The Alternative Incremental Credit (AIC) 10% Rate in Indiana: Statutory Compliance and Strategic Implications for the Research Expense Credit

The Alternative Incremental Credit (AIC) 10% rate is an elective method for calculating the Indiana Research Expense Credit (REC). It applies a 10% rate to a taxpayer’s current-year Qualified Research Expenses (QREs) that exceed 50% of the QRE average from the three preceding tax years.1

This calculation method, codified under Indiana Code (IC) 6-3.1-4, provides a simplified path for businesses to claim research tax benefits, though its availability may be restricted to certain industries, demanding meticulous statutory and regulatory review for compliance.

I. Introduction: The Strategic Context of Indiana’s R&D Tax Incentive

A. Overview and Statutory Foundation of the Research Expense Credit (REC)

The State of Indiana offers the Research Expense Tax Credit (REC) as a key financial incentive designed to encourage substantial investment in research and development activities within the state.3 This incentive is fundamentally established under IC 6-3.1-4.3 The stated purpose of the REC is to provide a mechanism for taxpayers to offset their state income tax liability based on a percentage of qualified research expenses incurred specifically within Indiana’s borders.3

A critical characteristic of the Indiana REC is that it is a nonrefundable tax credit. While it cannot result in a direct cash refund upon filing, any portion of the credit that remains unused in the current taxable year due to insufficient tax liability may be carried forward for a period of up to ten subsequent taxable years.4 This significant carryforward period enhances the long-term value of the credit, making it an essential component of strategic corporate tax planning for companies with a presence in Indiana.

B. Defining Indiana Qualified Research Expenses (QREs) and Geographic Restriction

The definition of a Qualified Research Expense (QRE) in Indiana begins by mirroring the federal standard found in Section 41(b) of the Internal Revenue Code (IRC), as that section existed on January 1, 2001.5 Generally, QREs include the sum of in-house research expenses (such as wages paid to employees directly involved in research and costs of supplies) and certain contract research expenses.3

However, Indiana imposes a critical modification upon the federal definition: only expenses for qualified research that is conducted in Indiana are eligible for the state credit.3 This localization requirement means that multi-state or multinational corporations must undertake extensive processes to accurately source their research expenditures. The Indiana Department of Revenue (IDOR) considers several factors when prescribing what qualifies as an in-state research expense, including the place where the services are performed, the residence or business location of the performing persons, and the place where qualified research supplies are consumed.5

The necessity of strict geographic cost tracking fundamentally elevates the compliance demands for the Indiana REC compared to the federal credit. While federal QREs can be calculated based on global research activities (subject to U.S. situs rules for certain expenses), Indiana explicitly demands proof that the costs are tied to activities physically performed or consumed within the state. Consequently, organizations must implement robust, auditable methodologies—such as detailed location-based time tracking for R&D personnel or sophisticated inventory logs for supplies—to successfully segregate and substantiate Indiana-specific QREs.5 This granular level of documentation is crucial to minimize the risk of credit disallowance during a state audit.

II. The Dual Calculation Pathways: RRC vs. AIC

Indiana taxpayers have an election between two distinct methodologies established under IC 6-3.1-4 for determining their Research Expense Credit: the traditional Regular Research Credit (RRC) and the Alternative Incremental Credit (AIC).

A. The Standard Research Credit (RRC) Method (Fixed Base Percentage)

The RRC method, based on the traditional method found in federal tax law, utilizes a historical Base Amount derived from a lookback at prior years’ activities. This calculation requires the taxpayer to compute a Fixed-Base Percentage (FBP) and apply it against average prior-year gross receipts.3

Indiana adapts the federal rules by substituting state-specific figures. Specifically, the base amount calculation follows the manner set forth under IRC § 41(c), but mandates the use of Indiana gross receipts and Indiana QREs.2

1. Base Calculation: The Base Amount is calculated by multiplying the Indiana fixed-base percentage by the average Indiana gross receipts of the taxpayer for the four preceding years.3
2. The Floor Rule: The resulting Base Amount calculated under the FBP method is subject to a statutory floor: the amount cannot be less than 50% of the taxpayer’s Indiana QREs for the current taxable year.3

Once the Base Amount is determined, the credit is calculated based on the resulting Excess QREs (Current QREs minus the Base Amount) using a tiered rate structure 3:

• 15% Rate: Applied to the lesser of $1 million or the calculated excess QREs.2
• 10% Rate (RRC Tier 2): Applied to any remaining excess QREs that exceed the initial $1 million threshold.2

B. Introduction to the Alternative Incremental Credit (AIC) Method

The AIC method was introduced for Indiana qualified research expenses incurred after December 31, 2009, offering an alternative elective calculation.5 Its primary appeal lies in simplifying the base calculation by eliminating the requirement to use the complex FBP formula involving historical gross receipts.2 This makes the AIC particularly attractive to companies that may have incomplete historical records for gross receipts or whose gross receipts fluctuate significantly relative to their research spending.2

The key differences between these two methodologies can be summarized as follows:

Comparison of Indiana Research Expense Credit Calculation Methods

III. Deconstructing the AIC 10% Rate (For Average QREs)

The AIC 10% rate calculation is an elective methodology explicitly detailed in Indiana statute, providing a straightforward calculation based solely on historical QRE performance.

A. Statutory Definition and Calculation Mechanics

When a taxpayer elects the AIC, the credit amount is precisely defined: it is equal to ten percent (10%) of the portion of the taxpayer’s Indiana qualified research expense for the current taxable year that surpasses fifty percent (50%) of the taxpayer’s average Indiana qualified research expense for the three (3) taxable years immediately preceding the current year.1

The calculation proceeds in clear steps:

1. Determine the Average QREs: The taxpayer must calculate the arithmetic average of their Indiana QREs for the three preceding taxable years (T-1, T-2, T-3).2
2. Calculate the AIC Base Amount (The 50% Rule): The mandated base is 50% of the three-year average QREs.1 This 50% threshold ensures that a company must demonstrate research spending in the current year that significantly exceeds their calculated historical baseline to generate incremental credit.
3. Calculate Excess QREs: This is the resulting amount of current-year QREs that exceed the calculated AIC Base Amount.
4. Apply the 10% Incremental Rate: The final credit is calculated by multiplying the entire amount of Excess QREs by 10%.2 Unlike the RRC, the AIC does not offer the higher 15% rate cap on the first million dollars of excess; it is a consistent 10% rate applied to the full increment.

B. The 5% Fallback Rule: Addressing Zero or Missing Historical QREs

A crucial component of the AIC framework is the statutory fallback rule designed for companies lacking a complete history of research spending.

• Trigger Condition: If the taxpayer fails to establish a consistent three-year history—specifically, if the taxpayer did not have Indiana qualified research expenses in any one of the three taxable years preceding the taxable year for which the credit is being determined—the standard 10% incremental calculation cannot be used.1
• Fallback Calculation: In such a case, the statute mandates that the credit amount defaults to a flat five percent (5%) of the taxpayer’s total Indiana qualified research expense for the current taxable year.2

This 5% fallback provision functions as a critical statutory relief mechanism, particularly for newer companies or those whose R&D spending has been highly erratic. By providing a flat 5% on current-year QREs, the state ensures that these companies are not penalized with a zero credit outcome simply because they lack the necessary historical data to establish a valid incremental base. Although 5% is significantly less advantageous than the potential benefits available under the 10% AIC rate or the RRC’s 15% rate, it guarantees an immediate incentive for current research expenditures, reinforcing the state’s broader goal of promoting investment in innovation.2

IV. Indiana Regulatory Guidance and Statutory Constraints

Navigating the Indiana REC, particularly the AIC election, requires careful consideration of specific legislative constraints and the ongoing guidance issued by the Indiana Department of Revenue (IDOR).

A. The Critical Restriction: The Aerospace Industry Clause (IC 6-3.1-4-8)

A significant point of regulatory interpretation relates to the statutory scope of the AIC method. While multiple official and expert sources describe the AIC as an “alternative method of calculating the credit” available for QREs incurred after 2009 5, the specific statutory section governing special calculations creates ambiguity.

The complexity arises because specific provisions within IC 6-3.1-4-8 introduce an alternative calculation method that directly mirrors the structure of the general AIC (Current QREs minus 50% of the 3-year average QREs). However, this specific provision applies only to taxpayers involved in “the production of civil and military jet propulsion” (the aerospace industry).4 Furthermore, the IDOR’s own general information notes that “For the aerospace industry there is an alternative method of calculating this credit”.9

If an IDOR audit determines that the AIC calculation, as codified, is legally restricted solely to aerospace entities under IC 6-3.1-4-8, then non-aerospace taxpayers who elect the AIC may face a significant compliance challenge. If the election is deemed invalid, the claimed credits based on the 10% AIC rate could be disallowed, necessitating a retroactive recalculation under the RRC method (which might yield a lower credit or zero credit, depending on the taxpayer’s historical gross receipts and QREs), plus the imposition of interest and potential penalties.4 Therefore, non-aerospace businesses considering the AIC election must perform extensive due diligence on the current binding statutory interpretation from the IDOR to mitigate the risk of disallowance.

B. Claiming the Credit: Forms and Documentation Requirements

To claim the Research Expense Credit, taxpayers must file the appropriate forms with their annual Indiana income tax return. The specific state schedule is Schedule IN-STTC (historically known as IT-20REC), which must be fully completed and enclosed with the return.3

The IDOR places a heavy emphasis on documentation, requiring taxpayers to provide sufficient detail to prove that the claimed qualified research activity was conducted in Indiana.6 Schedule IN-STTC mandates specific responses regarding:

• The place(s) where the services were performed.
• The residence or business location of the person(s) performing the services.
• The place where qualified research supplies were consumed.6

The necessity for gathering contemporaneous documentation to support the Indiana REC claim is frequently highlighted in IDOR guidance.3 This includes maintaining records adequate to substantiate the purchase price of supplies, wages, and contract research expenses, ensuring the documentation supports the statutory definitions and the in-state requirement.

C. Mandatory Federal/State Credit Disclosure (HEA 1001, 2019)

Indiana implemented new tax compliance regulations starting in 2019, through HEA 1001, which introduced mandatory disclosure requirements linking the state REC claim to any corresponding federal R&D tax credit claims.9

A taxpayer claiming the Indiana REC is now required to report to the IDOR whether they also determined a credit for those same Indiana qualified research expenses under either the federal Regular Research Credit (IRC Sec. 41(a)(1)) or the Alternative Simplified Credit (IRC Sec. 41(c)(4)).9

Crucially, if a taxpayer claims the Indiana REC but elects not to claim a federal R&D credit for those underlying expenses, the taxpayer must provide a detailed disclosure to the IDOR explaining the reasons for this decision.9 This reporting structure means that a change to the federal credit calculation or claim status will be considered a modification affecting the state claim.

This disclosure rule significantly tightens state audit capabilities. By demanding reconciliation between state and federal claims, the IDOR can use the detailed documentation requirements established by the Internal Revenue Service (IRS)—such as the identification of business components, description of research activities, and information on the objectives of the research 10—to validate the substance of the Indiana claim. A company claiming research activity sufficient for the Indiana credit but insufficient for the federal credit must possess a robust, technical justification for that determination, as the IDOR may adopt rules to scrutinize state-only claims more rigorously.

V. Practical Application and Detailed Calculation Example

To illustrate the mechanism of the AIC 10% rate and its associated fallback provision, a detailed numerical example based on a hypothetical company, InnovateCorp, is provided below, calculating the credit for Tax Year (TY) 2024.

A. Scenario 1: Successful AIC Election and the 10% Rate

This scenario assumes InnovateCorp has maintained consistent QREs throughout the lookback period and successfully elects the AIC method.

Historical Data for InnovateCorp (Indiana QREs):

• TY 2024 (Current QREs): $2,000,000
• TY 2023 (T-1 QREs): $1,500,000
• TY 2022 (T-2 QREs): $1,000,000
• TY 2021 (T-3 QREs): $1,100,000

Detailed AIC (10% Rate) Calculation Example (Scenario 1)

The resulting $140,000 is the nonrefundable research expense tax credit available to InnovateCorp for TY 2024, subject to the 10-year carryforward rule for any unused portion.2

B. Scenario 2: Application of the 5% Fallback Rule

This scenario assumes InnovateCorp had inconsistent research activity, triggering the statutory fallback.

Historical Data for InnovateCorp (Indiana QREs):

• TY 2024 (Current QREs): $2,000,000
• TY 2023 (T-1 QREs): $1,500,000
• TY 2022 (T-2 QREs): $1,000,000
• TY 2021 (T-3 QREs): $0

Detailed AIC (5% Fallback Rate) Calculation Example (Scenario 2)

In this case, despite high current-year spending, the failure to have QREs in one of the three prior years forces the taxpayer to the 5% fallback rate, resulting in a significantly reduced credit of $100,000 compared to the incremental calculation’s $140,000.2

VI. Conclusion and Strategic Recommendations

The Alternative Incremental Credit (AIC) 10% rate represents a valuable simplification for calculating the Indiana Research Expense Credit, offering a predictable method based on historical QREs rather than requiring complex gross receipt calculations. This method incentivizes R&D investment by providing a clear threshold for incremental spending (50% of the three-year average).

However, corporate tax professionals and financial leaders must adopt a risk-managed approach when electing the AIC, factoring in statutory constraints and administrative demands.

1. Mandatory Review of Statutory Scope: While the AIC is often presented as a general elective alternative, the specific statutory language linking the underlying formula to taxpayers involved in “civil and military jet propulsion” raises significant compliance concerns for non-aerospace entities.4 A company outside the aerospace industry should secure authoritative confirmation from legal counsel or the IDOR regarding the general availability of the AIC method under IC 6-3.1-4-2 before making the election, thereby preempting potential audit disallowances and costly retroactive recalculations.
2. Strategic Modeling of Calculation Methods: Taxpayers should conduct internal financial modeling comparing the benefits of the AIC (simplicity, flat 10% rate) against the RRC (higher potential rate of 15% on the first $1 million of excess QREs).2 For companies with substantial and consistent QRE growth, the RRC may yield a superior financial outcome, whereas the AIC is generally better suited for stability or where historical gross receipt data is insufficient.
3. Enhanced Documentation and Disclosure Compliance: The requirement under HEA 1001 to disclose any discrepancy between the Indiana REC claim and the corresponding federal R&D tax credit claim elevates the necessary level of documentation for state purposes.9 Taxpayers must maintain meticulous, contemporaneous records that not only support the technical and financial aspects of the QREs but also definitively prove the research activities were conducted physically within Indiana.3 Furthermore, companies should utilize the parallel incentive, the 100% sales and use tax exemption for qualified R&D equipment, ensuring compliance with the separate documentation requirements (Form ST-105) for that benefit.3
4. Utilization of Carryforward: Given the nonrefundable nature of the credit, taxpayers should track and fully utilize the 10-year carryforward period, integrating the accrued benefits into long-term financial forecasts and tax projections.4

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/