and Competition
The refundable credit program is subject to statewide resource limitations, necessitating prompt application:
- Statewide Cap: Refunds for all taxpayers are subject to a competitive annual statewide cap, historically set at $5 million.4
- Authorization Order: The ACA authorizes refundable tax credits based on the order in which applications are received, determined by the date and time stamp from the electronic application system.13 A non-refundable processing fee equal to 1% of the credit being refunded is also required.3
The competitive nature of the cap emphasizes that qualified small businesses must submit their ACA application as early as possible after the close of the taxable year to maximize their probability of accessing the cash refund before the annual cap is exhausted.
VIII. Conclusion and Strategic Insights
The 24% credit rate is intentionally engineered as the cornerstone of the Arizona R&D incentive, designed to rapidly reward companies for their first $2.5 million increase in incremental research spending with the maximum available financial benefit ($600,000). Strategic utilization of this credit transcends mere tax preparation, demanding sophisticated knowledge of computational methodology and strict adherence to administrative protocol.
Successful R&D tax planning in Arizona hinges on three key operational requirements:
- Computational Rigor: Taxpayers must perform dual calculations using both the Regular Credit Method and the Alternative Simplified Credit (ASC) to ensure the methodology that generates the largest excess QRE amount—and thus the maximum claimable credit under the 24% and 15% tiers—is selected.
- Vigilant Carryover Tracking: The recent statutory transition from a 15-year carryforward period (for credits pre-2022) to a 10-year period (for credits post-2021) requires detailed, vintage-specific tracking to prevent the inadvertent expiration and forfeiture of accumulated credit value.
Mandatory Administrative Sequencing: For qualifying small businesses (under 150 employees) seeking the crucial 75% cash refund, the application timeline involving the ACA is non-negotiable. Securing the Certificate of Qualification from the ACA must precede the filing of the original tax return with the DOR, making administrative coordination the primary determinant of whether a credit remains non-refundable or becomes monetized cash flow.
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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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