Shared Eligible Expenses: The Core Definition
"Shared Eligible Expenses" in the context of the Arizona R&D tax credit refers to the aggregation of Qualified Research Expenses (QREs) across a unitary controlled group to calculate a single group credit, which is then allocated back to members based on their proportionate contribution to the expenses.
This mechanism prevents "double-dipping" on intercompany transactions and ensures that the credit reflects the true economic research activity of the entire business enterprise operating within Arizona.
Detailed Analysis: Context & Application
To understand Shared Eligible Expenses, one must look at Arizona's conformity to the Internal Revenue Code (IRC) § 41(f). Arizona law treats a "controlled group" of corporations as a single taxpayer for the purpose of identifying eligible research expenses and calculating the credit amount.
The Unitary Concept
Arizona requires unitary businesses to file combined returns. In this environment, "sharing" expenses doesn't mean simply splitting a bill. It means:
- Aggregation: All QREs (Wages, Supplies, Contract Research) incurred by Member A and Member B are pooled together.
- Elimination: Intercompany transactions (e.g., Member A paying Member B for research) are eliminated. The expense is recognized only when it is paid to an external party (like an employee's wage).
- Calculation: The base amount and the fixed-base percentage are calculated at the group level.
Why it Matters
Without these rules, companies could artificially inflate expenses by paying each other for the same research activities. The "Shared" framework forces a calculation based on the economic reality of the group's external spending.
Impact of Aggregation
This chart illustrates how aggregation (sharing) affects the calculated Base Amount compared to standalone filing (hypothetical scenario).
Interactive Scenario: Unitary Group Allocation
Adjust the expenses below for a hypothetical unitary group consisting of TechCorp (Company A) and SalesCo (Company B). See how the Arizona R&D Credit is calculated at the group level and then "shared" (allocated) back.
1 Enter Qualified Expenses (QREs)
Company A (TechCorp)
Company B (SalesCo)
Note: We assume a fixed Base Amount of 50% of current year QREs for this simplified simulation. In reality, the Base Amount is a complex historical calculation.
2 Allocation Results
Local State Revenue Office Guidance
According to the instructions for Form 308 (Credit for Increased Research Activities):
"If two or more taxpayers are members of a unitary group... the unitary group is considered a single taxpayer... The credit is calculated for the entire group and then allocated to each member based on their proportionate share of the expenses."
This explicitly defines the "Shared" nature as a proportionate allocation derived from the aggregate calculation.
This statute establishes the credit for increased research activities for corporations. Subsection D specifically references the Internal Revenue Code § 41, mandating that Arizona conforms to federal interpretations of what constitutes a "Controlled Group" and how expenses must be aggregated.
When expenses are shared via contract (e.g., Company A hires Company B):
- Within Unitary Group: The intercompany payment is ignored. The "Eligible Expense" is the wage/supply cost incurred by the performing member (Company B).
- Third Party: If Company A hires a 3rd party, only 65% of the expense is eligible (per IRC § 41(b)(3)).
The Allocation of Shared Eligible Expenses Under the Arizona R&D Tax Credit (A.R.S. § 43-1168)
Shared Eligible Expenses represent Qualified Research Expenses (QREs) or Basic Research Payments (BRPs) jointly incurred by multiple related or partnered entities. Arizona mandates that taxpayers sharing these expenses must claim a pro rata allocation of the resulting state tax credit.
This mechanism ensures that the benefits of the Credit for Increased Research Activities are accurately and proportionally distributed to the corporate partners, S-corporation shareholders, or other co-venturers who funded the research conducted within Arizona.
II. Statutory and Regulatory Context of Arizona R&D Credit Allocation
The Arizona Credit for Increased Research Activities is established under Arizona Revised Statutes (A.R.S.) § 43-1168, providing a corporate income tax credit for qualified expenditures.1 This statute forms the basis for defining and allocating Shared Eligible Expenses, modifying federal standards to align with state policy goals.
A. A.R.S. § 43-1168: Adoption and Modification of IRC § 41
Arizona’s statutory framework is fundamentally linked to the federal R&D tax credit provisions codified in Internal Revenue Code (IRC) § 41.1 The Arizona law adopts the federal definitions for “qualified research” and “qualified research expenses” (QREs), which typically include expenditures for wages, supplies, and contract research involved in research activities.3
However, A.R.S. § 43-1168 implements two crucial exceptions that define the scope of the Arizona credit:
- Arizona Research Requirement: For state credit purposes, qualified research explicitly includes only research conducted in Arizona.1 This geographically restricted base requires taxpayers, especially those operating multi-state enterprises, to meticulously track and substantiate QREs and basic research payments (BRPs) specifically incurred within the state.
- Pro Rata Sharing Mandate: The statute explicitly addresses joint research endeavors, stating that if two or more corporate taxpayers, including corporate partners in a partnership, share in the eligible expenses, “each taxpayer is eligible to receive a proportionate share of the credit”.2 This mandate necessitates detailed administrative guidance from the Arizona Department of Revenue (ADOR) regarding calculation and distribution.
B. Core Concepts: QREs, Computation, and the Base Period
The credit calculation is based on the excess of current-year Arizona QREs and BRPs over a statutorily defined base amount, as determined by IRC § 41(c) and § 41(e)(1)(A).2 The state offers generous rates: for taxable years before December 31, 2030, the credit is 24% of the excess amount up to $2.5 million, plus 15% of any amount exceeding $2.5 million.2
The Importance of Arizona Base Period Complexity
Although Arizona adopts the federal methodology, the geographical restriction to Arizona-only research expenses introduces significant computational complexity, particularly in determining the base amount. Since the base amount is historically tied to prior year research expenditures, multi-state taxpayers must perform a rigorous analysis to calculate a localized Arizona base period amount, including only research conducted in the state during the statutory base years, rather than simply transposing their federal base figures. This necessity for state-specific historical analysis is compounded for shared entities that may have undergone structural changes over the base period.
Alternative Simplified Credit (ASC) Election
Arizona allows taxpayers to compute the Credit for Increased Research Activities using either the regular method or the Alternative Simplified Credit (ASC) method.5 The ASC method simplifies the base calculation (using a percentage of the prior three years’ gross receipts), offering an administrative benefit, particularly for smaller firms or entities new to R&D. However, the requirement to track and limit QREs solely to those incurred in Arizona remains regardless of the computation method elected.7
III. Shared Eligible Expenses: Defining the Pro Rata Share for Flow-Through Entities
The clearest application of the “Shared Eligible Expenses” rule is found within flow-through entities, specifically partnerships and S-corporations. These structures generate the credit at the entity level but must distribute the resulting benefit to their partners or shareholders.
A. The Pro Rata Principle and Pass-Through Requirements
For flow-through entities, the mandate that each recipient receive a “proportionate share of the credit” is tied directly to their economic interest in the entity.5
- Partnerships: A partnership must compute the R&D credit using Form 308 and pass the credit through to its partners.5 The credit distribution is typically determined by the partner’s share of profits, losses, or capital, as defined in the partnership agreement. Corporate partners claim their share on Form 308, while individual partners use Form 308-I.5
- S-Corporations: An S-Corporation has a choice: it may claim the credit against any corporate-level tax (e.g., Unrelated Business Taxable Income or built-in gains tax), or it can make an irrevocable election to pass the credit through to its shareholders. If passed through, the allocation is generally based on stock ownership percentages.5
B. The Mechanics of Proportionate Share (ADOR Compliance)
ADOR administrative guidance, particularly the instructions for Form 308, clarifies the precise calculation methodology for flow-through entities. The allocation is applied to the total calculated credit amount, not the underlying QREs.8
The procedural sequence is as follows: The partnership or S-Corporation calculates the total allowable current-year credit (e.g., the amount determined on Line 29 of Form 308).8 This total credit is then multiplied by the partner’s or shareholder’s pre-determined proportionate share percentage to arrive at the allocable credit amount.8
This method provides administrative simplicity compared to strict federal rules, which would typically require allocating QREs first, then having each member calculate their own credit. By allocating the final, computed credit, Arizona aligns the tax benefit directly with the entity’s economic structure, ensuring the tax credit flows to the entities bearing the economic risk of the research.
Taxpayers must ensure that the “proportionate share” used for the credit allocation aligns with the economic reality of the venture. If a partnership agreement incorporates special allocations of the R&D expenses or the resulting tax credits, the taxpayer must demonstrate that these allocations possess substantial economic effect under federal tax principles. Deviations from general profit/loss sharing that lack economic justification may lead to departmental scrutiny regarding the legitimacy of the claimed pro rata share.
Table: Pass-Through R&D Credit Allocation Framework
| Entity Type | Entity Filing Form | Allocation Basis (Pro Rata Share) | Recipient Claim Form |
| Partnership | Form 308 | Proportionate Share of Credit (based on economic allocation) | Form 308 (Corporate) or 308-I (Individual) |
| S-Corporation | Form 308 | Proportionate Share of Credit (based on ownership/election) | Form 308 (Corporate) or 308-I (Individual) |
IV. Specialized Allocation Rules: Controlled Groups and Affiliated Taxpayers
For corporate structures, particularly those involving related entities, the definition of a “shared expense” taxpayer changes significantly depending on the Arizona filing method.
A. The Federal Controlled Group Precedent
Under IRC § 41(f), all trades or businesses under common control, including controlled groups of corporations, must be treated as a single taxpayer for R&D credit calculation purposes.9 This federal standard requires all QREs and base period amounts across the group to be aggregated to compute a single “group credit”.9 Federally, this result is then allocated back to the corporate members, usually in proportion to their contribution to the aggregate QREs. Group membership is generally determined as of December 31 of the taxable year.10
B. The Arizona Unitary/Affiliated Group Override
Arizona administrative guidance clarifies how the state treats related corporations that file together, creating a critical distinction from the federal allocation requirement.
ADOR instructions specify that if two or more members of an Arizona unitary group or an affiliated group incur qualifying expenses and file a combined or consolidated Arizona return (Form 120), these individual members are not considered separate taxpayers.1 Instead, the entire group is treated as a single taxpayer.1
This administrative interpretation significantly simplifies compliance for consolidated groups in Arizona. When a combined return is filed, the group calculates one unified R&D credit based on the combined Arizona QREs and base amount. The resulting credit is claimed against the group’s total Arizona tax liability, and the statutory requirement for applying a “pro rata share” to multiple corporate taxpayers becomes unnecessary for internal allocation within the group.1
Bifurcation of Related Entities
It is essential for multi-state practitioners to determine if a federally controlled group meets Arizona’s definition of a “unitary” business. If members of a federally controlled group conducting Arizona R&D are excluded from the Arizona combined return (for instance, if they do not meet the state’s unitary test or fail to make a required election), those entities are treated as separate corporate taxpayers. In such a scenario, if these separate corporations jointly incurred eligible expenses, the statutory “pro rata share” rule applies, necessitating a documented agreement for how the credit benefit will be distributed among the separate corporate taxpayers, similar to a partnership structure.
V. Illustrative Example: Application of Shared Eligible Expenses Rules
The following case study illustrates the required methodology for allocating the Arizona R&D credit among corporate partners, emphasizing the importance of applying the pro rata share to the calculated credit amount.
A. Case Study: Two Corporate Partners in a Limited Partnership (LP)
Scenario: BioCorp X (70% interest) and DataCorp Y (30% interest) establish AZ Research LP, a limited partnership, which incurs Qualified Research Expenses (QREs) entirely within Arizona.
| Metric | Amount ($) | Calculation Context |
| AZ Research LP Total AZ QREs (Current Year) | $5,000,000 | All research conducted in Arizona |
| AZ Research LP Base Amount (Historical AZ QREs) | $1,800,000 | Calculated using the federal regular method (A.R.S. standard) |
| Excess Research Expenses | $3,200,000 | $\$5,000,000 – \$1,800,000$ |
B. Step-by-Step Calculation of the Shared Credit
Step 1: Compute Total Entity Credit (A.R.S. § 43-1168)
The total excess qualified amount ($3,200,000) exceeds the statutory threshold of $2,500,000. The credit rate structure (for years before 2031) is applied:
- Credit on the first $\$2,500,000$ (24% rate): $\$2,500,000 \times 0.24 = \$600,000$
- Credit on the remainder (over $\$2,500,000$): $(\$3,200,000 – \$2,500,000) \times 0.15 = \$700,000 \times 0.15 = \$105,000$
- Total Entity Credit (Calculated by AZ Research LP on Form 308): $\$600,000 + \$105,000 = \$705,000$
Step 2: Apply Pro Rata Share of the Credit
AZ Research LP must allocate the total $\$705,000$ credit based on the documented partnership interests (70%/30%).
| Partner | Proportionate Share (Economic Interest) | Allocated Credit (Pro Rata Share) |
| BioCorp X | 70% | $\$705,000 \times 0.70 = \$493,500$ |
| DataCorp Y | 30% | $\$705,000 \times 0.30 = \$211,500$ |
| Total Allocated Credit | 100% | $\$705,000$ |
Step 3: Filing and Documentation
AZ Research LP files Form 308 and issues supporting schedules detailing the distribution.8 Both BioCorp X and DataCorp Y, being corporate partners, then attach Form 308 to their respective Arizona corporate tax returns to claim their allocated credit amounts.
C. Example Nuance: Basic Research Payments (BRPs)
Arizona also allows an additional nonrefundable credit amount for taxpayers making basic research payments to an Arizona university under the Board of Regents’ jurisdiction.2 This additional credit is equal to 10% of the excess BRPs over the qualified organization base period amount.2
If AZ Research LP incurred eligible BRPs, that resulting additional 10% credit amount is calculated by the LP and subsequently included in the total credit amount subject to the same 70%/30% pro rata allocation to ensure the proportionate distribution of all research-related tax benefits derived from the shared eligible expenses.8
VI. Regulatory Compliance and ADOR Documentation Requirements
Proper documentation and the use of correct forms are mandatory for taxpayers claiming credits based on shared eligible expenses, ensuring the claim can be validated by the Arizona Department of Revenue (ADOR).
A. Required Forms and Identification
The specific form utilized depends on both the entity generating the credit and the entity claiming the credit.5
- Credit Calculation and Distribution: C-corporations, S-corporations, partnerships, and exempt organizations with Unrelated Business Taxable Income (UBTI) must use Form 308 (Credit for Increased Research Activities) to calculate the credit and report its distribution.5
- Recipient Claim: Corporate recipients (C-corps, corporate partners) use Form 308 when filing their corporate income tax return. Individual taxpayers (individual partners or S-Corp shareholders) must use Form 308-I.5
- Identification Mandate: All returns, statements, and forms filed with the department must include a taxpayer identification number (TIN) or Employer Identification Number (EIN). Failure to include the appropriate identification may subject the taxpayer to penalties.7
B. Documentation and Allocation Transparency
For pass-through structures, the audit trail must clearly link the allocated credit back to the generating entity and substantiate the allocation percentage. The distributing entity (partnership or S-corporation) must provide documentation to the recipient detailing the credit amount and the specific percentage used for allocation.8 This percentage should be justified by the underlying legal documentation, such as the operative partnership agreement or corporate bylaws, that defines the recipient’s economic proportionate share of the venture.
C. The Refundable Credit Certification Process
Arizona offers both nonrefundable and partially refundable R&D tax credits.3 To claim the refundable component of the credit (generally available to small businesses with fewer than 150 full-time employees) resulting from shared eligible expenses, a preliminary certification process is required before filing the tax return.6
- Certification: The taxpayer must first receive certification from the Arizona Commerce Authority (ACA).11
- Approval: Subsequently, the taxpayer must obtain a Letter of Approval from the ADOR that certifies the specific amount of the credit the applicant is eligible to claim.11
If the shared expenses result in a refundable credit, the maximum refundable portion certified by the ADOR is also distributed to the partners or shareholders according to their respective pro rata shares of the total computed credit.8
Table: ADOR Compliance Checklist for Shared Expenses
| Compliance Requirement | Basis for Allocation/Claim | Mandatory Documentation/Form | Key Statutory Reference |
| Credit Calculation | Arizona-only QREs and BRPs | Completed Form 308 (Entity Level) | A.R.S. § 43-1168 1 |
| Allocation Basis (Flow-Through) | Proportionate economic share of the credit | Partnership/Operating Agreement; Form 308 Distribution Schedules | A.R.S. § 43-1168 5 |
| Unitary Group Treatment | Combined/Consolidated Filing Status | AZ Combined Tax Return (Form 120) | ADOR Administrative Guidance 1 |
| Refundable Credit Claim | ACA Certification and ADOR Approval Letter | Certification Letter from ACA; Letter of Approval from ADOR | A.R.S. § 41-1507 11 |
VII. Strategic Considerations and Conclusion
A. Coordination with the University Research Credit Cap
When shared eligible expenses include Basic Research Payments (BRPs) to Arizona universities, taxpayers must coordinate their claims due to a strict annual statewide limit. The combined total of the additional BRP credit allowed under A.R.S. §§ 43-1168 and 43-1074.01 cannot exceed $10,000,000 in any calendar year.2 Shared entities claiming this supplemental credit must verify the availability of the capped amount, as the allocation of the credit to partners/shareholders is based on the amount certified by the ADOR, which operates within this overall state fiscal limitation.
B. Key Compliance Risks
The determination of “Shared Eligible Expenses” hinges on accurately classifying the relationship between the research participants. Two major areas of risk emerge:
- Misclassification of Corporate Groups: Failure to properly identify and treat members of an Arizona unitary group as a single taxpayer can lead to inaccurate base period calculations and improper allocations. Conversely, if a controlled group files separate state returns, they must adhere to the more complex federal aggregation rules (IRC § 41(f)) using the Arizona-only QREs before applying the state’s pro rata share rule among themselves, a process that requires careful documentation.
- Disregard of Economic Substance: While ADOR accepts the application of the pro rata share to the calculated credit for flow-throughs, the underlying allocation percentage must reflect the true economic sharing arrangement of the research venture. If a partnership distributes the credit disproportionately without valid non-tax economic justification, the allocation could be challenged, resulting in the disallowance or reallocation of the claimed tax benefit.
C. Conclusion
The framework for Shared Eligible Expenses under A.R.S. § 43-1168 is highly effective in extending the Arizona R&D tax credit benefit to collaborative research structures. The law’s primary mechanism is the mandate for a pro rata share of the credit to be distributed to co-venturers.
For corporate taxpayers, the key differentiator is the filing status: unitary groups filing combined returns benefit from simplification, being treated as a single taxpayer. In contrast, partnerships and S-corporations must meticulously calculate the total Arizona credit and distribute the final credit amount according to the economic interests of their partners or shareholders, ensuring the proportionate share is well-documented and compliant with all ADOR filing requirements (Form 308 and Form 308-I). Successful compliance depends on rigorous documentation of Arizona-specific QREs and clear legal substantiation of the agreed-upon proportionate share.
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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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