Expert Report on Research Conducted in Delaware: Nexus and Compliance Requirements for the R&D Tax Credit

Research conducted in Delaware refers to Qualified Research Expenses (QREs) sourced specifically to activities physically performed within the state’s geographic boundaries, which must satisfy the eligibility criteria established under Internal Revenue Code (IRC) § 41. These localized expenses form the essential foundation for calculating and claiming the Delaware Research and Development (R&D) Tax Credit, a fully refundable incentive designed to support in-state innovation.

I. Executive Summary: The Strategic Value of Delaware R&D Incentives

The Delaware R&D Tax Credit is codified under Title 30, Chapter 20, Subchapter VIII of the Delaware Code (§ 2070 et seq.) and represents a significant state mechanism for fostering economic development through technological advancement.1 This incentive structure is particularly advantageous in the national landscape because of its unique operational features, which distinguish it from R&D incentives offered by many other states.

The primary strategic value of the Delaware credit lies in its structural integrity. Prior to legislative changes, the credit was constrained by a $5,000,000 statewide cap, resulting in pro-rata reductions if aggregate claims exceeded that threshold, and the value was limited to 50% of the taxpayer’s annual liability.2 The elimination of these prior restrictions, effective January 1, 2017, ensures that companies may receive 100% of their expected credit amount without diminution.3 Furthermore, the credit is fully refundable.1 This means that if the approved credit amount exceeds the taxpayer’s qualified tax liability, the unused portion is paid directly to the taxpayer as a cash refund.4

This mandate for full refundability, coupled with the elimination of the annual cap, signals a critical shift in state policy, transforming the credit from a simple tax offset into a potent economic stimulus tool. For high-growth, technology-heavy businesses, especially those in the biotechnology, life sciences, and manufacturing sectors that often operate at a loss during development, the credit provides vital liquidity.1 The ability to convert R&D expenditures into immediate cash flow, even in the absence of corporate income tax liability, is a mechanism that strategically enhances Delaware’s national competitiveness and supports ongoing capital investment in the state.6 The state’s commitment to this aggressive incentive structure contributes to its robust standing, ranking highly in the United States for industrial R&D intensity relative to Gross Domestic Product (GDP).6

II. Statutory and Regulatory Foundation: Defining Qualified Research

A. Legal Basis and Federal Conformity

The Delaware R&D tax credit relies heavily on federal definitions to establish eligibility, promoting ease of compliance for multi-state entities. Delaware Code § 2071 mandates substantial conformity with federal standards, stipulating that any term used in the Delaware R&D subchapter shall have the same meaning as when used in a comparable context in the Internal Revenue laws of the United States, specifically referencing IRC § 41.4

To qualify for the Delaware credit, the underlying R&D activities must satisfy the rigorous four-part test defined under federal law.8 These requirements ensure that only truly innovative activities are incentivized:

1. Permitted Purpose: The activity must seek to create or significantly improve a business component (product, process, service, or software).
2. Elimination of Uncertainty: The research must aim to eliminate technological uncertainty regarding the development or improvement of the component.
3. Technological Nature: The research must fundamentally rely on principles of engineering, physics, chemistry, or computer science.
4. Process of Experimentation: The activities must involve a systematic process of experimentation, which may include modeling, simulation, or trial and error.9

B. The Cornerstone: The Geographical Nexus Requirement for Delaware QREs

A prerequisite to claiming the Delaware credit is the establishment of the geographical nexus: the qualified research must physically take place in Delaware.5 For multi-state corporations, this necessitates meticulous tracking and sourcing of expenses to ensure they are attributable to activities within the state.

The categories of expenses eligible for inclusion as Delaware QREs mirror the federal definitions but are strictly limited by location 1:

• Wages: Salaries and related employment costs paid to employees who are directly performing, supervising, or directly supporting qualified research. The wages are only eligible to the extent the services were performed physically within Delaware.9
• Supplies: Costs of materials, prototypes, and equipment consumed or used up during the research process within Delaware.
• Contract Research Expenses (CRE): 65% of amounts paid or incurred to unrelated third-party contractors for qualified research services. Crucially, these contract services must be sourced to, and performed within, Delaware.1
• Computer Rentals: Costs for leased computers or equipment used exclusively in qualified research located within the state.1

The federal tax landscape has recently reinforced the strategic importance of state incentives like Delaware’s. While the R&D tax credit (IRC § 41) is distinct from the rules governing the deductibility of R&E expenditures (IRC § 174), the immediate deduction for domestic R&E expenditures was permanently restored by the One Big Beautiful Bill Act (OBBBA).6 This federal change, which allows companies to expense R&D costs immediately rather than amortizing them over several years, significantly enhances federal cash flow. When combined with the Delaware fully refundable credit, the overall cash-on-cash return for performing R&D within Delaware is maximized. This potent synergy of federal expensing and state refundability makes Delaware a highly attractive location for substantial R&D investment.6

III. Apportionment and Localization: Sourcing Delaware Qualified Research Expenses

A. Sourcing Rules for QRE Categories

Effective compliance requires careful apportionment of expenses to satisfy the “conducted in Delaware” requirement. The determination of Delaware QREs often involves segregating costs incurred by personnel or facilities operating both inside and outside the state.

For instance, the sourcing of Wages paid to R&D employees is paramount. If a researcher splits their time between a laboratory in Wilmington and an office in Philadelphia, only the salary allocated to the time spent physically performing, supervising, or supporting qualified research activities in the Delaware location is eligible.9 This necessitates the implementation of granular, defensible time-tracking and expense allocation systems that attribute labor costs not just to qualifying R&D projects, but also to the specific geographical area where the work was performed.

Similarly, the localization of Contract Research Expenses requires scrutiny. If a Delaware-based company pays an independent lab for qualified research, that expense only counts toward Delaware QREs if the lab performs the services within Delaware. The geographical source of the research services—not the location of the contracting entity—governs eligibility.1

B. Sourcing Gross Receipts for the Traditional Base Calculation

For taxpayers electing the Traditional Credit calculation method (detailed below), the determination of the Delaware Base Amount requires a look-back period of four preceding tax years, involving the calculation of Delaware gross receipts.1

The Fixed-Base Percentage calculation uses the ratio of Delaware QREs to Delaware gross receipts for the four preceding years.1 For this calculation, the gross receipts must be sourced according to Delaware apportionment rules applicable to that historical period.1

This requirement for four years of historical gross receipts data creates a specific compliance complexity for established multi-state firms. The analysis must accurately reconcile past Delaware apportionment methodologies for gross receipts, which may involve tracing revenue streams over time. If a company has recently expanded into Delaware, or if comprehensive historical records for both Delaware QREs and Delaware Gross Receipts are unavailable, the Fixed-Base Percentage is set to zero, which can be advantageous as it maximizes the “excess QREs” eligible for the credit.1 However, for firms with established operations, this historical data requirement necessitates thorough compliance documentation and may lead some taxpayers to favor the Alternative Simplified Credit (ASC) method to avoid this friction.

IV. Delaware Division of Revenue (DOR) Administrative and Compliance Guidance

Compliance with the Delaware R&D Tax Credit requires adherence to strict administrative requirements set forth by the Delaware Division of Revenue (DOR).

A. Required Forms and Filing Deadlines

The election and computation of the Delaware R&D tax credit are documented on the specific application schedules provided by the DOR, designated as Form 2070AC or 2071AC, which serve as the Application and Computation Schedule for Claiming Delaware Research and Development Tax Credits.1

The taxpayer’s election to claim the credit is an annual decision, independent of the federal method used.7 This election must be made by submitting the required application form to the DOR. A critical compliance requirement is the filing deadline: Qualified taxpayers must submit their application on or by September 15 after the end of the taxable year during which the qualified R&D expenses were incurred.5 It is imperative to note that unlike the general corporate income tax return (Form CIT-TAX), which benefits from an automatic extension based on the federal extension 14, the R&D credit application deadline is firm, and failure to meet the September 15 deadline results in the forfeiture of the credit for that tax year.

B. Refundability and Statutory Limitations

As noted previously, the Delaware R&D tax credit is distinguished by its operational flexibility and generosity. The unused portion of an approved credit, if it exceeds the qualified tax liability for the year, is paid to the taxpayer in the nature of a tax refund.4 This feature provides direct cash support to qualifying businesses.1

Furthermore, recent legislative action has secured the full value of the claim for all applicants by removing previous limitations.3 The prior maximum liability offset (50% of tax liability) and the $5 million statewide annual credit cap have been eliminated.2 This removal ensures that the credit is not subject to pro-rata reductions and can provide maximum utility even to the largest R&D spending corporations operating in the state. Delaware is noted as the only state combining a zero-expenditure cap and a fully refundable tax credit, highlighting its strategic commitment to innovation funding.3

C. Applicability and Multi-Entity Compliance

Delaware imposes a corporate income tax (CIT) of 8.7% on federal taxable income apportioned to the state.14 Every domestic or foreign corporation doing business in Delaware is required to file a CIT return.14

A significant administrative point is that Delaware does not permit consolidated corporate income tax returns.14 Each corporation that is a member of a consolidated federal group must file a separate state return, reporting income and deductions as if it filed a separate federal return.14 This non-consolidation rule impacts R&D credit compliance, as the legal entity performing the qualified research and incurring the Delaware QREs must be the entity that files Form 2070AC and claims the credit. For large organizational structures where R&D activities are centralized or shared among affiliates, precise inter-company charging and documentation are necessary to correctly allocate and claim the QREs within the legally defined structure.

For pass-through entities (PTEs), such as S-Corporations or partnerships, the mechanism differs. Although S-Corporations do not pay corporate income tax in Delaware, businesses not subject to the CIT are entitled to pass the R&D credits through to their partners or shareholders, who may then use the credits against their personal income tax liability.4 The refundability feature still applies at the entity or owner level.

V. Detailed Analysis of Credit Calculation Methodologies

Taxpayers must make an annual election between two distinct calculation methodologies when filing Form 2070AC.1 This choice is critical, as it significantly affects the final calculated credit amount.

A. Method 1: The Traditional Credit Calculation

The Traditional Credit method, also known as the regular method, determines the credit based on the excess of current-year QREs over a historically calculated base amount.

1. Determine Current Delaware QREs: Establish the total amount of QREs sourced exclusively to Delaware for the current tax year.1
2. Calculate the Delaware Base Amount: The calculation relies on a historical look-back 1:

• Fixed-Base Percentage: This is the ratio of Delaware QREs to Delaware gross receipts for the four preceding tax years.1
• Base Amount Formula: This fixed-base percentage is multiplied by the average Delaware Gross Receipts for the four preceding tax years.1

1. Apply the Minimum Base (50% Floor): To prevent an inflated credit claim based on minimal historical spending, the calculated Base Amount is subject to a floor: it must be at least 50% of the current year’s Delaware QREs.1
2. Calculate Excess QREs: The credit is applied only to the amount by which current QREs surpass the calculated (or minimum) Base Amount.1
3. Apply Credit Rate:

• Standard Rate: 10% of the excess QREs.7
• Small Business Rate: 20% of the excess QREs, applicable only to taxpayers designated as a “small business” (average annual gross receipts not in excess of $20,000,000).7

B. Method 2: The Alternative Simplified Credit (ASC) Apportionment

The ASC method is an elective alternative based on IRC § 41(c)(5) and is often favored by businesses lacking extensive historical data or those with fluctuating R&D expenditures.1

1. Federal ASC Calculation: The taxpayer first calculates the federal R&D tax credit using the ASC methodology.7 This calculation typically involves taking 14% of the current QREs that exceed 50% of the average QREs from the prior three years.1
2. Delaware Apportionment: The resulting Federal ASC amount is then specifically apportioned to Delaware using a ratio that isolates the in-state activity. Delaware’s apportioned share of the federal credit is determined by multiplying the Federal ASC by a percentage equal to the ratio of the taxpayer’s Delaware QREs to the taxpayer’s total (everywhere) QREs for the taxable year.7
   The statutory apportionment formula is:
   $$\text{Delaware Apportioned Credit Base} = \text{Federal ASC} \times \left( \frac{\text{Delaware QREs}}{\text{Total QREs}} \right)$$
3. Apply Credit Rate to Apportioned Base:

• Standard Rate: 50% of Delaware’s apportioned share of the Federal ASC.7
• Small Business Rate: 100% of Delaware’s apportioned share of the Federal ASC.7

C. Strategic Comparison of Calculation Methods

The strategic choice between the Traditional Credit and the ASC is guided by the taxpayer’s operational history and size.

Table 3: Comparison of Delaware R&D Tax Credit Calculation Methods

The ASC method often yields a higher effective return for specific profiles. For new companies or those that have dramatically increased their R&D spending, the ASC can circumvent the potentially high fixed-base amount inherent in the Traditional method.1 Furthermore, the incentive for small businesses (those with average annual gross receipts $\le$ $20,000,000$) is compelling under the ASC, offering a dollar-for-dollar match (100% rate) on the calculated apportioned credit base. This 100% rate is a powerful mechanism for maximizing the benefit from in-state R&D spending compared to the 20% maximum available under the Traditional method for small businesses.7

VI. Detailed Application Example: Multi-Year Apportionment and Credit Calculation

The following example illustrates the application of the ASC apportionment method, utilizing the highly advantageous 100% rate available to small businesses, which are defined as taxpayers with average annual gross receipts not exceeding $20,000,000.13

A. Scenario Description

A Delaware-based biotech company, classified as a small business, conducts qualified research across two states. The company elects the ASC method for tax years 2024 through 2026. The key is to calculate the Delaware R&D credit by isolating the percentage of total QREs physically conducted in Delaware.

The formula applied by the DOR for small businesses electing the ASC is:

$$\text{Delaware Credit} = 100\% \times \text{Federal ASC} \times \left( \frac{\text{Delaware QREs}}{\text{Total (Everywhere) QREs}} \right)$$

B. Apportionment Calculation

The data provided below reflects the allocation of QREs and the resulting federal credit amounts for the three-year period.5

Table 4: Multi-Year Delaware R&D Tax Credit Calculation using Small Business ASC

Calculation Analysis:

1. Sourcing Determination: The analysis confirms that a significant majority of the company’s R&D activity (84.3% in aggregate) was properly sourced to Delaware (Delaware QREs $\div$ Total QREs). This strict sourcing of the QREs (the definition of “Research Conducted in Delaware”) dictates the magnitude of the state credit.
2. Apportionment: The Federal ASC claimed by the taxpayer ($271,832 over the period) is multiplied by the corresponding annual ratio of Delaware QREs to Total QREs to determine the share attributable to Delaware.
3. Credit Calculation: Because the company is a small business, the entire apportioned amount ($229,116) is claimed as the Delaware R&D Tax Credit (100% rate).

C. Cash Value of Refundability

For an early-stage company that is typically generating operating losses and therefore has minimal or zero state corporate income tax liability, the total credit of $229,116 does not merely reduce a tax burden; it represents a direct cash refund.4 This mechanism provides working capital that can be immediately reinvested in core research and development activities, thereby sustaining the innovation cycle without relying exclusively on external financing. The fully refundable status effectively lowers the net cost of performing R&D within Delaware, serving as a powerful financial lubricant for the state’s technology sector.

VII. Conclusion and Expert Recommendations for Compliance

The Delaware R&D Tax Credit provides an exceptional, strategically valuable incentive, rooted in strict federal definitional compliance but enhanced by state-level mechanisms such as full refundability and eliminated caps. Successful utilization depends on navigating the precise localization requirements for Delaware QREs and strategically choosing the appropriate calculation methodology.

Expert Recommendations

1. Prioritize the September 15 DOR Deadline: The statutory deadline for submitting the application (Form 2070AC) on September 15 is absolute.5 Tax teams must establish internal timelines that treat the R&D credit application as a critical, standalone filing requirement, independent of the deadlines and extensions associated with the corporate income tax return (Form CIT-TAX).
2. Establish Robust Geographical Sourcing Mechanisms: Given that the credit hinges on “Research Conducted in Delaware,” multi-state taxpayers must maintain rigorous, auditable documentation proving that wages, supplies, and contract research were physically incurred or consumed within the state.9 Time tracking for R&D personnel is non-negotiable for accurate wage apportionment.
3. Conduct Annual Calculation Modeling: Taxpayers should model both the Traditional Credit and the ASC Apportionment methods annually to determine which yields the optimal result.7 For new market entrants or small businesses with historical gross receipts under $20 million, the ASC, offering the 100% multiplier on the apportioned federal credit, is frequently the most financially beneficial path.13
4. Acknowledge Multi-Entity Compliance Complexity: Due to Delaware’s prohibition on consolidated corporate income tax returns 14, R&D claims must be carefully structured and filed by the specific legal entity that directly incurred the Delaware QREs, requiring detailed inter-company accounting and documentation.
5. Utilize Refundability as Capital Planning: Corporate tax and finance professionals should integrate the fully refundable nature of the credit into cash flow and capital planning strategies, recognizing that the benefit represents a non-dilutive, direct cash source for financing ongoing R&D expenditures.

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