Geographic Sourcing and Compliance for the Idaho R&D Tax Credit: Defining “Research Conducted in Idaho”

I. Executive Summary: The Idaho Research Sourcing Mandate

The meaning of “Research Conducted in Idaho” refers specifically to Qualified Research Expenses (QREs) incurred within the state’s geographical borders that simultaneously meet stringent federal eligibility criteria. This provision mandates that businesses meticulously allocate all research expenditures, including wages, supplies, and contract costs, to Idaho to qualify for the state’s tax credit, while also calculating the credit base amount using only Idaho-sourced gross receipts.

This jurisdictional limitation requires taxpayers to strictly align the federal definitions of qualified research activity (IRC §41) with a robust geographic sourcing methodology, enabling the Idaho State Tax Commission (ISTC) to verify that only activities contributing to the state’s economy receive the incentive under Idaho Code §63-3029G.1

A. Credit Overview and Key Provisions

The Idaho R&D Tax Credit is authorized under Idaho Code §63-3029G, establishing a substantial incentive for technological advancement and innovation within the state.1 The credit is nonrefundable and is applied against taxes imposed by sections 63-3024, 63-3025, and 63-3025A of the Idaho Code.2

The total credit allowed is the sum of two components: 5% of the excess of qualified research expenses for research conducted in Idaho over a base amount, plus 5% of basic research payments (for corporations only) that exceed the qualified organization base period amount, provided the basic research was conducted in Idaho.1

A crucial feature of the Idaho credit is its long-term financial stability for businesses. Although the credit is nonrefundable, meaning it cannot create or contribute to a tax refund, any unused credit can be carried forward for up to 14 tax years.1 This extended carryforward period provides a significant financial advantage, particularly for early-stage companies or those engaged in multi-year R&D projects that may generate substantial expenses long before achieving profitability and subsequent Idaho income tax liability. The extended carryforward acts as an assurance of future tax savings, enhancing the overall present value of the incentive and encouraging sustained, capital-intensive R&D investment within Idaho’s borders.

II. Statutory and Regulatory Foundation: Integrating Federal and State Requirements

The Idaho research credit framework is based on a “federal conformity, state limitation” model. Idaho adopts the substance of the federal R&D tax credit (IRC §41) but applies a critical geographic filter.

A. Conformity to Federal IRC §41 Definitions (The “What”)

Idaho Code §63-3029G explicitly uses the same definitions for “basic research payments,” “basic research,” “qualified research expenses” (QREs), and “qualified research” as those found in Section 41 of the Internal Revenue Code.4 This conformity standardizes the definitions of eligible costs and activities, but the fundamental requirement remains that only the amounts related to research specifically “conducted in Idaho” qualify for the state credit.1

B. The Four-Part Test: Defining Qualified Research Activity

Before any expenditure can be sourced to Idaho, the underlying activity must satisfy the rigorous federal four-part test, as detailed in ISTC guidance and administrative decisions.6 Failing any of these qualitative tests will result in the disallowance of the entire expense, regardless of its Idaho location.

1. Section 174 Test (Permitted Purpose)

The research expenditure must be treated as a research or experimental expenditure under IRC §174.7 This requirement ensures the activity is directed toward fundamental research and experimentation, allowing the cost to be recognized as an expense in connection with the taxpayer’s trade or business.6

2. Technological Information Test

The process of experimentation used to discover new information must fundamentally rely on the principles of the physical sciences, biological sciences, engineering, or computer science.7 The ISTC specifies that activities related to research in economics, business management, behavioral sciences, arts, or humanities are specifically excluded from qualifying.10 Taxpayers may employ existing technologies or principles in their experimentation and still satisfy this requirement.7

3. Business Component Test

The taxpayer must intend to apply the information being discovered to develop a new or improved business component. A business component includes any product, process, computer software, technique, formula, or invention that is held for sale, lease, or use in the taxpayer’s trade or business.7 The activity must aim to improve the component’s functionality, performance, reliability, or quality.11

4. Process of Experimentation Test (Elimination of Uncertainty)

This test requires that the taxpayer intends to discover information that would eliminate uncertainty concerning the development or improvement of the business component.11 Uncertainty is defined as existing when the information available to the taxpayer does not establish the capability, method, or appropriate design of the product or improvement.7 This uncertainty requirement can be met even if the taxpayer knows that the goal is technically possible, but is unsure of the optimal method or design required to achieve it.7

The ISTC places significant emphasis on the quality of documentation backing these four criteria during audits. Audit decisions show that credits may be denied if taxpayers fail to provide sufficient documentation demonstrating how projects meet the technological information test, satisfy the process of experimentation, or address specific technical uncertainties.7 The failure to employ a “project-by-project approach” when determining which activities meet the definition of “qualified research” is a common deficiency noted by the ISTC.13 The physical performance of the research in Idaho is merely the jurisdictional starting point; success hinges on substantiating the fundamental technical nature of the work.

Table 1 provides a summary of the alignment between the federal qualitative standards and the Idaho credit requirements.

Table 1: Idaho R&D Tax Credit Eligibility: The Four-Part Test

III. ISTC Guidance: Geographic Allocation of QREs (The “Where”)

For multi-state entities, the most complex aspect of the Idaho R&D credit is the geographical sourcing of Qualified Research Expenses. The ISTC’s instructions, particularly those related to Form 67 (Credit for Idaho Research Activities), define exactly what constitutes “Research Conducted in Idaho” by specifying the required location for each expense category.10

A. Sourcing Rules for In-House Expenses (Form 67, Lines 4-6)

1. Wages for Qualified Services Performed in Idaho (Form 67, Line 4)

Wages for qualified services—which include engaging in, directly supervising, or directly supporting qualified research—must be sourced based on where the services were physically performed in Idaho.10

For employees who travel or perform services across state lines, the rules for determining the amount of compensation that constitutes Idaho source income, as detailed in the Income Tax Administrative Rules (IDAPA 35.01.01.270), apply.14 These rules dictate that if an individual performs personal services both within and without Idaho on the same day, that day is treated as an Idaho workday if 50% or more of the services were performed within the state that day. If an employee is working on a regular full-time basis, working hours must be utilized to determine the precise Idaho compensation percentage.14 Consequently, taxpayers claiming QREs for multi-state employees must maintain sophisticated, detailed time tracking records to substantiate the exact fraction of wages attributable to Idaho QREs. Simply using an employee’s residence or primary office address is insufficient if the work location is fluid.

2. Cost of Supplies Used in Idaho (Form 67, Line 5)

Supplies, defined as tangible property other than land or property subject to depreciation, must be physically used in Idaho during the qualified research process.10 This necessitates tracking the consumption or final installation location of materials utilized in prototyping, testing, or experimentation.

3. Rental or Lease Costs of Computers Used in Idaho (Form 67, Line 6)

Costs associated with renting or leasing computers qualify only if the computers are used in Idaho.10 Furthermore, the expense must meet the federal limitations: the computer must be located off the taxpayer’s premises, and the taxpayer cannot be the operator or primary user.10 The expense claimed must also be reduced by any amounts received by the taxpayer for the right to use substantially identical property.

B. Allocation of Contract Research Expenses (Form 67, Line 7)

Contract research expenses (CREs) relate to payments made to third parties for qualified research performed on the taxpayer’s behalf.10 To qualify for the Idaho credit, the contracted research must be conducted in Idaho.

The percentage of the expense eligible for inclusion is generally 65% of the amount paid or incurred.10 This percentage increases to 75% if the payments are made to a qualified research consortium that conducted the research within Idaho.10 Additionally, the Idaho calculation incorporates 65% of any basic research payments that do not exceed the qualified organization base period amount.10

C. Exclusion of the Alternative Simplified Credit (ASC) Method

Idaho mandates the use of the regular credit calculation method (Fixed-Base Percentage, or FBP), which is based on historical activity.4 The state does not allow the calculation of the Alternative Simplified Credit (ASC), a method often favored at the federal level for its computational simplicity.4 The exclusion of the ASC method significantly increases the compliance burden for Idaho taxpayers, as they must maintain and, if necessary, reconstruct historical financial records for both QREs and Idaho Gross Receipts (IGR) dating back to 1984 or 1994 to accurately determine their FBP.10 This rigorous historical data requirement underscores the importance of robust record-keeping for companies seeking to claim or defend the Idaho credit.

IV. Calculating the Base Amount: Idaho Gross Receipts Apportionment

The mechanism used to calculate the Base Amount is where the geographical constraint is applied to a company’s financial performance, ensuring the credit incentivizes an increase in Idaho-specific research activity relative to Idaho-specific sales.

A. The Base Amount Calculation

The Idaho R&D credit is calculated on the incremental QREs, which are the current year Idaho QREs that exceed the calculated Base Amount.1

The Base Amount is determined by multiplying the Fixed-Base Percentage (FBP) by the Average Annual Idaho Gross Receipts (IGR) from the four preceding tax years.1

$$\text{Base Amount} = \text{FBP} \times \text{Average IGR (prior 4 years)}$$

The Base Amount calculation is subject to a statutory minimum floor: it cannot be less than 50% of the taxpayer’s current year Idaho QREs.1 This floor functions as a safeguard, limiting the credit benefit for companies that have a sustained history of high R&D expenditures relative to their base period, preventing 100% of current-year QREs from qualifying as excess.

B. Defining Idaho Gross Receipts (IGR)

Idaho Gross Receipts (IGR) are the foundational element for calculating the average annual gross receipts used in the Base Amount formula. Idaho Code §63-3029G specifies that for purposes of the credit calculation, a taxpayer’s gross receipts include only those gross receipts attributable to sources within Idaho.2

This attribution must utilize the multistate corporation apportionment rules detailed in Idaho Code §63-3027.2 For most multistate corporations, the default apportionment factor under Idaho Code §63-3027 is a single sales factor.15 Therefore, IGR generally corresponds to sales sourced to customers within Idaho using the state’s apportionment methodology.

The reliance on the single sales factor for IGR calculation introduces a unique dynamic for multi-state R&D firms. The standard goal of tax apportionment is generally to maximize the Idaho taxable income (which relies on Idaho-sourced sales). However, for the R&D credit base calculation, a lower IGR is financially advantageous, as a smaller base amount (FBP $\times$ Low IGR) results in higher “excess QREs” eligible for the 5% credit rate.1 For companies that conduct significant R&D in Idaho (high Idaho QREs) but market and sell their resulting products predominantly outside the state (low IGR), the base amount is naturally minimized, maximizing the credit benefit. Conversely, companies with high IGR relative to their FBP may see their base amount increase, potentially triggering the 50% QRE minimum floor and consequently reducing the calculated credit.

C. The Irrevocable Start-Up Election

Idaho offers a special provision that allows taxpayers to elect to be treated as a start-up company, irrespective of whether they meet the federal criteria for start-up status under IRC §41(c)(3)(B).2

If this election is made, the fixed-base percentage is determined using the federal start-up formula, but only Idaho QREs and Idaho gross receipts are included in the calculation.2 The FBP for a start-up is capped at 16%.1

A critical consideration is that the start-up election, once made, is irrevocable.1 This permanence requires significant long-term strategic tax planning. A company must project its expected growth in both Idaho QREs and IGR over the long term. While the start-up election may provide a low FBP in early years, maximizing initial credit claims, a permanent election could become detrimental if the company experiences a rapid future increase in Idaho sales (high IGR) while R&D spending stabilizes relative to revenue. The locked-in FBP might then result in a higher calculated base amount than a standard historical FBP calculation would have yielded, potentially reducing future credits.

V. Practical Example: Allocation and Calculation for a Multi-State Firm

To demonstrate the application of RCI principles and IGR apportionment, consider Boise Tech Innovators (BTI), a multi-state engineering firm headquartered in Oregon but maintaining a fabrication lab in Boise, Idaho.

A. Geographic Sourcing of QREs (Tax Year 2024)

BTI incurs $2,000,000 in total federal QREs. Sourcing these activities to Idaho is mandatory:

B. Base Period Data and Fixed-Base Percentage

BTI’s Fixed-Base Percentage (FBP) is 12%. The calculation uses Idaho Gross Receipts (IGR) derived from the multistate apportionment rules.

C. Final Credit Calculation (Tax Year 2024)

1. Determine Current Year Idaho QREs:

• $1,430,000.

1. Calculate Base Amount using FBP:

• FBP (12%) $\times$ Average IGR ($2,000,000$) = $240,000.

1. Calculate Minimum Statutory Floor:

• 50% of Current Idaho QREs: $1,430,000 \times 50% = $715,000.1

1. Determine Statutory Base Amount:

• The Base Amount used must be the greater of the FBP-derived amount ($240,000) or the 50% QRE minimum floor ($715,000).
• Statutory Base Amount Used: $715,000.

1. Calculate Excess QREs:

• Current Idaho QREs ($1,430,000) – Statutory Base Amount ($715,000) = $715,000.1

1. Calculate Idaho R&D Tax Credit:

• Excess QREs ($715,000) $\times$ 5% Credit Rate = $35,750.1

This example highlights the impact of the 50% minimum QRE floor. In this case, the company’s sustained, high level of current R&D, relative to its historical base ratio, caused the minimum floor to govern the calculation. The floor reduced the potential excess QREs eligible for the credit by $475,000 ($715,000 used vs. $240,000 calculated base), demonstrating that even with high, qualified Idaho expenses, the credit is inherently limited to half of the current QREs when the historical calculation yields a lower base. This mechanism ensures that the credit remains focused on incentivizing the sustained continuation of research activities, even if the measured increase is capped.

VI. Compliance, Audit Considerations, and Strategic Takeaways

Maximizing the Idaho R&D credit requires a holistic strategy encompassing rigorous documentation of both the qualitative nature of the research and the geographic sourcing of costs.

A. ISTC Audit Focus and Substantiation Requirements

ISTC audit decisions frequently highlight documentation failure as the primary reason for credit disallowance. Taxpayers must move beyond merely listing expenses and provide project-specific evidence that satisfies the federal four-part test, particularly showing that the research activities eliminated technical uncertainty and that the methodology relied on technological information.7

To satisfy the RCI geographical requirement, businesses must ensure complete geographic traceability of QREs. This involves maintaining detailed records that substantiate the allocation of multi-state employee wages based on actual workdays or hours spent in Idaho.10 For supplies and leased equipment, physical location verification must be maintained to confirm the property was used in Idaho.10

B. Unitary Groups and Apportionment Consistency

For multi-state and unitary corporations, consistency in applying the jurisdictional allocation rules is vital.

1. Unitary Group Credit Sharing

Corporations included as members of a unitary group that file a combined report are permitted to share the Idaho research credit earned by one member with other members of the group.3 This sharing provision is strategically important because it prevents the credit from being trapped in an entity that may not have sufficient current Idaho income tax liability to utilize it immediately. However, the corporation that initially earned the credit must first claim the credit to the extent allowable against its own Idaho income tax before sharing any remaining credit.3 This mechanism optimizes the immediate utilization of the nonrefundable credit across the combined group, improving cash flow management. Unused credits retain the 14-year carryforward period.4

2. Apportionment for Gross Receipts

Taxpayers must consistently use Idaho’s multistate corporation apportionment rules, which generally rely on the single sales factor under Idaho Code §63-3027, to determine Idaho Gross Receipts (IGR) for the Base Amount calculation.2 While the apportionment calculation is typically used to determine taxable income, here it serves to measure the taxpayer’s Idaho-centric business activity for the purpose of defining the historical base against which current R&D intensity is measured.

C. Post-TCJA Considerations

Since 2022, the federal Tax Cuts and Jobs Act (TCJA) requires domestic R&D expenditures to be amortized over five years for federal tax purposes.7 While the Idaho credit calculation relies on the QREs paid or incurred during the tax year (before amortization), the complexity of managing R&D expenditures has increased. Taxpayers must ensure they correctly track and document the costs qualifying for the Idaho credit while simultaneously managing the federal capitalization requirements, necessitating a high degree of integration between federal and state R&D tax compliance efforts.

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