The Technical Framework of Incremental Research Expenditures in the Iowa Research Activities Credit

I. Executive Summary: The Principle of Incremental Research Expenditures

1.1. Incremental R&D Defined

Incremental Research Expenditures represent the amount of a taxpayer’s current Qualified Research Expenses (QREs) that exceed a predetermined historical spending threshold, known as the base amount.1

The Iowa Research Activities Credit (RAC) is calculated primarily against this positive excess, ensuring the state only incentivizes increased R&D investment relative to prior years.1

1.2. Detailed Analysis of the Incremental Concept

The Iowa Research Activities Credit (RAC) is fundamentally structured as an incremental credit, a mechanism explicitly designed to reward and incentivize the growth of research activities rather than providing a broad subsidy for baseline, routine operations [3, 4]. This design aligns state financial incentives directly with observable economic behavior change.

The calculation of this increment begins by establishing a statutory Base Amount and subtracting it from the current year’s Iowa Qualified Research Expenditures (QREs). If the resulting difference is positive, this value represents the Incremental Research Expenditures eligible for the credit calculation. This structure mirrors the federal framework established under Internal Revenue Code (IRC) Section 41, which Iowa utilizes as the foundation for defining eligible QREs [5]. A prerequisite for claiming the Iowa RAC is that the taxpayer must first claim and be allowed the federal research credit (Form 6765) for the corresponding taxable year [5, 6].

The reliance on this incremental mechanism serves a strategic policy purpose: to direct state fiscal resources toward the stimulation of new economic activity. By limiting the incentive to expenditures exceeding a historical average, Iowa ensures that the tax benefit is statistically correlated with new, growth-oriented QREs that might not have materialized otherwise [4]. This model allows the state to allocate resources effectively, minimizing the subsidization of maintenance-level research and development while reinforcing the program’s performance-based nature.

II. Statutory and Administrative Foundation

The legal foundation for the Research Activities Credit is Iowa Code section 422.33(10) for corporations, with compliance and specific guidance provided by the Iowa Department of Revenue (IDR).

2.1. Qualified Research Expenditures (QREs) in Iowa

Iowa Qualified Research Expenditures (QREs) must meet the definitional standards set forth in federal IRC Section 41, but they are strictly limited to costs incurred within the state of Iowa 7. The types of expenditures that qualify include:

• Wages: Payments for qualified research services performed by employees in Iowa [1, 3].
• Supplies: The cost of materials and supplies directly used or consumed during the conduct of qualified research [1, 3].
• Rental/Lease Costs: Expenses for the rental or lease of personal property, such as computers, used in carrying out qualified research activities [1, 3].
• Contract Expenses: Payments made to third parties for contract research. Generally, only 65% of contract expenses are included in QREs. However, this inclusion percentage increases to 75% for payments made to qualified research consortia, and up to 100% for payments related to qualified energy research performed by specific entities, such as eligible small businesses or universities [8].

2.2. Eligibility Restrictions: The Industry Mandate

Since tax years beginning on or after January 1, 2017, Iowa imposed a critical limitation on who may claim the RAC [6, 9]. Taxpayers must satisfy two independent requirements to be eligible: (1) claim and be allowed the Federal Research Credit for qualified research expenses under IRC Section 41, and (2) be engaged in one of the following four specified industries 6:

1. Manufacturing: Defined broadly to include activities like refining, purifying, combining different materials, meat packing, and post-extractive processes such as crushing or blending aggregate materials.
2. Life Sciences: Sciences dedicated to the study of living organisms, encompassing fields such as agriscience, biology, botany, and biochemistry.
3. Software Engineering: The professional discipline involving the detailed study of the design, development, operation, and maintenance of software.
4. Aviation & Aerospace: Encompassing the design, development, or production of aircraft, rockets, spacecraft, and associated machinery.

This strict industry limitation reflects a deliberate legislative strategy to focus the substantial resources of the refundable RAC program on sectors deemed high-value and essential for Iowa’s future economic prosperity 6. Given that the credit is highly liquid (42% of claims processed in 2023 were direct refunds to firms with no state income tax liability [10]), confining eligibility to these innovation-intensive sectors ensures the state’s financial relief supports targeted growth in high-skill areas, explicitly excluding many service-based or retail-oriented R&D activities.

III. The Incremental Calculation: Regular Credit Method (Form IA 128)

The Regular Credit Method is the baseline calculation method for the RAC, utilizing a fixed-base percentage (FBP) and historical gross receipts. This method is claimed using Form IA 128 [11].

3.1. Base Amount Determination: The Fixed-Base Percentage Approach

Under the Regular Method, the Base Amount—the threshold that Incremental Research Expenditures must surpass—is determined by multiplying the Fixed-Base Percentage (FBP) by the Average Annual Gross Receipts (AAGR) 6:

$$\text{Tentative Base Amount} = \text{Fixed-Base Percentage (FBP)} \times \text{Average Annual Gross Receipts (AAGR)}$$

The Fixed-Base Percentage (FBP) is calculated precisely as required for the corresponding federal research credit, rounded to four decimal places, and capped at 16.00% [8, 12]. The Average Annual Gross Receipts (AAGR) represents the average annual gross receipts of the taxpayer for the four taxable years preceding the current credit year (T-4 through T-1). For Iowa tax purposes, the receipts used must be the Iowa-apportioned gross receipts [6, 13].

3.2. The Mandatory 50% QRE Floor Rule

A crucial aspect of Iowa’s calculation methodology, frequently clarified by the IDR, is the statutory minimum base amount 6. The Iowa Code explicitly mandates that in no event shall the base amount be less than fifty (50) percent of the qualified research expenses for the credit year 6.

The Statutory Base Amount is thus the higher value resulting from either the Tentative Base Amount calculation (FBP $\times$ AAGR) or 50% of the current year’s Iowa QREs. This 50% floor operates as a fiscal safeguard for the state. If a company experienced rapid recent R&D growth following a period of low gross receipts, the FBP calculation might yield a very low base. By requiring that at least half of the current year’s QREs are excluded from the incremental calculation, the state minimizes the possibility of fully subsidizing a large R&D increase, ensuring that the credit benefit is moderated even during periods of accelerated R&D investment 6.

3.3. Special Rules for Startups

New businesses classified as startups—those without sufficient operational history to compute four full years of gross receipts—are subject to specific phase-in rules for the Fixed-Base Percentage. For these entities, the FBP starts at a minimum of 3% and is phased upward over a ten-year period, eventually reaching the statutory maximum of 16.00% 13.

3.4. Final Credit Rate (Regular Method)

Once the Incremental Research Expenditures (excess QREs) are determined, the final credit is calculated at a rate of 6.5% of that excess amount. An additional credit of 6.5% is also allowed for qualified basic research payments made to universities or nonprofit scientific organizations [7, 13].

IV. The Alternative Simplified Credit (ASC) Method (Form IA 128S)

As an alternative to the administrative complexity of tracking historical gross receipts and calculating the FBP, taxpayers may elect the Alternative Simplified Credit (ASC), claimed on Form IA 128S [11].

4.1. ASC Base and Rate Structure

The ASC method simplifies the base determination by focusing solely on prior qualified expenditures:

• ASC Base Amount: The base is set at 50% of the average Iowa QREs for the three taxable years immediately preceding the credit year [13, 14, 15].
• New Taxpayer Rule: If the taxpayer incurred no QREs during that three-year historical period, the ASC Base Amount is zero, allowing all current QREs to potentially qualify as incremental expenditures 13.
• Credit Rate: Due to the simpler base determination, the ASC method offers a reduced credit rate of 4.55% applied to the incremental expenditures (current Iowa QREs minus the ASC Base Amount) [14, 16].

4.2. Method Consistency Requirement

A key regulatory update effective for tax years beginning on or after January 1, 2023, dictates that taxpayers must use the identical method—either Regular or ASC—to calculate the Iowa credit that they utilized for computing their federal credit [9]. This requirement eliminated the prior strategic advantage of electing the most beneficial state method independent of the federal filing choice.

The decision between the Regular Method (6.5% rate) and the ASC Method (4.55% rate) involves a clear trade-off between administrative burden and credit maximization. Businesses with volatile research spending histories, or those for whom compiling historical gross receipts data is difficult, often prefer the simplicity of the ASC. However, taxpayers who maintain a stable, high FBP, or those whose current QREs significantly exceed the ASC base, often find that the Regular Method, despite its complexity, yields a higher overall tax credit due to the more generous 6.5% rate [13, 14].

V. Revenue Office Guidance and Compliance Requirements

The Iowa Department of Revenue (IDR) provides specific administrative guidance to ensure compliance and proper calculation of Incremental Research Expenditures.

5.1. Compliance Forms and Federal Mandate

To claim the Iowa RAC, a taxpayer must first have claimed the federal R&D tax credit, submitting Federal Form 6765, Credit for Increasing Research Activities [17]. Key data points used to establish U.S. QREs (lines 2 through 8 of IA 128) are transcribed directly from the federal forms [5, 18].

The state calculation is finalized using:

• IA 128: For taxpayers electing the Regular Credit Method [11].
• IA 128S: For taxpayers electing the Alternative Simplified Credit Method [11].

The final credit amount determined by either IA 128 or IA 128S is then reported on the IA 148 Iowa Tax Credits Schedule, used to apply the credit against tax liabilities, including corporate and individual income tax [19].

5.2. IDR Guidance on Base Amount Interpretation

The IDR has consistently reinforced the calculation methodology, specifically clarifying that the definition of the base amount—including the critical component that it must be at least 50% of the current QREs—is a clarification of existing Iowa law and applies to all tax years, retroactively and prospectively 6. This clarification provides regulatory certainty regarding the persistent application of the minimum 50% floor in the incremental calculation.

5.3. Pass-Through Entity Reporting

For partnerships, S corporations, or other pass-through entities, the determination of Incremental Research Expenditures must be performed at the entity level. The entity is responsible for filing the IA 128 and the corresponding Federal 6765 with its return [18]. The resulting tax credit is then passed through to the entity members. A crucial rule for compliance is that special allocations of the tax credit among members are expressly prohibited [18].

VI. Practical Application and Illustrative Example

This example demonstrates the calculation of Incremental Research Expenditures and the resulting credit under both the Regular and Alternative Simplified methods for the same taxpayer in Tax Year 2025.

6.1. Scenario Setup

Assume a qualified Iowa manufacturer is performing R&D activities in 2025:

6.2. Calculation using the Regular Credit Method (IA 128)

The Regular Credit Rate is 6.5% 7.

Calculation of Regular Credit Base Amount:

1. Tentative Base Amount: $5,000,000 (AAGR) $\times$ 8.00% (FBP) $=$ $400,000

1. Minimum Base Amount Check (50% Floor): $1,000,000 (Current QREs) $\times$ 50% $=$ $500,000

The Statutory Base Amount is the greater of the two: $500,000 6.

Calculation of Incremental Research Expenditures and Credit:

Iowa Regular Research Activities Credit Calculation (TY 2025)

6.3. Calculation using the Alternative Simplified Credit (IA 128S)

The ASC Credit Rate is 4.55% 14.

Calculation of ASC Base Amount:

1. Average Prior 3-Year QREs: $900,000

1. ASC Base Amount: $900,000 $\times$ 50% $=$ $450,000 13

Calculation of Incremental Research Expenditures and Credit:

Iowa Alternative Simplified Credit Calculation (TY 2025)

In this scenario, while the ASC generated a larger amount of Incremental Research Expenditures ($550,000 vs. $500,000), the higher 6.5% rate of the Regular Method resulted in a significantly larger total credit ($35,750 vs. $25,025), demonstrating the quantitative advantage of the Regular Method when the 50% floor is not overly restrictive.

VII. Strategic Incentive: The Supplemental Research Activities Credit (SRAC)

The Supplemental Research Activities Credit (SRAC) is a powerful mechanism designed to amplify the incentive for Incremental Research Expenditures, especially for companies participating in specific state economic development programs.

7.1. Eligibility and Tiered Rates

The SRAC is not universally available; it is awarded by the Iowa Economic Development Authority (IEDA) and requires the company to be approved under the Enterprise Zone Program or the High-Quality Jobs (HQJ) Program [1, 7, 13].

The SRAC is calculated as an additional percentage applied directly to the qualifying incremental research expenditures (the “excess” QREs determined in the primary RAC calculation) 2. The rate structure is tiered based on the company’s annual gross revenue, aligning the magnitude of the supplemental subsidy with the size of the firm:

• Small Firms: Businesses with annual gross revenues of less than $20 million can claim a supplemental credit of up to an additional 10% of their qualifying incremental research expenditures [7, 13, 20].
• Large Firms: Businesses with annual gross revenues of $20 million or more are eligible for a supplemental credit of up to an additional 3% of their qualifying incremental research expenditures [7, 13, 20].

Companies must use the same calculation method (Regular or ASC) for the SRAC that they used for the primary RAC [20].

7.2. Enhanced Refundability and Liquidity

A primary benefit of the RAC program is its status as a refundable credit, allowing taxpayers to receive cash even if they have no state income tax liability [9, 10]. Recent limits have been imposed on this refundability 13:

• The standard RAC (calculated on IA 128 or IA 128S) is refundable up to 80% of the excess credit.
• The Supplemental RAC is refundable up to 90% of the supplemental credit amount 13.

Any portion of the credit that is not refunded may be carried forward for up to seven years [17]. For a small firm (under $20 million in revenue) approved under an HQJ program, the total effective credit applied to the Incremental Research Expenditures increases from 6.5% (Regular RAC) to 16.5% (6.5% RAC + 10% SRAC) 13. This significant combined rate, coupled with the generous 90% refundability on the Supplemental portion, functions as an aggressive state incentive designed to provide immediate, substantial cash liquidity to targeted, growing businesses.

VIII. Program Sunset and Future Compliance (Post-2025)

The framework for incentivizing research and development in Iowa is set to undergo a fundamental regulatory change, requiring taxpayers to adjust their long-term strategic planning.

8.1. Repeal of the Incremental RAC Structure

The current Research Activities Credit (RAC), based on the incremental calculation methods (IA 128 and IA 128S), is scheduled to be phased out. The program sunsets after tax year 2025 and is scheduled for full repeal from the Iowa Code on January 1, 2027, pursuant to Senate File 657 [9, 13]. This means that all Incremental Research Expenditures incurred in tax years beginning after December 31, 2025, will no longer be eligible for the current RAC program.

8.2. Transition to the New IEDA R&D Tax Credit Program

The RAC is being replaced by a new Research and Development Tax Credit Program, which takes effect for expenditures incurred in tax years beginning on or after January 1, 2026 [21]. This new program involves a significant shift in oversight and design, moving authority from the Iowa Department of Revenue to the Iowa Economic Development Authority (IEDA) [22].

The key differences between the legacy RAC and the new program are structural and highly consequential for taxpayers:

• Non-Incremental Structure: The new credit is based on a direct percentage of total QREs, completely abandoning the complex historical Base Amount calculation [21].
• Reduced Rate: The credit rate is substantially lower, capped at up to 3.5% of the eligible expenditures [21].
• Annual Cap: The program is subject to a strict statewide annual funding limit of $40 million, beginning Fiscal Year 2026 [21, 22].
• Discretionary Approval: Unlike the prior entitlement-based system, businesses must pre-apply to the IEDA for eligibility determination and receive a tax credit certificate before claiming the credit. The IEDA holds discretion in approving applicants and allocating the available funds [22].

The transition from a refundable, formula-based entitlement (the incremental RAC) to a capped, discretionary, and application-based program represents a legislative response to manage the program’s fiscal footprint. By introducing a $40 million annual limit and shifting administration to the IEDA, the state gains tight control over spending, transforming the R&D incentive from a mechanism tied to economic activity growth (incremental model) into a competitive, budget-controlled economic development grant prioritized by the administering agency.

IX. Conclusion: Strategic Implications for Iowa Taxpayers

The calculation of Incremental Research Expenditures forms the core of the Iowa Research Activities Credit (RAC) for tax years up to and including 2025. This measurement, calculated as the excess of current Iowa QREs over a carefully computed Base Amount, is fundamental to quantifying the tax benefit. Taxpayers must meticulously track historical data, adhering to IDR guidance regarding the Fixed-Base Percentage approach (Form IA 128) or the streamlined 3-year average (Form IA 128S), while always ensuring compliance with the mandatory 50% QRE floor rule.

For companies operating under the current framework, maximizing the claim involves not only selecting the calculation method that yields the lowest base but also leveraging the Supplemental Research Activities Credit (SRAC) if approved under IEDA programs. The strong refundability of the incremental credit provides critical liquidity for eligible manufacturers, life science firms, and other qualified entities.

However, the impending sunset of the incremental RAC structure mandates a critical shift in tax and business strategy. Post-2025, the R&D incentive landscape will be characterized by a lower credit rate (up to 3.5%) and strict budgetary constraints ($40 million annual cap). Businesses planning significant R&D investment in Iowa after 2025 must prioritize securing IEDA approval through the new pre-application process, as the incentive will transition from a tax calculation right to a competitive government grant.

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