In-House Research Expenses and Compliance for the Idaho Research Activities Tax Credit (Idaho Code §63-3029G)

I. Executive Summary: The Strategic Role of Idaho-Sourced In-House Research Expenses

In-House Research Expenses (IHRE) constitute the direct costs associated with qualified research, primarily encompassing employee wages, the cost of supplies, and certain computer lease payments. For the purposes of the Idaho R&D Tax Credit, these expenditures must be specifically sourced, meaning the research activities corresponding to the expenses must be physically conducted within the state of Idaho.

1.1. Overview of the Idaho Research Activities Credit

The Idaho R&D Tax Credit for Research Activities, enacted under Idaho Code §63-3029G, serves as a significant nonrefundable incentive designed to encourage businesses to invest in qualified research conducted within the state.1 This credit structure aligns closely with the federal credit for increasing research activities found in Internal Revenue Code (IRC) Section 41, adopting the fundamental definitions of “qualified research” and “qualified research expenses” (QREs).3

The calculation of the Idaho credit is based on an incremental model. The credit amount is determined as the sum of two components: 5% of the excess of qualified research expenses (QREs) for research conducted in Idaho over a computed base amount, and 5% of basic research payments (for corporations only) that exceed the base period amount for basic research conducted in Idaho.1 The core function of this state statute is to apply the highly technical definitions and calculation methodologies of the federal IRC §41, but strictly limited to expenses paid or incurred for activities that originate within Idaho’s geographical boundaries.1

1.2. Key Compliance Challenge: The Dual Requirement of Scope and Sourcing

The effective utilization of the Idaho R&D tax credit necessitates simultaneous compliance with two independent regulatory tests. First, the taxpayer must ensure that the underlying activities meet the federal functional definition of “qualified research” (the four-part test: IRC §174 treatment, technological discovery, business component improvement, and process of experimentation).1 Second, and often more critically for multi-state entities, the taxpayer must demonstrate adherence to the Idaho sourcing requirement—that the expenses were exclusively related to research activities physically conducted in Idaho.1

The implication of this dual requirement is that internal tracking systems must move beyond general ledger categorization. While federal QREs encompass all eligible research activities within the United States, Idaho’s statutory mandate necessitates rigorous geographical segregation of those expenses. For IHRE, this means that every element—wages, supplies, and computer leases—must be time-allocated or consumed based on verifiable documentation confirming the expense’s physical location within Idaho. Without meticulous documentation demonstrating Idaho sourcing, even technically “qualified” expenses are subject to disallowance by the Idaho State Tax Commission (ISTC).

II. Definitional Deep Dive: The Components of In-House Research Expenses (IHRE)

Qualified Research Expenses (QREs), as defined under IRC §41(b)(1), serve as the foundational measure for the credit calculation and consist of two principal categories: In-House Research Expenses (IHRE) and Contract Research Expenses (CRE).5 Idaho adopts these precise federal definitions. IHRE, which represents costs incurred internally by the taxpayer, is further subdivided into three distinct components.

2.1. IHRE Component 1: Qualified Research Wages

Qualified research wages are perhaps the most substantial component of IHRE for many businesses. This expense category includes any wages paid or incurred to an employee for qualified services performed by that employee.7

2.1.1. Definition of Qualified Services and Allocation

The term “qualified services” is not limited merely to those who directly perform the research. It statutorily encompasses three specific functional categories 8:

1. Engaging in Qualified Research: This involves the actual conception, design, or testing that constitutes the research process (e.g., engineers writing code or scientists running experiments).
2. Direct Supervision: This includes the immediate supervision (first-line management) of employees who are directly engaging in qualified research.
3. Direct Support: This category covers services that are essential and directly supportive of the research activity, such as maintaining a research facility, compiling data, or performing clerical work necessary for the research effort.9

The term “wages” adopts the definition provided in IRC §3401(a), which relates to standard federal income tax withholding wages.8 Critically, if an employee performs both qualified services (eligible for the credit) and nonqualified services (ineligible), only the amount of wages allocated to the performance of qualified services may be included as an IHRE.9 The taxpayer bears the burden of demonstrating the appropriateness of the allocation method used, often relying on time sheets or detailed activity logs to accurately track the percentage of time spent on qualifying activities versus non-qualifying management or administrative tasks.9

2.2. IHRE Component 2: Cost of Supplies Used in Research

The cost of supplies represents the second major element of IHRE. This category includes any amount paid or incurred for supplies used directly in the conduct of qualified research.7

2.2.1. Statutory Definition and Exclusions

The IRC provides a precise definition of “supplies” as any tangible property other than land, improvements to land, and property subject to the allowance for depreciation.8 This strict exclusion is crucial: if an item of property is capitalized and depreciated—such as a large specialized piece of lab equipment, a building modification, or certain test fixtures—its cost cannot be claimed as an IHRE supply expense.10

Furthermore, the supplies must satisfy the “consumption rule.” They must be consumed or expended during the experimentation process. Examples of qualified supply expenses include raw materials used to fabricate and test prototypes.10 Conversely, items generally considered administrative or overhead—like standard office supplies or general facility maintenance materials—do not meet the direct consumption threshold and are therefore ineligible.10

2.3. IHRE Component 3: Computer Lease or Rental Costs

The third component of IHRE encompasses amounts paid or incurred to another person for the right to use computers in the conduct of qualified research.7

This component is subject to specific regulatory constraints often outlined by the Secretary of the Treasury. This expenditure typically applies to specialized computer usage, such as time purchased on off-site supercomputers or cloud computing resources utilized for research modeling, where the taxpayer is not the primary operator or user of the physical machine.4 A necessary anti-abuse provision requires that this amount must be reduced by any amount the taxpayer receives or accrues from another person for the right to use substantially identical personal property.7

2.4. Distinction Between In-House and Contract Research Expenses

Understanding the distinction between IHRE and Contract Research Expenses (CRE) is paramount for maximizing the credit value. IHRE (wages, supplies, and computer leases) are included in QREs at 100% of their cost.7 Conversely, CRE, which involves amounts paid to third parties (non-employees) for qualified research, is only included at 65% of the total paid or incurred amount.5

This percentage difference creates a mandate for careful classification of all personnel involved in the research effort, particularly consultants or contingent workers. If a legitimate independent contractor is mistakenly treated and documented as an employee, the IHRE claim fails because the expense does not constitute wages paid to an employee.8 Conversely, if a bona fide employee’s wage cost is mistakenly classified as a CRE, 35% of that cost is unnecessarily removed from the QRE base. Therefore, robust human resources and legal diligence is necessary to ensure correct classification to avoid audit risk and maximize the allowable credit base.

III. Idaho Statutory Framework and Sourcing Limitations (Idaho Code §63-3029G)

Idaho’s tax law governs the application of the credit, adopting the technical federal definitions while overlaying the critical jurisdictional limitation that ensures the incentive benefits only research conducted within the state.

3.1. General Conformity and the Idaho Sourcing Rule

Idaho Code §63-3029G establishes that the Idaho research credit conforms to the IRC Section 41 definitions of qualified research, qualified research expenses, and basic research payments.1 However, the state statute explicitly limits eligibility: only those amounts related to research conducted in Idaho qualify for the credit.2 This localized mandate requires meticulous expense tracking beyond what is necessary for federal filing.

3.2. Sourcing IHRE Components in Idaho

The Idaho State Tax Commission (ISTC) guidance, specifically through Form 67 instructions, clarifies how the IHRE components must be sourced to meet the Idaho requirement.4

• Wages: Must be for services performed in Idaho.4 This necessitates tracking the employee’s physical location when performing the qualified service. For employees who travel frequently or work remotely from neighboring states, detailed time tracking is required to segregate eligible Idaho work hours from ineligible out-of-state work hours.
• Supplies: Must be used in Idaho.4 The expense is sourced based on the point of consumption in the research process, requiring inventory and consumption logs that confirm the raw materials were utilized within an Idaho research facility.
• Computer Leases: Must be amounts paid or incurred for the rental or lease of computers used in qualified research conducted in Idaho.4

3.3. Calculating the Idaho Base Amount

The Idaho R&D tax credit is calculated as 5% of the excess QREs over a base amount.1 This base amount calculation is integral to determining the final credit value and requires specific consideration of Idaho-sourced economic activity.1

The base amount is generally calculated by multiplying the taxpayer’s fixed-base percentage (FBP) by the average annual Idaho gross receipts (AIGR) for the preceding four tax years.1 Gross receipts used in the calculation must be attributable to sources within Idaho, determined by applying the state’s multistate corporation apportionment rules, as detailed in Idaho Code §63-3027(12) and (13).2 The FBP is capped at 16% of the AIGR.1

Furthermore, Idaho law, mirroring the federal statute, imposes a minimum base amount floor: the calculated base amount may not be less than 50% of the current year’s total Idaho QREs.1 This floor prevents taxpayers with rapidly increasing QREs from receiving a disproportionately large credit by ensuring a minimum portion of current-year spending is excluded from the incremental calculation.

3.4. Irrevocable Start-Up Company Election

A unique feature of the Idaho statute is its modification of the federal start-up company rules. Idaho Code §63-3029G permits any taxpayer to elect to be treated as a start-up company under IRC §41(c)(3)(B), even if they do not meet the federal requirements for being defined as such.2

The primary benefit of this election is simplicity and immediate credit maximization, as it fixes the FBP at 3% for the first five tax years that the taxpayer has Idaho QREs.4 This 3% FBP is generally lower than the historically calculated FBP for mature companies, thus resulting in a smaller base amount and a higher amount of incremental QREs eligible for the credit.1

However, the statute is explicit: the election to be treated as a start-up company is irrevocable.2 This permanence demands careful strategic analysis. If a company anticipates moderate QRE growth in the first five years but expects QREs to rapidly accelerate and stabilize at a very high ratio to gross receipts in subsequent years (Years 6 through 10), electing the irrevocable 3% FBP may limit long-term credit potential. After Year 5, the FBP will be calculated based on the statutory ramp-up rules, which could ultimately result in a percentage lower than a historically calculated FBP might have allowed had the start-up election not been made. Therefore, businesses must weigh the certainty and immediate benefit of the 3% base against the potential for maximizing future credit amounts under the standard historical calculation method.

IV. Idaho State Tax Commission (ISTC) Guidance and Reporting Procedures

Taxpayers must utilize specific forms and adhere to the administrative guidance provided by the ISTC to claim the credit, ensuring strict compliance with the Idaho sourcing mandate.

4.1. Formal Reporting Requirements

The primary document used to calculate the credit for research activities is Form 67, Credit for Idaho Research Activities.4 Each member of a unitary group that earns or is allowed the credit must file a separate Form 67.4 Partnerships report the credit they earn on Form 65, Partnership Return of Income, referencing the calculation completed on Form 67.15

The ISTC is responsible for enforcing Idaho’s tax laws and providing guidance to ensure fair and accurate tax payments.17 In the context of R&D, this guidance is operationalized primarily through the instructions for Form 67.

4.2. ISTC Guidance: Detailing IHRE Sourcing on Form 67

The instructions for Form 67 explicitly direct the reporting of Idaho-sourced IHRE, corresponding to Lines 4, 5, and 6 on the form. This guidance reinforces the geographical constraint imposed by Idaho Code §63-3029G.4

• Line 4: Wages for Qualified Services Performed in Idaho. The instructions specify that only wages paid for qualified services performed by the employee in Idaho are includible. This rule inherently requires employers to isolate compensation related to work performed outside Idaho, such as travel time or temporary assignments in other states, even for Idaho-based employees.4
• Line 5: Cost of Supplies Used in Idaho. The amount entered must represent supplies used in Idaho to conduct qualified research. The instructions reiterate the federal definition of supplies, emphasizing tangible property other than land, improvements, or depreciable property.4
• Line 6: Rental or Lease Costs of Computers Used in Idaho. This line mandates the inclusion of costs for computers used in qualified research conducted in Idaho, reiterating the constraint that the computer must be off the taxpayer’s premises, and the taxpayer cannot be the primary user.4

4.3. Documentation and Audit Rigor

While a search for specific IDAPA administrative rules or agency guidance documents detailing documentation requirements for IHRE related to the R&D credit did not yield explicit documents 17, compliance demands rigorous substantiation necessary to withstand an ISTC audit. Because Idaho adopts the federal definitions but imposes a crucial geographic filter, the ISTC’s audit focus is heavily weighted toward proving the sourcing of the expense rather than challenging the fundamental “qualified research” criteria.

To successfully support an Idaho IHRE claim, taxpayers must maintain detailed, real-time documentation:

• For Wages: Comprehensive time-tracking records, such as time cards, project management software logs, and travel records, must substantiate the specific physical location where R&D employees performed their qualified services during the claim period. Payroll records alone are insufficient if the employee is known to work or travel outside the state.
• For Supplies: Inventory management systems must track the physical movement of raw materials from purchase or receipt to final consumption in an Idaho facility. Invoices and consumption logs tied directly to specific Idaho research projects provide the necessary objective evidence of the “used in Idaho” requirement.

The failure to maintain robust sourcing documentation represents the most significant area of audit exposure for multi-state entities claiming the Idaho R&D credit.

V. Calculation Methodology and Practical Example

The calculation of the Idaho credit is a sequential process that involves determining the total Idaho QREs, calculating the base amount, and applying the 5% incremental credit rate.

5.1. Determining Total Idaho QREs

The total Idaho QREs are derived by summing all Idaho-sourced IHRE (Wages, Supplies, Computer Leases) and 65% of Idaho-sourced Contract Research Expenses.5 For this example, the focus is solely on the IHRE components:

5.2. Calculating the Idaho Base Amount

The base amount calculation utilizes historical data to establish a benchmark for current research spending.

Scenario Parameters (Year 2024):

• Current Year Idaho QREs (2024): $950,000 (from Section 5.1).
• Taxpayer is a mature company (6+ years of QREs) but elects the irrevocable start-up election in 2024.
• Average Idaho Gross Receipts (AIGR) (2020–2023): $6,000,000.1

Steps for Base Amount Determination:

1. Determine Fixed-Base Percentage (FBP): Since the company elects the irrevocable start-up rule, the FBP is 3.0% for the first five years.2
2. Calculate Statutory Base: Multiply the Average Idaho Gross Receipts (AIGR) by the FBP:
   
   $$\text{Statutory Base} = \$6,000,000 \times 3.0\% = \$180,000$$
3. Calculate Minimum Base Test: Apply the 50% QRE floor:
   
   $$\text{Minimum Base} = \text{Current Idaho QREs} \times 50\% = \$950,000 \times 0.50 = \$475,000$$
4. Determine Final Base Amount: The Final Base Amount is the greater of the Statutory Base or the Minimum Base Test.1 In this scenario, the Minimum Base ($475,000) governs, as it is greater than the Statutory Base ($180,000).

Table 1: Illustrative Example: Calculation of Idaho IHRE and R&D Credit (Year 2024)

The resulting Idaho R&D Tax Credit earned for 2024 is $23,750. Since the credit is nonrefundable, it can be used to offset Idaho income tax liabilities for the current year, and any unused portion may be carried forward for up to 14 tax years.3

VI. Conclusion: Strategic Compliance and Maximizing Idaho IHRE

The Idaho Research Activities Tax Credit provides a material incentive for technological advancement within the state, offering a 5% credit on incremental qualified research expenditures. The realization of this benefit is fundamentally tied to the accurate identification and stringent sourcing of In-House Research Expenses (IHRE).

The state’s reliance on federal IRC §41 definitions ensures technical alignment regarding the scope of qualifying activity (wages, supplies, and computer leases). However, the ultimate qualification for the Idaho credit relies entirely on the taxpayer’s ability to substantiate that these IHRE components—especially the labor performed and supplies consumed—occurred physically within Idaho.4

Strategic compliance dictates that multi-state taxpayers establish granular, activity-based documentation protocols that specifically address the geographic location of research activities. The principal vulnerability in claiming the Idaho credit rests not in the definition of “qualified research” but in the defensibility of the cost allocation and sourcing.

Furthermore, corporations must carefully evaluate the strategic implication of the irrevocable start-up election, as fixing the Fixed-Base Percentage at 3% may limit long-term credit potential if anticipated QRE growth exceeds initial projections. The enduring benefit of the nonrefundable credit, with its generous 14-year carryforward period, makes maximizing accurate IHRE reporting a critical component of corporate tax planning and capital investment strategies in Idaho.3

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