Expert Report on Hawaii Form N-346 and the Tax Credit for Research Activities (TCRA) Compliance

The Hawaii Form N-346, titled Tax Credit for Research Activities, is the official document used by Qualified High Technology Businesses (QHTBs) to claim a highly beneficial, refundable income tax credit under section 235-110.91 of the Hawaii Revised Statutes (HRS).1 This state credit is calculated by taking the federal R&D tax credit (determined via Federal Form 6765) and multiplying it by a proration ratio reflecting the proportion of eligible research expenses (QREs) conducted within the state.1

The Hawaii Tax Credit for Research Activities (TCRA) is a cornerstone of the state’s efforts to incentivize local technological development, particularly within high-tech sectors like biotechnology and software development.2 Unlike many state R&D credits, the refundable nature of the Hawaii TCRA means that businesses—even those that do not yet have an income tax liability—can receive a cash payment for their qualifying expenses, offering crucial financial support to startups and growth-phase companies.2 Strategic planning for this credit, however, requires a deep understanding of the interwoven requirements set by federal law (Internal Revenue Code Section 41) and strict administrative procedures enforced by two separate state agencies: the Department of Business, Economic Development, and Tourism (DBEDT) and the Department of Taxation (DOTAX).

Statutory and Regulatory Foundation: HRS §235-110.91

The Nexus with Federal Law (IRC Section 41)

The foundation of the Hawaii TCRA is rooted entirely in federal tax law. A critical prerequisite for claiming the Hawaii credit is that the taxpayer must also claim the federal tax credit for increasing research activities under Section 41 of the Internal Revenue Code (IRC).1

This intrinsic link means that the definitions governing eligible expenses and activities are largely federal. Qualified Research Expenses (QREs) for the Hawaii credit align with the federal definition, primarily encompassing in-house research expenses such as wages paid for qualified services, the cost of supplies used in research, and 65% of contract research expenses.4 The term “qualified services” includes services consisting of engaging directly in qualified research or engaging in the direct supervision or direct support of research activities that constitute qualified research.5

The requirement to file the federal credit (Form 6765) first provides a necessary structure for the state calculation, ensuring that the research activities meet the four-part test for qualified research established under federal statutes. If a taxpayer does not claim the federal credit under IRC Section 41, the Hawaii TCRA cannot be claimed.1

Defining the Qualified High Technology Business (QHTB)

The TCRA is not universally available to all businesses operating in Hawaii; it is strictly limited to an entity designated as a Qualified High Technology Business (QHTB).1

Recent legislative action, specifically Act 139, Session Laws of Hawaii (SLH) 2024, formalized and updated the definition of a QHTB for taxable years beginning after December 31, 2023.1 To qualify, a business must meet three specific criteria:

1. Small Business Status: The entity must be a small business, which is explicitly defined as a company having no more than 500 employees.1
2. Activity Threshold: The QHTB must conduct more than 50 percent of its activities in qualified research within the state of Hawaiʻi.1
3. Registration Status: The entity must be registered to do business in the State of Hawaiʻi.1

The legislative decision to impose the 500-employee limit and the 50% in-state research activity threshold ensures that the tax incentive, which is subject to a strict annual cap, focuses its economic benefit on locally anchored, research-intensive enterprises. This selectivity is designed to maximize the economic multiplier effect of the limited funding pool by subsidizing smaller, homegrown technology firms, rather than funding marginal research costs for large national or multinational organizations.2

The Dual Compliance Path: DOTAX and DBEDT Requirements

Claiming the Hawaii TCRA involves navigating a unique and rigorous administrative path that is split between the Department of Business, Economic Development, and Tourism (DBEDT) and the Department of Taxation (DOTAX). This bifurcation necessitates strict attention to separate deadlines and requirements.

DBEDT: The Certification Gatekeeper (Form N-346A)

DBEDT holds the primary responsibility for verifying the nature of the qualifying research activity, totaling the costs, and certifying the credit amount.3 Taxpayers must obtain this certification before the credit can be successfully claimed on the income tax return.

The process centers on Form N-346A. Every QHTB must submit a written, certified statement—specifically Form N-346A—to DBEDT identifying the qualified expenditures and the amount of tax credits claimed for the previous taxable year before March 31st of the subsequent year.3

The Critical $5 Million Annual Cap

The total amount of tax credits that can be certified by DBEDT is limited to an aggregate maximum of $5,000,000 for all taxpayers in any given taxable year.8

Certifications under this limited pool are issued strictly on a first-come, first-served basis until the $5 million cap is reached.8 DBEDT uses the date and time a completed and signed N-346A form is uploaded and received to determine an applicant’s priority.8

This allocation methodology creates extreme timing pressure. Industry reports indicate that the $5 million maximum has been reached almost immediately upon the online applications opening in recent years.8 Consequently, the true operational deadline is not the statutory March 31st submission date for Form N-346A, but rather the opening minute of the application window. QHTBs must have their credit calculations and required documentation finalized well in advance to ensure immediate submission, as a delay could mean a 100% loss of the credit opportunity for that tax year, irrespective of the validity of the underlying research.

The DBEDT application process is multi-part, typically requiring the upload of the completed, signed N-346A form (Part A), followed by the completion of an online questionnaire (Part B(1)) and the uploading of a detailed spreadsheet (Part B(2)) by the required deadline.8 DBEDT reviews these materials and, if approved, signs Part II of the N-346A form, which serves as the official certificate.11 This signed certificate is then mailed to the QHTB for inclusion with their tax return.11

DOTAX: The Filing Authority (Form N-346)

Once the certification is obtained from DBEDT, the claim is formally made using Hawaii Form N-346 and filed with the Department of Taxation (DOTAX). The mandatory attachments to the taxpayer’s Hawaii income tax return (such as Form N-11 for individuals or N-35 for corporations) include:

1. Hawaii Form N-346 (Tax Credit for Research Activities).7
2. The certified Hawaii Form N-346A (Certificate from DBEDT).7
3. A copy of the Federal Form 6765 (Credit for Increasing Research Activities).1
4. For flow-through entities (e.g., partnerships and S corporations), copies of Schedule K-1s must also be attached by the partners or shareholders claiming their pro rata share of the credit.1

The Strict 12-Month Claim Deadline

A crucial compliance detail enforced by DOTAX is the deadline for claiming the credit. The statute mandates that the deadline to claim the credit, including amended claims, is strictly 12 months after the close of the taxpayer’s taxable year.1 This 12-month limitation is notably shorter than the standard three-year statute of limitations typically applied to tax returns. This truncated window eliminates the opportunity for QHTBs to discover and claim the credit retroactively years later, underlining the necessity of rigorous, contemporaneous record-keeping and proactive annual filing.

Detailed Analysis of TCRA Calculation Methodology

The calculation of the Hawaii TCRA is a proportional methodology defined by HRS §235-110.91, which links the state credit amount directly to the federal credit calculation.

The Impact of Act 139, SLH 2024: Reinstating the Federal Base

For taxable years beginning after December 31, 2023, the calculation methodology changed fundamentally due to Act 139, SLH 2024.1 Previously, Hawaii allowed credits for all qualified research expenses without regard to the amount of expenses for previous years, simplifying the calculation considerably.3 Act 139 repealed this simplifying provision.1

Under the revised statute, the calculation of the federal base amount under IRC §41 is now mandatory for the Hawaii credit.1 The federal base amount relies on historical data, calculated by applying a fixed-base percentage to the average annual gross receipts for the four preceding tax years. Furthermore, the base amount cannot be less than 50% of the current year’s QREs.2

This reinstatement of the base amount introduces significant compliance complexity. QHTBs must now compile and verify five years of financial data (the four prior years plus the current year) to determine their eligible credit. This transition requires companies that previously enjoyed the simplified calculation to perform a comprehensive documentation effort to accurately determine their historical fixed-base percentage and gross receipts, thereby increasing the technical difficulty and cost of compliance.

The Three-Step Proportional Calculation Process

The Hawaii TCRA is derived using a proration formula based on the location of the qualified research activity. The process can be systematically broken down as follows:

Step 1: Compute the Federal Credit

The taxpayer must first calculate their federal credit amount using the methodology prescribed by IRC §41 and Federal Form 6765, including the now-mandatory base amount computation.1 This results in the final Federal Credit, typically 20% of the excess QREs (Current QREs minus the calculated Base Amount).2 For startup companies, special rules apply where the fixed-base percentage begins at 3%.2

Step 2: Determine Hawaii QREs and Total Federal QREs

The taxpayer must isolate the amount of eligible research expenses that are specifically attributable to research activities physically conducted within Hawaii (Hawaii QREs). This figure is compared against the total amount of QREs eligible for the federal credit nationwide (Total Federal QREs).1

Step 3: Apply the Hawaii Proration Formula

The Hawaii TCRA is then calculated by multiplying the Federal Credit (from Step 1) by the ratio of Hawaii QREs to Total Federal QREs.1

$$\text{Hawaii TCRA} = \text{Federal Credit} \times \left(\frac{\text{Hawaii QREs}}{\text{Total Federal QREs}}\right)$$

This proportional method ensures that only the portion of the federal credit derived from research activity physically performed within Hawaii is granted by the state.

Strategic Compliance and Risk Management

Beyond the calculation and filing deadlines, QHTBs must manage continuous and post-filing requirements that carry severe penalties for non-compliance.

Post-Filing Requirements: The Mandatory Annual Survey

A crucial administrative requirement follows the filing of the tax return. QHTBs that claim the TCRA are legally mandated to complete and file an annual economic survey with DBEDT by June 30th of the year subsequent to the filing year.2 This survey collects data regarding the qualified expenditures and activities, which DBEDT and DOTAX use to evaluate the effectiveness of the tax credit.13

Compliance with this deadline is non-negotiable. The guidance explicitly states that credits will not be allowed for those taxpayers who fail to complete the questionnaire by the June 30th deadline.12 This administrative requirement imposes a critical, separate calendared deadline, demonstrating that successful compliance requires ongoing vigilance. Missing this survey deadline can result in the disallowance of a credit that was successfully certified months earlier and properly filed with DOTAX, functioning as a “silent compliance killer.”

Program Lifespan and Legislative Certainty

The continuity of the TCRA program is relevant for long-term strategic investment planning. Previously set to expire, Act 139 extended the sunset date for the research activities tax credit. The TCRA is now scheduled to be repealed from statute on December 31, 2029.1 This extension provides qualified businesses with a five-year planning horizon to structure their research investments and maximize the utilization of the refundable credit.

Case Study: Calculating the Hawaii TCRA (Form N-346)

The following example illustrates the calculation of the Hawaii TCRA for a Qualified High Technology Business (QHTB) for a tax year beginning after December 31, 2023, following the mandate under Act 139 to incorporate the federal base amount.

Scenario Setup

TechAloha Corp. is a QHTB registered in Hawaii, employing 350 individuals (well under the 500-employee limit). TechAloha conducts R&D operations in multiple locations, including substantial activity in Honolulu.

Financial Data for Tax Year 2024:

• Total Current Federal QREs (U.S.): $1,500,000
• Hawaii QREs (In-State): $600,000
• Average Annual Gross Receipts (2020–2023): $12,000,000
• Fixed-Base Percentage (calculated historically per IRC §41 rules): 4%

Step-by-Step Calculation Walkthrough

The TCRA calculation must first establish the amount of the federal credit.

The final calculated Hawaii TCRA of $81,600 must be submitted on Form N-346A to DBEDT during the application window. Because this claim exceeds the $25,000 threshold, the standard $500 certification fee would typically apply, though the fee was waived for the 2025 application cycle.2 Once certified by DBEDT, TechAloha Corp. would attach the signed N-346A, Federal Form 6765, and Hawaii Form N-346 to their relevant Hawaii income tax return for processing by DOTAX.1

Conclusions and Strategic Recommendations

The Hawaii Tax Credit for Research Activities (TCRA) is a crucial, high-value component of the state’s economic development strategy, offering qualified small technology businesses a substantial refundable cash benefit. However, the mechanism is characterized by high administrative complexity and acute time sensitivity, requiring expert compliance planning.

Summary of Key Compliance Challenges

1. The Priority of Speed: Due to the $5 million annual aggregate cap and the first-come, first-served allocation method, the window for successful certification by DBEDT (Form N-346A) is extremely brief. The highest risk in claiming the credit is the administrative failure to file the certified statement at the exact moment the application opens, potentially voiding the credit even if technically qualified.8
2. Increased Documentation Burden: The legislative requirement under Act 139 to apply the federal base amount calculation for tax years starting after 2023 necessitates meticulous documentation of gross receipts and QREs for the four preceding tax years, placing new demands on historical financial record-keeping for QHTBs.1
3. Multiple Critical Deadlines: Taxpayers must manage three distinct, mandatory deadlines: the highly competitive N-346A submission to DBEDT (early March), the strict 12-month filing deadline for Form N-346 with DOTAX, and the mandatory annual economic survey submission to DBEDT by June 30th.2

Actionable Recommendations for QHTBs

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