Arizona Revised Statutes § 43-1074.01
Research & Development Tax Credit Refundability Explorer
"Provides a mechanism for qualified small businesses to convert non-refundable R&D tax credits into an immediate refundable cash benefit at 75% value."
Deep Dive: The Meaning of § 43-1074.01
While Arizona generally offers a non-refundable R&D tax credit (which can be carried forward for 15 years), A.R.S. § 43-1074.01 creates a critical exception for small businesses. It acknowledges that many innovative startups (pre-revenue or pre-profit) cannot use a tax credit because they have no tax liability to offset.
This statute allows these entities to elect to receive a refund of 75% of the excess credit amount, effectively trading 25% of the face value for immediate liquidity.
Key Provisions (Click to Expand)
Strategic Analysis: To Refund or Carry Forward?
This chart illustrates the financial decision. A startup with $100k in credits must choose between $100k in future tax offsets (uncertain timing) or $75k in cash today (certainty).
Eligibility Snapshot
- ● Fewer than 150 Employees
- ● ACA Certification Obtained
- ● Exceeds Tax Liability
Did You Know?
The refund is subject to an annual aggregate cap managed by the Arizona Commerce Authority. It is effectively "first-come, first-served."
Refund Estimator
Enter your estimated Arizona R&D Credits to see the impact of § 43-1074.01. Note: This is a simplified estimation for educational purposes.
Enter 0 if pre-revenue or in a loss position.
Projected Outcome
Opportunity Cost: By electing the refund, you forfeit $0 in credits that could have been carried forward.
Compliance Workflow
1. Calculate Credit
Determine total R&D expenses and basic credit amount.
2. ACA Application
Apply to Arizona Commerce Authority for Certificate of Qualification.
3. Receive Certificate
ACA issues certificate subject to the annual cap.
4. File Tax Return
Attach Form 308 & 308-I with ACA Certificate to tax return.
5. ADOR Processes Refund
Revenue department issues check for 75% of excess.
Official Guidance Summary
Guidance from the Arizona Department of Revenue (ADOR) and the Arizona Commerce Authority (ACA) highlights specific procedural requirements to ensure the refund is not denied.
Form 308-I Requirement
Taxpayers must complete Arizona Form 308-I specifically to figure the refundable credit. This form reconciles the ACA certificate amount with the actual tax return data.
Non-Refundable Offset First
The law requires that the credit first be applied to any tax liability (plus the $50 minimum tax for Corps) before calculating the excess available for refund.
The "First-Come" Cap
The ACA has a statutory limit on how much refundable credit they can certify annually. Early application in the calendar year is critical.
Audit Risk
Receiving a refund does not preclude an audit. The ADOR retains the right to audit the underlying R&D expenses (Section 41 IRC conformity) even after the refund is paid.
Example Scenario
Context: "TechSolar AZ," a solar panel startup, spent $1,000,000 on qualified research in Maricopa County.
The Calculation: Assuming a simplified calculation, they generate a $100,000 Arizona R&D tax credit.
The Situation: TechSolar is pre-revenue and has $0 in corporate income tax liability.
The Outcome under § 43-1074.01:
1. Excess Credit: $100,000.
2. TechSolar applies to ACA and gets certified.
3. TechSolar elects the refund on their return.
4. Refund Amount: $100,000 × 75% = $75,000 check.
5. Forfeited: The remaining $25,000 is lost forever (cannot be carried forward).
Expert Analysis of Arizona Revised Statutes § 43-1074.01: The R&D Tax Credit for Increased Research Activities
Arizona Revised Statutes § 43-1074.01 establishes a nonrefundable individual income tax credit for increasing qualified research and development activities conducted exclusively within the state.1
The credit is calculated using a tiered, incremental method, currently offering 24% on the first $2.5 million of excess qualified expenses and 15% on the remainder, and includes a critical provision for a partial refund (up to 75%) for qualifying small businesses, subject to state caps and mandatory pre-approval by the Arizona Commerce Authority.3
I. Legal Foundation and Scope of the Credit for Increased Research Activities
The Arizona Credit for Increased Research Activities (R&D Tax Credit) is a nonrefundable individual income tax credit designed to promote innovation within the state economy. While enacted in 1999 for individuals, the incentive is structurally tied to federal law, requiring taxpayers to understand both state mandates and federal concepts.4
A. Statutory Authority and Federal Nexus
The foundation of the Arizona R&D credit relies on the definitions and computational methodologies established under Internal Revenue Code (IRC) § 41, but with several critical state-level modifications. The amount of the credit is based on the excess of qualified research expenses (QREs) for the taxable year over the base amount, as defined in IRC § 41(c).1 This federal nexus means that the determination of what constitutes “qualified research” is guided by federal law, although the expenditures must be sourced within Arizona.2
A key stability feature of the Arizona statute is that the termination provisions (sunset clauses) of IRC § 41 do not apply to the state credit.2 This statutory assurance reinforces the state’s long-term commitment to maintaining the incentive. Furthermore, the statute confirms that the credit is structured to accommodate pass-through entities. If two or more taxpayers, including partners in a partnership or shareholders of an S corporation, share in the eligible expenses, each is entitled to receive a proportionate share of the credit.2 The credit is established in the year the activities are performed and the expenses are incurred, consistent with the taxpayer’s established method of accounting.7
B. Arizona-Specific Qualification Requirements and Exclusions
Arizona imposes a crucial geographical restriction on the scope of eligible activities. Qualified research, for purposes of this credit, includes only research conducted in this state.1 This requirement applies to all QREs, including research conducted at a university in the state and paid for by the taxpayer. This “Arizona-only” sourcing mandate for QREs means that multistate taxpayers face a heightened burden of proof to geographically isolate eligible expenditures, particularly employee wages, which must be demonstrably linked to research performed within state borders.
In adherence to federal law, Arizona also incorporates the exclusion for funded research. Qualified research under IRC § 41 does not include any research to the extent funded by any grant, contract, or otherwise by another person or governmental entity.7
C. State Treatment of Federal Tax Interaction (ADOR Guidance)
The Arizona Department of Revenue (ADOR) guidance, particularly related to individual income tax Form 308-I, clarifies unique interactions regarding federal tax computations. These provisions ensure that the Arizona incentive is maximized without unnecessary state tax consequences 2:
- No Reduction of Arizona Credit: If a taxpayer elects to claim a reduced federal credit for increased research expenses, Arizona statutes do not require the taxpayer to reduce the corresponding Arizona credit for increased research activities. This provision is highly favorable to taxpayers.2
- No Required Income Addition: Unlike some jurisdictions, Arizona statutes do not require the taxpayer to make an addition to Arizona gross income for the amount of qualified research expenses equal to the allowable Arizona credit amount.2 This avoids a state-level income tax consequence that often reduces the net value of credits in other states, thereby maximizing the incentive’s effective value.
- Deduction Adjustments: If a taxpayer reduces the amount of the deduction for qualified research activities in the computation of federal adjusted gross income, Arizona statutes do not allow the taxpayer to take a subtraction from Arizona gross income for the expense reduction amount. Similarly, if the federal asset basis of capitalized research expenses is adjusted, Arizona does not allow a subtraction from gross income for additional amortization.2
II. Core Calculation Mechanics: The Tiered Incremental Method
Arizona’s calculation mechanics are distinguished by the mandate to use the federal regular credit method, a calculation requiring a comparison of current-year QREs against a historically derived base amount, and the application of highly attractive tiered credit rates.
A. Calculation Methodology Mandate: Regular Credit Required
The state’s compliance directives are explicit regarding the required calculation method. ADOR guidance establishes that the allowable credit is computed using the federal regular credit computation method.2 This means that the determination of the credit is based on the excess of current Arizona QREs over a fixed-base amount.5
A crucial compliance divergence exists in that taxpayers cannot use the federal alternative credit computation method (ASC) for the Arizona credit.2 This creates a compliance trap for taxpayers who may elect the ASC for federal purposes, requiring them to run two parallel sets of R&D tax calculations.
The base amount determination follows IRC § 41(c) definitions, requiring the calculation of a fixed-base percentage multiplied by the average Arizona gross receipts for the prior four years.3 This calculated base amount is subject to a minimum floor, requiring the base amount to be the greater of the calculated figure or 50% of the current year’s Arizona QREs.3 This minimum floor ensures that only truly incremental growth in R&D spending beyond 50% of current activity is credited.
B. The Arizona Tiered Rate Structure (Through 2030)
Arizona incentivizes scaling research by providing tiered rates that are higher than the standard federal credit rates. The credit is applied to the calculated Excess QREs.3
The current rate structure, applicable through the 2030 tax year, provides a powerful incentive for the first $2.5 million of excess spending 4:
- Tier 1 (High Rate): 24% of the amount of excess QREs that do not exceed the $2,500,000 threshold.2
- Tier 2 (Marginal Rate): 15% of the amount of excess QREs exceeding $2,500,000.2
If the allowable expenses do not exceed $2,500,000, the allowable credit is 24% of this amount. If the allowable expenses exceed $2,500,000, the allowable credit amount is $600,000 (which is 24% of $2.5 million) plus 15% of the amount of expenses over $2,500,000.2 This design specifically targets and maximizes the incentive for companies to achieve a minimum of $2.5 million in incremental R&D spending. For tax years 2031 and thereafter, the rates are scheduled to decrease to 20% and 11%, respectively.4
III. Administrative Compliance and Regulatory Framework (ADOR and ACA)
The administration of the Arizona R&D credit, particularly the refundable component, involves mandatory compliance steps with two state agencies: the Arizona Commerce Authority (ACA) and the Arizona Department of Revenue (ADOR).
A. The Arizona Commerce Authority (ACA) Certification Requirement
The ACA plays a critical role as the agency responsible for qualifying taxpayers for the refund component of the R&D credit. To qualify for a refund, the taxpayer must apply to the ACA for a Certificate of Qualification pursuant to ARS § 41-1507.1 The application must be submitted and the certificate received prior to filing the income tax return with ADOR.2
The ACA application requires specific data points, including the taxpayer’s business description, the research activities conducted, and, most importantly, the number of full-time employees on the payroll on the last day of the taxable year. Only taxpayers employing fewer than 150 full-time employees qualify for the refund.10 For pass-through entities, the S Corporation or partnership must apply for the Certificate of Qualification on behalf of its partners or shareholders.2
Crucially, the refundable program operates on a “first come, first served” basis, according to the date of application.9 Since the statewide refund pool is capped annually, the proactive timing of the ACA application is essential for securing the limited funds.
B. The Arizona Department of Revenue (ADOR) Role
ADOR is responsible for the final tax processing, managing the nonrefundable portion of the credit against tax liability, and issuing approved refunds. The taxpayer must submit a copy of the ACA’s Certificate of Qualification to ADOR along with the income tax return (Form 308-I or 308).1
The refund, once approved by the ACA and certified by ADOR, is paid in the manner prescribed by ARS § 42-1118 and remains subject to state setoff under ARS § 42-1122.1 While the ACA certifies eligibility for the refund, ADOR retains the authority to audit the underlying QREs and base amount calculation, necessitating strict adherence to ADOR’s technical instructions.
IV. Detailed Analysis of the Refundable Credit (A.R.S. § 41-1507)
The partial refundable credit provision, established under ARS § 41-1507, is designed to assist small businesses that have insufficient tax liability to fully utilize their accrued R&D credits, effectively converting a portion of the tax asset into working capital.
A. Eligibility and Refund Calculation Mechanics
Eligibility for the refundable portion hinges entirely on the taxpayer qualifying as a small business, defined as employing fewer than 150 full-time employees worldwide as of the last day of the tax year.4
The refundable amount is calculated based on the excess credit, which is the current year’s allowable credit under ARS § 43-1074.01 that exceeds the taxpayer’s current year Arizona income tax liability.1 The refund amount is limited to the lesser of:
- Seventy-five percent (75%) of the excess credit.1
- The maximum refund amount indicated on the ACA’s Certificate of Qualification.2
The election to claim the refundable credit must be made when the taxpayer originally files their tax return to claim the current year’s credit.2 A non-refundable processing fee equal to 1% of the company’s tax credit being refunded must also be remitted.9
B. Annual and Per-Taxpayer Limitations
The utility of the refundable credit is significantly restricted by statewide and individual limitations:
- Statewide Annual Cap: The ACA may approve refunds up to a total of $5 million in any calendar year.3 Refunds are allowed on a first-come, first-served basis, creating intense competition for the limited pool of funds.10
- Per-Taxpayer Cap: The maximum refund amount for any single taxpayer is strictly limited to $100,000 in a single tax year.9
C. Strategic Carryover Provisions
The decision to claim the refund must be strategically evaluated against the value of the credit carryforward. The state provides for the carryover of unused nonrefundable credit amounts. For taxable years beginning from and after December 31, 2021, the unused credit may be carried forward for the next ten consecutive taxable years.2
A critical trade-off exists: if a taxpayer receives a refund of 75% of the excess credit, they do not have any excess amount to carry forward for that refunded portion.2 For a high-growth company projecting large future tax liabilities, maximizing the credit carryforward over 10 years may be more economically advantageous than accepting the immediate, capped cash refund. This necessity to balance immediate liquidity against long-term tax mitigation defines a key financial planning decision for qualifying small businesses.
V. Additional University Research Credit
Arizona provides an additional incentive for taxpayers who engage in basic research through collaborations with public universities, further broadening the scope of R&D support.
This is an additional 10% nonrefundable income tax credit specifically for qualifying basic research payments made during the taxable year to a university under the jurisdiction of the Arizona Board of Regents (Arizona State University, Northern Arizona University, and the University of Arizona).13
The credit is computed as 10% of the amount by which the “basic research payments” exceed the taxpayer’s “qualified organization base period amount” (calculated using the methodology of IRC § 41(e)).13
Similar to the general R&D credit, this additional university credit requires pre-qualification. The taxpayer must first receive certification from the ACA pursuant to ARS § 41-1507.01. After ACA certification, the taxpayer must then request final approval from ADOR to receive a Letter of Approval certifying the eligible credit amount.13 The administration of this credit is subject to a distinct, combined annual limitation for individual and corporate taxpayers: ADOR cannot approve more than $10 million in total university R&D credits in a calendar year.13
VI. Practical Application: Detailed Calculation Example
This example demonstrates the application of the regular credit method, the tiered rates, and the subsequent determination of the refundable portion for a qualifying small business.
Scenario Parameters
A small business (fewer than 150 employees) incurred the following Arizona-sourced expenses for the current tax year:
| Metric | Value |
| Current Year Arizona QREs ($\text{QRE}_{C}$) | $4,500,000 |
| Average 4-Year Arizona Gross Receipts ($\text{Avg GR}$) | $15,000,000 |
| Fixed-Base Percentage ($\text{FBP}$) | 4% |
| Current Year Arizona Tax Liability ($\text{T}_{L}$) | $200,000 |
Step-by-Step R&D Credit Calculation
1. Calculate the Base Amount ($\text{BA}$)
The base amount is calculated as the greater of the fixed-base calculation or 50% of current QREs 3:
- Fixed-Base Calculation: $0.04 \times \$15,000,000 = \$600,000$
- 50% QRE Floor: $0.50 \times \$4,500,000 = \$2,250,000$
The Base Amount ($\text{BA}$) is $\mathbf{\$2,250,000}$ (the minimum floor).3 This emphasizes that the minimum 50% floor substantially impacts the credit by setting a high benchmark for incremental spending.
2. Calculate Excess Qualified Research Expenses (Excess QREs)
$$\text{Excess QREs} = \text{QRE}_{C} – \text{BA}$$
$$\text{Excess QREs} = \$4,500,000 – \$2,250,000 = \mathbf{\$2,250,000}$$
3. Calculate Total Nonrefundable Credit
Since the Excess QREs of $2,250,000 fall entirely within the Tier 1 threshold of $2,500,000 2:
$$\text{Total Credit} = 24\% \times \$2,250,000 = \mathbf{\$540,000}$$
4. Determine Excess Credit and Refundable Portion
The credit is first applied against the current year’s tax liability ($\text{T}_{L} = \$200,000$).
- Credit Used: $200,000
- Excess Credit (Available for Refund/Carryover): $\$540,000 – \$200,000 = \mathbf{\$340,000}$.2
5. Determine Actual Refund Claimed
The maximum potential refund is 75% of the Excess Credit 1:
- Potential Refund: $0.75 \times \$340,000 = \$255,000$.
- Application of Per-Taxpayer Cap: The potential refund ($255,000) exceeds the statutory per-taxpayer cap of $100,000.9
The Actual Refund Claimed (if certified by ACA) is $\mathbf{\$100,000}$.
6. Calculate Credit Carryforward
The amount of credit carried forward is the remaining Excess Credit not utilized as a refund 2:
- Credit Carryforward: $\$340,000 – \$100,000 = \mathbf{\$240,000}$
The taxpayer gains $100,000 in immediate cash (if certified) and retains $240,000 of nonrefundable credit to be carried forward for up to 10 consecutive taxable years.3
VII. Synthesis and Conclusion
The Arizona Revised Statutes § 43-1074.01 establishes a high-value, yet administratively complex, incentive for R&D spending within the state. The effectiveness of this law hinges on the strategic management of its technical requirements and procedural timelines.
Strategic and Financial Conclusions
- High-Value Tiered Structure: The 24% Tier 1 rate on the first $2.5 million of excess QREs provides one of the strongest state R&D incentives nationally.4 This structure encourages companies to push their incremental R&D investment to at least the Tier 1 maximum to maximize the premium rate.
- Compliance Divergence is Mandatory: Taxpayers must recognize and strictly adhere to the mandatory use of the Regular Credit computation method, even if they utilize the simpler ASC method for federal reporting. Failure to maintain the four-year gross receipts data and the fixed-base percentage calculation for state purposes will result in the denial of the credit during examination.2
- Liquidity Strategy dictated by ACA: The refundable portion, while capped at $100,000 per taxpayer and limited by a $5 million statewide cap 9, offers crucial non-dilutive capital for small businesses. However, because refunds are processed on a first-come, first-served basis, successful realization of the cash refund depends entirely on prompt, early application to the ACA following the close of the tax year.
- Optimal Credit Utilization: Companies must strategically weigh the immediate benefit of the $100,000 cash refund against the long-term value of the nonrefundable credit carryforward. In the example provided, the taxpayer effectively forfeited the potential to carry forward $375,000 (75% of the excess credit) in exchange for securing $100,000 immediately, highlighting a key capital management decision.2
Long-Term Stability: The statutory provision explicitly preventing the application of federal R&D credit termination clauses to the Arizona credit (ARS § 43-1074.01) ensures the program’s continuity, providing certainty necessary for multi-year capital investment planning.2
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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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