A Deep Dive into the Indiana Research Expense Credit (REC): Clarifying the Role of Schedule IN-EDGE-R

The Indiana Research Expense Credit (REC), codified under Indiana Code (IC) 6-3.1-4, is a nonrefundable income tax incentive designed to reward businesses for increasing qualified research and development (R&D) activities conducted within the state. Taxpayers calculate this credit based on their Qualified Research Expenses (QREs), utilizing tiered rates of up to 15% on incremental investment over a calculated base amount.

This report provides a detailed analysis of the Indiana REC, clarifies the common administrative confusion surrounding Schedule IN-EDGE-R, and outlines the precise guidance provided by the Indiana Department of Revenue (DOR) for maximizing compliance and credit utilization.

Critical Distinction: Schedule IN-EDGE-R vs. the Research Expense Credit (REC)

One of the most frequent errors in state tax compliance involves the misidentification of the schedule used to claim the Research Expense Credit (REC). It is essential to understand that Schedule IN-EDGE-R is wholly unrelated to the calculation or claim of the statutory R&D credit.

The True Purpose of Schedule IN-EDGE-R

Schedule IN-EDGE-R (State Form 55363) is exclusively designated for claiming the Economic Development for a Growing Economy Retention Credit (EDGE-R).1 This incentive is fundamentally distinct from the REC in its administration, purpose, and required documentation.

The EDGE-R credit is an economic development incentive, often tied to contractual obligations for job creation or retention.3 Eligibility is determined by the Indiana Economic Development Corporation (IEDC), not the DOR, and requires a formal, pre-approved certification process.1

When filing Schedule IN-EDGE-R, taxpayers must provide specific administrative details for the certified project, including the Certification Year, Project Number, and Project PIN.2 A taxpayer attempting to use this schedule to claim R&D expenses will fail because the claim will lack the necessary IEDC pre-approval and unique identification numbers required for the Retention Credit.1 Taxpayers claiming this credit must complete the schedule and enclose it with their tax return (e.g., Form IT-20, IT-40, IT-65, etc.); failure to enclose the required form will result in disallowance of the credit.1

The Correct Mechanism for the Research Expense Credit (REC)

The Research Expense Credit is an entitlement credit claimed directly by the taxpayer by calculating QREs against a defined base, requiring a separate filing mechanism.

The REC is calculated on a dedicated form, historically designated as Schedule IT-20REC, which must be attached to the taxpayer’s annual state income tax return (such as Form IT-20 for corporations or Schedule 5/F for individuals).2 To ensure compliance with federal definitions, the Indiana DOR mandates that taxpayers attach a copy of the corresponding Federal Form 6765 (Credit for Increasing Research Activities).5

For pass-through entities, which include S corporations, partnerships, and LLCs, the entity computes the credit amount and then allocates it pro-rata to its owners (partners, shareholders, or members) using Schedule IN K-1.6 The individual owners then use this information to claim their proportionate share of the credit against their personal Indiana tax liability.6

This separation of forms and administrative oversight (IEDC for EDGE-R, DOR via IC 6-3.1-4 for REC) confirms that these are two fundamentally different incentives. Accurate form usage is the first critical step in successful compliance.

Statutory Foundation and Qualified Research Definition (IC 6-3.1-4)

The statutory authority for the Research Expense Credit is found in Indiana Code (IC) 6-3.1-4.8 This chapter defines the credit and sets stringent requirements regarding the types of expenses eligible and where the activities must occur.

Defining Indiana Qualified Research Expenses (QREs)

Indiana aligns its definition of Qualified Research Expenses (QREs) with federal standards, specifically Section 41(b) of the Internal Revenue Code (IRC).9 This typically includes in-house research expenses (such as wages for employees performing or supervising research, and supplies consumed in the research) and 65% of contract research expenses.9

However, Indiana imposes a crucial geographical limitation: QREs must be for qualified research that is conducted in Indiana.9 The DOR has clarified that documentation must substantiate the Indiana locations where services are performed, where qualified supplies are consumed, and where research personnel are located.5

Furthermore, the research expenditures must relate to a particular trade or business carried on by the taxpayer.9 Unlike the federal credit, which historically faced expiration dates, Indiana law specifically states that the termination date in IRC §41(h) does not apply to the Indiana credit, ensuring the incentive remains available permanently.12

The Technical Research Standard and Audit Guidance

To qualify as research, activities must satisfy the rigorous federal “four-part test,” which requires a taxpayer to demonstrate that the activities were undertaken for the purpose of discovering technological information intended to be useful in the development of a new or improved business component.13 Substantially all activities must constitute elements of a process of experimentation.13 The DOR explicitly uses guidance from the IRS when auditing the research credit, reinforcing the necessity of meeting federal technical standards.9

A noteworthy compliance provision requires any taxpayer claiming the Indiana credit but not claiming the federal credit for the same qualified research expenses to disclose the reasons for that deviation to the DOR.14 This mandate helps the DOR identify potential claims where the activity might qualify only under the narrow Indiana geographic scope but was otherwise structurally unsound or failed the federal four-part test.

Research Exclusions and Internal Use Software

In line with federal standards, certain activities are expressly excluded from the definition of qualified research 9:

• Research conducted outside of the United States.
• Research related to social sciences, arts, or humanities.
• Research that is funded by any grant, contract, or otherwise by another person or governmental entity.9

Internal Use Software (IUS) development is subject to special scrutiny. IUS, defined as software developed primarily for the taxpayer’s internal use in general and administrative functions, must meet a three-part “high-threshold-of-innovation test” in addition to the standard four-part test for qualified research.15 This high bar reflects the department’s heightened focus on ensuring IUS claims genuinely represent technological innovation rather than routine business process improvements.

Detailed Analysis of REC Calculation Methodologies

Indiana allows taxpayers to choose between two methods for calculating the REC, both based on increasing QREs above a historical base amount. Taxpayers should model both methods annually to determine the maximum allowable credit.

Method 1: The Regular (Incremental) Research Expense Credit

The Regular Method calculates the credit based on the growth of Indiana QREs (Q) over a statutory base amount (B).8

Calculation of the Base Amount

The base amount adheres to the complex fixed-base percentage rules of IRC §41(c), but utilizes only Indiana gross receipts and Indiana QREs.7 The base amount is generally the product of a fixed-base percentage and the average Indiana gross receipts for the four preceding tax years. By statute, the base amount may never be less than 50% of the current year’s QREs.7

For new businesses (startups), the fixed-base percentage is phased in, starting at 3% for the first five credit years, and gradually increasing to 16% by year ten. This phased approach mitigates the burden of a high base amount for nascent companies that are rapidly growing their R&D expenditures.7

Application of Tiered Credit Rates

Once the excess QREs (Q minus B) are calculated, Indiana applies favorable tiered rates, effective for expenses incurred on or after January 1, 2008 8:

1. Tier 1 (High Rate): 15% of the excess QREs, applied up to the first $\$1$ million of that excess.8
2. Tier 2 (Standard Rate): 10% of the remaining excess QREs above $\$1$ million.8

This tiered structure is highly strategic, offering a particularly strong incentive (15%) for companies showing modest to moderate incremental growth, making the first million dollars of growth extremely valuable.

Method 2: The Alternative Simplified Credit (ASC)

Available for tax years after 2009, the ASC provides a simpler, retrospective calculation method that removes the need to calculate the fixed-base percentage based on gross receipts.11 This method is advantageous for companies with volatile QREs or complicated receipt histories.

ASC Base and Rate

1. ASC Base: The base is defined as $50\%$ of the average Indiana QREs incurred during the three taxable years immediately preceding the current tax year.7
2. Standard ASC Rate: The credit is calculated as $10\%$ of the current year’s Indiana QREs that exceed the ASC base.11
3. Fallback Rate: If the taxpayer did not incur any Indiana QREs in any one of the three preceding tax years, a simplified fallback rate applies: the credit is $5\%$ of the total current year Indiana QREs.11 This fallback ensures that even very new or intermittent R&D performers can secure a benefit.

Indiana Department of Revenue (DOR) Compliance and Guidance

The DOR provides specific requirements concerning how the credit must be utilized and what level of documentation is necessary to withstand audit scrutiny.

Credit Utilization and Carryforward Rules

The REC is nonrefundable, meaning it can only offset a tax liability, not generate a cash refund in the current year.8 However, unused credits can be carried forward for up to 10 succeeding taxable years.6

A crucial compliance detail is the order of application for credits. IC 6-3.1-4-3(b) establishes a strict priority rule: the current year credit must be used first to offset the current tax liability before any accumulated credit carryforward is applied.6 For example, if a taxpayer has a credit carryforward from 2010 and a newly earned credit from 2018, the 2018 credit must be applied first, maximizing the lifespan of the older 2010 credit by pushing its use later.9

For combined tax groups, the credit carryforward must first be used by the earning member to offset their liability, and then by other members of the group, up to the amount of their respective tax liabilities.9

Mandatory Contemporaneous Documentation

The DOR emphasizes that random and unsupported allocations or estimates are generally insufficient and will not support a claim.9 To substantiate both the technical activity and the crucial in-state location requirement, documentation must be created contemporaneously (at the time the activity occurs) and maintained on a project-by-project basis.9

Key contemporaneous documentation required includes:

1. Project Scope and Uncertainty: A listing of each new or improved business component and documentation detailing the technological uncertainty addressed and the alternative methods considered to resolve that uncertainty.9
2. Activity Records: Records of research and testing activities performed in Indiana, including contract agreements and purchase orders for third-party vendors operating within the state.9
3. Expense Substantiation: Detailed records supporting material and supplies consumed in Indiana (e.g., invoices, material withdrawn from inventory).9
4. Time Tracking: Detailed job descriptions and records of time spent on R&D activities by employees in Indiana.9
5. Results: Testing verification data, project summaries, and progress reports demonstrating the results of the research and the resolution of the initial uncertainty.9

The DOR cites federal guidance in its auditing practice.9 Failure to provide comprehensive, contemporaneous documentation supporting the technical four-part test and the location requirement can lead to the denial of the credit claim, as demonstrated by past audit rulings.13

Related Incentive: The 100% R&D Sales Tax Exemption

Separate from the income tax credit, Indiana offers a significant cash flow benefit: a 100 percent sales tax exemption for qualified R&D equipment and property purchased for use in Indiana (IC 6-2.5-5-40).9

This exemption is claimed proactively by presenting Form ST-105, Indiana Sales and Use Tax Exemption Certificate, to the seller at the time of purchase.9 If a taxpayer inadvertently pays sales tax on exempt property, they may file a timely claim for a refund using Form GA-110L.18 Maintaining detailed records substantiating the purchase and the qualified research use is mandatory for this exemption and directly supports the overall REC claim.9

Practical Example: Calculating the Indiana Research Expense Credit

This example illustrates the application of the tiered rates under the Regular Method, which is often the most beneficial calculation for growth-oriented businesses.

Scenario: Indiana Manufacturing Co. is calculating its Research Expense Credit for the current year.

Calculation Steps:

1. Determine Excess QREs:
   Excess QREs = Current QREs (Q) $-$ Base Amount (B)
   $\$2,500,000 – \$800,000 = \$1,700,000$ (Excess QREs)
2. Apply Tier 1 Rate (15% on the first $\$1$ Million of Excess):
   $\$1,000,000 \times 15\% = \$150,000$
3. Apply Tier 2 Rate (10% on Excess over $\$1$ Million):
   Remaining Excess = $\$1,700,000 – \$1,000,000 = \$700,000$
   $\$700,000 \times 10\% = \$70,000$
4. Total Indiana Research Expense Credit:
   $\$150,000 + \$70,000 = \$220,000$ 7

This $\$220,000$ credit amount would be carried from the calculation schedule (IT-20REC) to the final tax return to offset the company’s Indiana income tax liability.

Conclusion: Strategic Compliance and Maximizing Indiana R&D Incentives

The Indiana Research Expense Credit (REC) represents a substantial tax savings opportunity, a fact reflected in the recent surge in claims, which increased significantly from $\$3.2$ million in tax year 2020 to $\$31.1$ million in tax year 2022.19

To successfully leverage this incentive, taxpayers must prioritize accuracy and substantiation:

1. Form Compliance is Paramount: Taxpayers must confirm they are calculating the Research Expense Credit (REC, utilizing forms like IT-20REC and Federal Form 6765) and not mistakenly filing under the unrelated, IEDC-certified Economic Development for a Growing Economy Retention Credit (EDGE-R, utilizing Schedule IN-EDGE-R).
2. Optimized Calculation: Strategic tax planning requires modeling both the Regular (tiered 15% / 10%) and the Alternative Simplified (10%) methods, using the strictly defined Indiana-only QREs and Indiana gross receipts. The Regular Method’s 15% tier often provides the greatest benefit for companies with consistent growth.
3. Adherence to DOR Rules: Compliance mandates strict adherence to the current-year-first application rule (LIFO) for credit utilization and the maintenance of comprehensive, contemporaneous documentation proving both the technical validity of the research and the exact geographical location of the R&D activities within Indiana.

By integrating the income tax credit with the accompanying 100% sales tax exemption for R&D equipment, businesses can realize the full financial benefit of Indiana’s commitment to incentivizing technological advancement.

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