Comprehensive Analysis of the Hawaii Research Activities Tax Credit (TCRA): The December 31, 2029 Sunset Provision and Act 139 Compliance Mandates

The Sunset Provision mandates that the Hawaii Tax Credit for Research Activities (TCRA), codified under Hawaii Revised Statutes (HRS) §235-110.91, will expire and cease to apply to Qualified Research Expenses (QREs) incurred in taxable years beginning after December 31, 2029. This critical expiration date, recently extended from an impending deadline, establishes a five-year window of opportunity for Qualified High Technology Businesses (QHTBs) while simultaneously imposing a strict new compliance framework derived from the federal incremental calculation methodology.

I. Statutory Context and Legislative History of the TCRA Sunset

A. HRS §235-110.91: The Research Credit Framework

The Hawaii Tax Credit for Research Activities (TCRA) has historically served as a critical mechanism for stimulating investment in high-technology sectors within the state. The credit is structured in alignment with federal tax law, specifically referencing Section 41 of the Internal Revenue Code (IRC).1 However, the state operates under a fixed conformity rule: the federal tax provisions in IRC §41, as enacted on December 31, 2011, remain the operative definition for purposes of determining the state income tax credit, regardless of any subsequent changes to the federal code.1 Furthermore, this fixed version of the federal code applies only to expenses incurred for qualified research activities after December 31, 2012.1

Prior to the 2024 legislative session, the future of the TCRA was critically uncertain. The statute (§235-110.91) had been scheduled for repeal after December 31, 2024, based on legislation passed in 2019.1 This necessitated immediate legislative action in 2024 to prevent the program’s expiration and maintain stability for the state’s research-intensive businesses.

B. Act 139, SLH 2024: The Mechanism for Extension to December 31, 2029

The legislative uncertainty was resolved by the enactment of Senate Bill 2497, which became Act 139, Session Laws of Hawaii (SLH) 2024. Governor Joshua Green signed this legislation, successfully postponing the pending sunset.2

Act 139 achieved two primary goals related to the program’s tenure: first, it formally extended the sunset date of the research activities tax credit to December 31, 2029.3 Second, the legislation codified the ultimate termination, stipulating that HRS §235-110.91 is officially repealed effective January 1, 2030.4 This extension provides QHTBs a guaranteed window for credit claimability for taxable years up through the 2029 period.

The effective date and applicability of Act 139 are crucial for compliance planning: the Act became effective on July 1, 2024, but its provisions apply retroactively to taxable years beginning after December 31, 2023.3

This retroactive application to the 2024 tax year resulted in a significant mid-year compliance shift for QHTBs operating on a calendar year basis. Although such businesses were already several months into their 2024 tax year when the law took effect in July, they were instantly required to change their internal tax calculation methodologies to comply with the newly imposed incremental calculation rules (discussed in Section II) for the entire 2024 period. This required prompt reevaluation of accumulated 2024 Qualified Research Expenses (QREs) against the new baseline rules, creating a substantial administrative hurdle for tax preparation.

C. Policy Objectives and Economic Context

The legislative decision to extend the TCRA program until 2029, despite data suggesting its small scale, underscores a consistent policy prioritization. Studies conducted by the University of Hawaii Economic Research Organization (UHERO) have concluded that the program, due to its size and strict $5 million annual cap, is “just too small to jumpstart Hawaii’s technology industry or contribute substantially to future economic growth”.5 Historically, Hawaii has ranked low nationally in R&D spending by private firms as a percentage of private output.5

However, the continued renewal suggests policymakers value the secondary and long-term effects. Research indicates that R&D incentives generate benefits that spill over to other firms and workers.5 For instance, external studies suggest that R&D incentives increase the number of highly skilled scientists located in states offering these incentives and produce a “sizeable multiplier effect” on overall employment in non-traded sectors, specifically citing construction and retail.5 Therefore, the extension through 2029 is a legislative commitment to securing these potential reputational and secondary employment benefits, even if the direct fiscal impact remains small relative to the state’s total GDP.

II. The Regulatory Overhaul: Impact of Reinstating the IRC §41 Base Amount

The extension of the TCRA by Act 139 was coupled with a fundamental change to the credit calculation, transitioning the program from a simplified system back to the more complex incremental method required by federal law.

A. Revoking the Simplified Calculation Mechanism

Prior to Act 139, the Hawaii statute contained a critical exemption that significantly simplified the credit calculation and maximized the potential claim. HRS §235-110.91 explicitly provided that “references to the base amount in section 41 of the Internal Revenue Code shall not apply, and credit for all qualified research expenses may be taken without regard to the amount of expenses for previous years”.1 This provision allowed QHTBs to calculate their credit based on the entirety of their current-year QREs conducted in Hawaii, bypassing the challenging process of determining a historical research base.

Act 139 (SLH 2024) specifically repealed this provision.3 Consequently, for taxable years beginning after December 31, 2023, QHTBs are now required to employ the incremental method mandated by IRC §41 (using the 2011 fixed conformity rules) to calculate their federal credit baseline.6

B. Consequences of Calculation Complexity and Base Amount Reliance

The reintroduction of the incremental calculation method carries significant consequences for many QHTBs:

1. Reduced Credit Value for Mature Firms: The state credit is now based only on the QRE amount that exceeds a calculated historical base. This mechanism substantially reduces the credit available to companies that have reached maturity and maintain consistent, high levels of QREs but are not increasing those expenditures year-over-year. The benefit is concentrated on companies with rapidly increasing research activities.
2. Historical Data Requirements: To calculate the required base amount, QHTBs must now identify their fixed-base percentage and establish their average gross receipts and QREs for their base period, which typically requires access to detailed financial records dating back to the 2013-2017 period.1 Taxpayers must ensure these calculations strictly adhere to the specific definitions and standards of IRC §41 as enacted on December 31, 2011, which may differ from current federal compliance standards.

This shift in methodology serves as an implicit mechanism for managing the state’s financial exposure to the TCRA. In the years immediately preceding Act 139 (2020–2023), when the base amount was disregarded, the total qualified credit claimed routinely reached or exceeded $11.9 million to $13.3 million, far surpassing the mandated $5 million annual aggregate cap.7 This forced the denial of certification for 17 to 30 QHTBs annually.7 By reinstating the complex base amount calculation, the average value of the credit claimed per QHTB declined dramatically. In the 2024 tax year, the certified credit value, $2.6 million, remained well below the cap, allowing all 18 certified QHTBs to receive their full credit.7 This change effectively prioritizes certifying a broader range of smaller claims while capping the total fiscal drain on the state budget below the strict $5 million maximum.

C. Modified Definition of Qualified High Technology Business (QHTB)

Act 139 also introduced a narrower and more specific definition of the eligible taxpayer, focusing the incentive on small businesses within the state. To qualify as a QHTB for tax years beginning after December 31, 2023, the business must meet several strict criteria:

1. Small Business Limitation: The entity must be classified as a small business.3
2. Employee Cap: A small business is explicitly defined as a company with no more than 500 employees.3
3. Local Research Focus: The business must conduct more than 50 percent of its activities in qualified research within Hawaiʻi and must be registered to do business in the state.3

This targeted approach reinforces the program’s goal of fostering indigenous, high-growth technology companies that may not yet be heavily established. Newer QHTBs, or those with very low QREs during the 2013-2017 base period, benefit disproportionately from the reinstated incremental calculation compared to mature firms, as their minimal historical base amount will maximize their incremental QREs eligible for credit until the 2029 sunset.

III. Compliance and Administrative Procedures: Dual Agency Mandates

Claiming the Hawaii TCRA is a two-step administrative process managed by separate state agencies: the Department of Business, Economic Development, and Tourism (DBEDT) handles certification, and the Department of Taxation (DOTAX) handles the actual credit claim.

A. DBEDT Certification Requirements (The Gatekeeper Role)

DBEDT serves as the gatekeeper, verifying that the business meets the definition of a QHTB and certifying the qualified research expenses incurred.8

1. The Application Requirement: Taxpayers seeking the credit must submit an application (Form N-346A) to DBEDT by March 31 following the close of the taxable year in which the research was conducted.8
2. Mandatory Annual Survey: In addition to the application, a QHTB must complete an annual survey as prescribed by DBEDT. Failure to satisfy these requirements, including the survey, automatically constitutes a waiver of the right to claim the credit.6

B. DOTAX Claiming Procedures and Deadlines

Once DBEDT issues the certification, the taxpayer uses the certified amount to claim the credit on their state income tax return.

1. Claim Forms: The credit is calculated and reported using DOTAX Form N-346 and summarized on Schedule CR.3
2. The Strict 12-Month Claim Deadline: The ultimate deadline to claim the credit, including amended claims, is strictly 12 months after the close of the taxpayer’s taxable year.6 This administrative deadline is absolute and takes precedence over standard income tax filing extensions for purposes of claiming the credit.6

C. The $5 Million Annual Aggregate Cap: Strategic Implications

The most volatile element of the TCRA program remains the severe limitation on total certified funds.

1. The Strict Limit: The total amount of certified tax credits allowed annually across all taxpayers is strictly limited to $5,000,000 in the aggregate.6

• Note on Discrepancy: While some secondary sources mentioned potential increases to $10 million following Act 139 2, the official guidance, including the instructions for Form N-346 (Rev. 2024), confirms that the aggregate limit remains $5,000,000.6 Strategic planning must adhere to the official, lower figure.

1. First-Come, First-Served Allocation: Certification against the $5 million cap is issued on a first-come, first-served basis.6

Historical program utilization demonstrates that high demand and cap saturation posed a significant financial risk to QHTBs when the simplified calculation allowed large claims. From 2020 to 2023, total claims routinely exceeded the cap, resulting in many qualified applicants being denied the credit.7 The transition to the complex incremental calculation drastically reduced the average claim size, leading to lower overall utilization in 2024 ($2.6 million certified) and zero denials due to cap exhaustion.7

The combination of the highly competitive cap allocation and the refundable nature of the credit creates a substantial incentive for administrative efficiency. Since the potential refund value is certain and high, the primary risk is administrative failure or timing. Therefore, securing an early position by meeting the March 31 DBEDT application deadline is a critical component of risk mitigation during the remaining years leading up to the 2029 sunset.

D. Refundability and the Conclusionary Nature of the Sunset

The Hawaii TCRA is fully refundable.9 Any amount of the certified credit that exceeds the taxpayer’s liability is paid out as a cash refund.9

Crucially, there is no provision for carrying forward any unused credit amount.9 This characteristic provides administrative clarity for the 2029 sunset. Unlike some expired nonrefundable tax credits which have resulted in millions of dollars in unutilized carryforwards lingering on state balance sheets 10, the refundable nature and the lack of a carryforward mechanism mean that the program will conclude cleanly after the final eligible tax year (2029). The credit must be claimed and monetized in the year it is certified.

The following table summarizes the historical risk profile related to the annual cap:

Table 1: Historical Utilization and Risk Profile of the Annual Aggregate Cap

IV. Calculation Mechanics and Apportionment of the TCRA

The determination of the Hawaii TCRA requires a two-step process to establish the federal baseline and then apply the Hawaii apportionment fraction, as detailed in the instructions for Form N-346.6

A. Step 1: Determining the Federal Baseline

The QHTB must first compute the federal tax credit for increasing research activities using the methodology required by IRC §41, specifically the version fixed as of December 31, 2011.1

Under the rules reinstated by Act 139, the credit is calculated incrementally. The QHTB must determine its historical base amount, typically equal to 50% of the average QREs from the base period. The federal credit (usually 20% of the qualified incremental amount) is calculated only on the portion of current-year QREs that exceed this base amount. This resulting federal credit is entered on Line 1 of Hawaii Form N-346.6

This calculation presents an elevated risk of audit and compliance complexity. Since the state credit is derived from the 2011 version of IRC §41 rules 1, tax professionals must manage dual conformity rules. The calculation for the state baseline may require different expense definitions or base period methodologies than those used for the taxpayer’s current federal Form 6765, necessitating highly specialized record-keeping to satisfy state auditors that the base amount and QRE definitions conform to the specific frozen statute.

B. Step 2: Calculating the Hawaii Apportionment Factor

The amount of the Hawaii TCRA is derived by multiplying the federal credit baseline (calculated in Step 1) by a statutory apportionment fraction.6 This fraction ensures that only the research activities conducted within the state are utilized for the local credit calculation.

The numerator of this fraction is the amount of eligible research expenses attributable to research activity conducted in Hawaii (recorded on Line 2g, Column B of Form N-346).6

The denominator is the total amount of expenses eligible for the federal tax credit for increasing research activities (recorded on Line 2g, Column A of Form N-346).6

The quotient of these values is the Hawaii Percentage (Line 3), which must be rounded to six decimal places. The Tentative Hawaii TCRA (Line 4) is then determined by multiplying the Federal Credit (Line 1) by this Hawaii Percentage.6 The final credit is the sum of this tentative amount and any flow-through credits received from pass-through entities.6

It is important to note that the state’s objective in mandating the local apportionment fraction is explicitly to stimulate in-state economic activity. Evidence suggests this is effective: in the 2024 tax year, over 80% of QREs incurred in Hawaiʻi by certified QHTBs were spent on wages, confirming that the credit primarily incentivizes local labor expenditures.7 Strategic planning up to the 2029 sunset should therefore prioritize maintaining high local QRE ratios to maximize this apportionment factor.

V. Illustrative Case Study: Financial Impact of Act 139 on TCRA Calculation (2026 Tax Year)

The following example demonstrates the practical application of the reinstated IRC §41 incremental calculation methodology required by Act 139, highlighting the financial consequence of moving away from the pre-2024 “credit-for-all-QREs” rule.

A. QHTB Profile and Research Activities

A certified QHTB, meeting the new 500-employee limit and 50%+ local research threshold, is calculating its tax credit for the 2026 tax year.

B. Step 1: Calculating the Federal Baseline Credit (Post-Act 139)

The new calculation requires the establishment of the base amount, which must be subtracted from the total QREs to find the incremental credit amount.

1. Base Amount Calculation: Assuming the fixed-base percentage calculation yields the maximum historical threshold, the base amount is 50% of the historical average QRE:
   
   $$\$2,000,000 \times 50\% = \$1,000,000$$
2. Incremental QRE: The portion of current QREs eligible for credit is the amount exceeding the base:
   
   $$\$3,500,000 (Total QRE) – \$1,000,000 (Base Amount) = \$2,500,000$$
3. Tentative Federal Credit (Line 1, N-346): Calculated at the federal rate (20%):
   
   $$\$2,500,000 \times 20\% = \$500,000$$

C. Step 2: Calculating the Hawaii TCRA Apportionment

The tentative federal credit is multiplied by the local apportionment percentage.

1. Hawaii Apportionment Fraction:
   
   $$\frac{\$2,800,000 (Hawaii\ QREs)}{\$3,500,000 (Total\ QREs)} = 0.800000$$
2. Tentative Hawaii TCRA (Line 4, N-346):
   
   $$\$500,000 (Federal\ Credit) \times 0.800000 (Hawaii\ Percentage) = \$400,000$$

Result: The QHTB is eligible for a certified credit of $400,000, assuming cap availability.

D. Financial Impact Comparison (Pre- and Post-Act 139)

Had the pre-Act 139 rules (disregarding the base amount) remained in effect, the company’s calculation would have been significantly more favorable:

The reinstatement of the base amount under Act 139 resulted in a $160,000 reduction in the available tax credit for this established QHTB. Given the certified credit of $400,000 and a tax liability of $150,000, the company would receive a cash refund of $250,000, demonstrating the high monetary value of securing the credit before the 2029 sunset.

VI. Conclusion and Strategic Recommendations for the 2029 Sunset Window

The extension of the Hawaii Tax Credit for Research Activities (TCRA) provides QHTBs with a limited, critical five-year period to capitalize on the incentive before its statutory expiration on December 31, 2029. The legislative action, while preserving the credit, fundamentally altered the compliance landscape by replacing simplicity with the complexity of the federal incremental calculation, HRS §235-110.91 must now be managed strategically to maximize returns and mitigate risk.

A. Strategic Compliance Mandates for QHTBs (2024–2029)

1. Establish Rigorous Base Period Documentation: Due to the reinstatement of the IRC §41 incremental calculation, QHTBs must immediately devote resources to establishing accurate and auditable documentation for QREs and gross receipts during the historical base period (2013-2017). This documentation must specifically adhere to the definitions present in the December 31, 2011, version of the IRC, which introduces substantial complexity compared to current federal compliance and is necessary for audit defense.
2. Prioritize DBEDT Filing for Cap Assurance: The $5 million annual aggregate cap is a hard limit and remains the primary competitive barrier to claiming the credit. Despite the reduced claims utilization observed in 2024, the high historical demand necessitates treating the March 31 DBEDT application deadline as a non-negotiable strategic priority. Filing promptly is essential to secure the QHTB’s position in the first-come, first-served allocation queue.6
3. Optimize Local QRE Ratios: The credit calculation is highly sensitive to the apportionment factor, which relies on the ratio of local Hawaii QREs to total QREs. Taxpayers should ensure R&D spending is strategically directed toward local activities, particularly payroll, which has historically constituted the largest percentage of verified local QREs, thereby maximizing the final certified credit amount.

B. Assessment of Program Effectiveness and Forward Outlook

The program’s ongoing legislative survival reflects a sustained political commitment to the high-technology sector, even though formal economic assessment suggests the program is too small to drive substantial aggregate economic transformation in Hawaii.5 Nonetheless, the program demonstrates effectiveness in generating local expenditures, particularly wages, which contribute to secondary employment benefits.5

The refundable status of the TCRA and the definitive absence of a carryforward provision mean that the 2029 sunset will provide an administratively clean conclusion for taxpayers.9 Taxpayers have until the close of the 2029 taxable year to incur QREs eligible for the credit; after this date, the statute is repealed, and no residual nonrefundable credits will remain to be utilized in subsequent tax years.

Barring comprehensive legislative action and a renewed budgetary allocation, the ability to accrue new credits will cease entirely after December 31, 2029. Any potential future R&D incentive mechanism would likely undergo intense legislative scrutiny, particularly regarding the efficiency and compliance complexity introduced by the recent Act 139 amendments.

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