Defining and Maximizing Qualified Wages under the Arkansas R&D Tax Credit: A Senior Tax Counsel’s Guide to Compliance

Qualified Wages (QW) in Arkansas are taxable salaries and usual fringe benefits paid to full-time employees, including contractual staff, who perform qualified research services within the state. These services must directly relate to the actual conduct, direct supervision, or direct support of an approved research and development project, forming the almost exclusive basis for the state’s R&D tax credit.

The Arkansas Research and Development (R&D) Tax Credit program is structured uniquely, concentrating the vast majority of eligible expenditures on labor costs. Administered primarily through the Arkansas Economic Development Commission (AEDC) and the Arkansas Science and Technology Authority (ASTA) 1, the program provides incentives for specific research activities, including university-based research, in-house research by mature firms, and R&D conducted by younger, “targeted” firms.2 Unlike the federal R&D tax credit (Internal Revenue Code (IRC) § 41), which recognizes a broader array of Qualified Research Expenditures (QREs), Arkansas mandates a significantly narrower QRE definition, primarily focused on salaries.1 Therefore, the successful monetization of this credit relies fundamentally on the precise definition, rigorous allocation, and meticulous documentation of Qualified Wages.

I. Statutory Framework: Arkansas Code and the Legal Foundation of Qualified Wages

A. Legal Authority and Program Scope

The foundation of the Arkansas R&D Tax Credit is rooted in state legislation, primarily Ark. Code Ann. § 15-4-2708 and associated sections within Title 26.1 The state legislature designed the credit to bolster the local technology sector by offering incentives specifically for activities such as university-based research, in-house programs for mature companies, and strategic R&D initiatives undertaken by start-up, technology-based enterprises.2

B. Statutory Definition of Qualified Wages and Compensation

Qualified Wages (QW) are statutorily defined as taxable wages paid to an employee for executing qualified services.3 This definition is broadened to ensure that the full cost of labor is recognized by explicitly including taxable wages and usual fringe benefits for eligible personnel.1

The personnel whose wages may qualify fall into two categories: full-time permanent employees or a “contractual employee” as defined in the Act.2 The research must be conducted in Arkansas.5

The inclusion of the contractual employee category warrants careful attention from tax planners. Federal regulations typically treat payments to non-employees (i.e., independent contractors or 1099 workers) as contract research, which is only eligible for 65% of the expenditure base. Arkansas’s framework offers a compliance advantage by allowing 100% of the qualified taxable wages and benefits paid to a properly defined contractual employee to be included in the QW calculation.2 For companies requiring specialized, high-skill labor for R&D projects, structuring these arrangements to meet the criteria for a “contractual employee” under the Act maximizes the QW base, offering greater financial flexibility and a higher eligible expenditure rate compared to the federal limitation. This provision incentivizes businesses to integrate specialized labor directly into their qualified research programs conducted within the state.

II. The Criteria for Qualified Services: Analyzing the Three-Part Test and Administrative Exclusions

The determination of QW is not based merely on an employee’s job title, but strictly on the nature of the qualified services performed. These services must be tied to “qualified research,” which itself must satisfy fundamental tests: the activity must aim to discover technological information, the application must be intended for a new or improved business component, and it must involve a process of experimentation.2

A. The Three Pillars of Qualified Services

The qualified services are categorized under three distinct pillars, all of which must relate to research conducted in Arkansas 5:

1. Engaging in the Actual Conduct of Qualified Research: This involves the hands-on execution of the experimental process, including empirical testing, data collection, and direct technical work performed by researchers, engineers, and scientists.2
2. Engaging in the Direct Supervision of Qualified Research: This category is limited to immediate supervision (first-line management) of qualified research personnel.2 Wages for a manager whose primary duty is technical oversight of the experiment (e.g., a laboratory manager or a lead engineer overseeing daily technical tasks) qualify. However, compensation for high-level executives whose duties involve general corporate strategy or administrative oversight, even if the strategy relates to R&D, is generally excluded unless they also actively engage in the actual conduct of research.
3. Engaging in the Direct Support of Research Activities: This covers services that are integral and proximate to the research process. Examples include technicians who maintain specialized R&D equipment, employees who prepare materials necessary for the experiment, or staff responsible for direct, real-time data input related to the testing.2

B. Explicit Statutory Exclusions: The Indirect Services Rule

Crucially, administrative rules explicitly narrow the scope of direct support. Direct support does not include general administrative services or other services only indirectly of benefit to the research activity.2

The most frequent area of compliance risk involves the misallocation of time for supervisory or support personnel. Time spent by an R&D supervisor on general human resources functions, corporate budgeting, or routine facility maintenance—as opposed to maintaining a specific piece of specialized R&D equipment—must be segregated and excluded from QW calculations. These activities are deemed general administrative services and are only indirectly beneficial, thus failing the qualified services test.

The strict definition of qualified services and the express exclusion of “indirect” activities impose a high burden on taxpayers to accurately segregate employee time. It is impossible to accurately demonstrate, for example, that a design engineer’s 75% allocated time meets the standard for actual conduct and not general administrative oversight without robust data. Therefore, while state law does not prescribe a specific methodology like the federal “80 percent rule” often referenced for allocation 6, the requirement to substantiate eligibility based on these detailed service definitions 2 makes contemporaneous time tracking an operational necessity for audit defense. Taxpayers cannot rely on post-facto estimations or generalized budget allocations; precise, real-time documentation is mandatory to link hours worked to the three defined qualified service categories.

III. Arkansas’s Narrower Scope: Qualified Wages as the Exclusive QRE Focus

A cornerstone of Arkansas’s R&D tax credit architecture is its significant deviation from the federal framework regarding eligible expenditures. Arkansas utilizes a substantially narrower definition of QREs compared to the standard set forth in IRC § 41.1

A. Arkansas’s Wages-Only Model

For the most common incentive—the In-House R&D credit—the state’s focus is clear: the credit is based almost entirely on qualified R&D salaries.2

This wages-only model results in several explicit exclusions that fundamentally constrain the credit base compared to the federal system:

• Supplies: Consumable supplies used in research do not qualify.2
• Equipment and Fixed Assets: The cost of purchasing machinery, equipment, land, or the construction or renovation of buildings is excluded from QREs.2 This is true even if the equipment is state-of-the-art and utilized solely for research.8
• Ordinary Expenses: Any ordinary and necessary expenses of conducting business are also explicitly excluded.4

This structural difference has profound implications for capital-intensive industries. Companies whose R&D programs depend heavily on non-labor expenditures—such as high volumes of raw materials, specialized prototyping supplies, or extensive server rental for technology testing—will find their overall eligible QRE base severely limited compared to jurisdictions that mirror the broader federal scope. Strategic tax planning in Arkansas must therefore pivot away from maximizing non-labor QREs and focus instead almost exclusively on optimizing the deployment, allocation, and documentation of labor costs to maximize the percentage of time allocated to qualified services. The inability to use non-labor costs as a buffer or compensating factor magnifies the importance of accurate QW compliance.

B. Arkansas QRE Components: State vs. Federal Comparison

The table below illustrates the critical differences in QRE inclusion between the federal standard and the primary Arkansas R&D credit programs.

Arkansas QRE Components: State vs. Federal Comparison

IV. State Administrative Oversight and Compliance Requirements

The Arkansas R&D tax credit is a discretionary incentive program, meaning eligibility is subject to approval by state agencies. This oversight mandates a strict, multi-step compliance process that requires upfront engagement and certification.

A. The Gatekeeping Role of AEDC and ASTA

The program is jointly administered by the Arkansas Economic Development Commission (AEDC) and the Arkansas Science and Technology Authority (ASTA). Taxpayers seeking the credit must submit an application to the AEDC to qualify for the income tax credit.2

Crucially, to ultimately claim the credit on a tax return, the taxpayer must demonstrate that both ASTA and the Department of Higher Education have formally approved the QRE—the Qualified Wages—as part of a qualified research program.8 Upon approval, ASTA issues a Certificate of Tax Credit, which must be attached to the taxpayer’s Arkansas return (e.g., Form AR1000TC).11

B. Project Plan Mandate and Term Limits

All applications for R&D tax credits, particularly those for targeted businesses, must include a detailed project plan.10 This plan must explicitly identify the intent of the project, the planned QW expenditures, the start and end dates, and an estimate of total project costs. The Commission’s decision to approve tax credit treatment for expenditures is based on this submitted research and development application and project plan.2

Furthermore, the term of financial incentive agreements under Ark. Code Ann. § 15-4-2708 is limited to five (5) years, beginning on the first day of the business’s tax year in which the agreement is signed.2

C. Documentation and Audit Defense

Taxpayers claiming the credit are obligated to retain records that are sufficiently usable and detailed to substantiate that the expenditures claimed—the Qualified Wages—meet all eligibility requirements.7

The documentation requirement extends beyond merely tracking hours. Given the nature of the approval process, the records must not only prove the time allocated to the three qualified services (actual conduct, direct supervision, or direct support) but must also explicitly link the claimed QW expenditures back to the scope and intent defined in the project plan approved by the AEDC and ASTA.2 If an employee’s work, even if technically related to R&D, falls outside the scope of the certified program, their wages may be disallowed because they lack the necessary prior state approval. Compliance thus requires strict alignment between the payroll accounting (QW hours) and the technical scope (ASTA-approved project plan).

V. Application of QW in Specific Arkansas R&D Credit Programs

Arkansas maintains multiple R&D incentive programs, each applying Qualified Wages using different calculation methodologies and incentive rates.

A. The In-House R&D Tax Credit (The 20% Incremental Program)

This program is designed as a discretionary tax incentive primarily for mature companies performing consistent, ongoing in-house R&D in the state.2

The calculation of this credit is based on growth. The credit is twenty percent (20%) of the incremental amount spent on qualified in-house research expenditures (QW) that exceeds the baseline established in the preceding year, over a maximum period of five years.2

The methodology for establishing the incremental base is statutory:

• For the first year of the program, credits are calculated based on eligible expenditures minus the initial baseline amount.4
• For succeeding years, the incremental amount is calculated as the difference between the current year’s research conducted in the state and the previous year’s research conducted in the state.4

This mechanism creates a direct financial incentive to increase Qualified Wages year-over-year. Taxpayers whose QW investment plateaus or decreases relative to the previous year will see a reduction in or elimination of the current year’s incremental credit.

B. Targeted Business, Strategic Value, and University Research Credits (The 33% Flat Rate Program)

This incentive structure offers a much higher credit rate and is aimed at strategic investments: younger, “targeted” firms, research and development in an area of strategic value (e.g., IT, biotechnology), or collaborations with Arkansas universities.1

The primary advantage of this category is the calculation basis: the credit is equal to 33% of QREs (QW) incurred each year for up to five years, and importantly, the calculation is based on the full QW amount, with no subtraction of a historical baseline required.1 This provides maximum upfront velocity for the credit.

A key limitation applies to research in an Area of Strategic Value: the maximum credit is capped at $50,000 per year.1

C. Strategic Choice and Prohibitions

Taxpayers must select the most advantageous program, as the 20% incremental in-house credit generally cannot be combined with other in-house R&D incentives authorized under Arkansas Code § 15-.4 This requires a forward-looking analysis of expected QW growth.

A new company with high QW but low historical spending might initially favor the 33% flat-rate program because it avoids the baseline calculation, providing immediate, maximal relief on the full QW base, even if limited by the $50,000 cap. Conversely, a large, stable firm projecting steady, significant growth in QW over the five-year period might find that the 20% incremental program—which is uncapped on the incremental amount—yields a higher net present value of credits over time, despite the baseline reduction. Careful financial modeling must project QW expenditures over the five-year term to determine the most beneficial path.

Arkansas R&D Tax Credit Program Comparison

VI. Practical Application and Calculation Example

To illustrate the critical role of QW allocation and the difference between the two main credit structures, consider the following scenario involving a mature firm, TechSolutions Inc., and its payroll for R&D activities conducted entirely in Arkansas.

A. Scenario Setup: TechSolutions Inc. QW Allocation

TechSolutions Inc. is an established technology firm with an approved R&D project plan certified by AEDC and ASTA. The relevant personnel and their total compensation (including taxable wages and usual fringe benefits) are:

• Dr. Smith (Lead Engineer): $150,000
• Ms. Jones (R&D Technician): $70,000
• Mr. Brown (First-Line Manager): $110,000
• Total QW Paid (Before Allocation): $330,000

B. Allocation Methodology: Documenting Qualified Services

TechSolutions utilizes a rigorous, contemporaneous time-tracking system tied to the certified project codes to ensure compliance with the three pillars of qualified services (Actual Conduct, Direct Supervision, Direct Support).

Note: The 50% exclusion for Mr. Brown represents time spent on non-qualified activities, such as general administrative tasks and HR meetings, which are only indirectly beneficial to research and must be excluded.4

C. Example Calculation: Applying QW to the Incremental 20% Credit

If TechSolutions Inc. is claiming the standard In-House R&D Tax Credit (20% Incremental Program):

1. Establish Baseline QW (Year 1): In the preceding tax year, the documented and certified QW (the baseline) was $200,000.
2. Determine Incremental QW (Year 2): The incremental QREs (QW) are calculated as the current year’s QW minus the preceding year’s baseline 4:
   
   $$\text{Incremental QW} = \$246,000 – \$200,000 = \$46,000$$
3. Final Credit Calculation: The credit is 20% of the incremental amount:
   
   $$\text{R\&D Credit} = 20\% \times \$46,000 = \$9,200$$

D. Example Calculation: Contrast with 33% Targeted Credit

If TechSolutions Inc. was a younger, targeted firm approved for the 33% Flat Rate Program, the calculation changes significantly, assuming the project is not limited by the Strategic Value Cap:

1. Credit Calculation: The credit is 33% of the total certified QREs (QW), with no baseline subtraction required 1:
   
   $$\text{R\&D Credit} = 33\% \times \$246,000 = \$81,180$$
2. Applying the Cap: If the specific project qualified as R&D in an Area of Strategic Value, the credit would be capped at the statutory maximum of $50,000 per year.1

This contrast highlights the strategic necessity of program selection. Although the 33% program offers a higher rate on the full QW amount, the potential $50,000 cap may render the 20% incremental credit more valuable over the long term for firms anticipating rapid growth in QW beyond the baseline, as the 20% credit is generally uncapped.

VII. Conclusion: Strategic Compliance for Arkansas R&D Tax Benefits

The Arkansas R&D tax credit provides a critical incentive for job growth and technological advancement within the state, but its value is inextricably linked to the precise definition and robust documentation of Qualified Wages.

The state’s decision to limit QREs almost exclusively to QW, excluding most supply and equipment costs, elevates labor allocation to the single most important component of the credit claim. Compliance success is predicated on rigorous adherence to two distinct requirements: the technical necessity of contemporaneous time tracking that separates direct qualified services from excluded administrative activities, and the administrative necessity of aligning those time allocations precisely with the scope and timeline of the pre-approved project plan certified by the AEDC and ASTA.

Taxpayers must proactively engage with state agencies to secure program approval and strategically model the benefits of the 20% incremental program versus the 33% flat-rate program over the mandated five-year term. Failure to obtain pre-certification or to meticulously document QW according to the three defined qualified service categories will result in significant risk of claim disallowance, regardless of the technological merit of the research performed. Properly substantiated credits are valuable assets, offering a long-term benefit, as unused portions may be carried forward for nine (9) years from the issue date.2

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/