The Aerospace Advantage: Analyzing Qualification Criteria for the Iowa Research Activities Tax Credit

The Aviation and Aerospace industry qualifies for the Iowa Research Activities Credit (RAC), providing substantial financial incentives for Iowa companies. This specialized sector is legally defined as encompassing the design, development, or production of aircraft, rockets, missiles, spacecraft, and other machinery and equipment that operates in aerospace.

The refundable RAC—currently offering up to 6.5% of incremental qualified research expenditures—is strategically aimed at supporting high-technology engineering and manufacturing, although strategic repositioning is required as the program transitions to a capped, application-based structure managed by the Iowa Economic Development Authority (IEDA) starting in 2026.

I. Executive Summary: The Aerospace Advantage in Iowa R&D Tax Policy

The Aviation and Aerospace industry represents one of the five specific sectors eligible for the Iowa Research Activities Credit (RAC), a state tax incentive designed to reduce liability for increasing research activities within Iowa.1

This credit has historically provided a crucial source of liquidity for advanced engineering and manufacturing firms. Eligibility is tightly restricted by the Iowa Department of Revenue (IDOR) guidance, which focuses narrowly on core creation activities—design, development, or production—of aerospace vehicles or complex components.3 Compliance demands meticulous documentation, particularly to ensure the claiming entity is not primarily categorized as one of the numerous explicitly disqualified business types, such as a transportation company or general contractor.1 Companies operating in this sector must urgently utilize the current uncapped, high-rate credit before the program is repealed and replaced by a competitive, IEDA-managed system under Senate File 657 (SF 657) effective for tax years beginning on or after January 1, 2026.6

A. Key Findings Synopsis

• Authoritative Definition: The legal definition is rooted in the Iowa Administrative Code rule 701—304.11, precisely defining eligibility based on core engineering and production activities related to air and space vehicles and equipment.3
• Critical Exclusions: Businesses must ensure their primary activity does not align with explicitly disqualified sectors, including transportation companies, retailers, wholesalers, or contractors engaged in residential/commercial installation and repair.1
• The 2026 Transition: The current uncapped RAC is sunsetting after the 2025 tax year. It will be replaced by the SF 657 program, featuring a lower maximum rate (up to 3.5% of QREs) and operating under a competitive, capped $40 million annual allocation pool administered by the IEDA.6

II. Statutory and Administrative Foundation: Defining Aviation and Aerospace

Eligibility for the Iowa Research Activities Credit (RAC) is conditional upon two foundational criteria: the research must comply with the federal definition of Qualified Research Expenditures (QREs) under Internal Revenue Code (IRC) Section 41, and the business must be demonstrably engaged in one of Iowa’s five specific qualifying industries.1

A. Iowa Code § 422.10: The Framework for Qualified Industries

The Iowa Code establishes the legal framework for the RAC. Specifically, Code Section 422.10 mandates that an individual or business claiming the credit must meet several requirements, including the critical industry test.1

The requirement states that the business must be engaged in one of the following five sectors: manufacturing, life sciences, agriscience, software engineering, or the aviation and aerospace industry.1 This industry limitation, which was applied retroactively for tax years beginning on or after January 1, 2017, significantly narrowed the scope of businesses eligible for the previously more broadly available credit.2

B. Defining “Aviation and Aerospace”: IDOR and IAC Guidance

The Iowa Department of Revenue (IDOR) relies on the strict administrative rules to define qualifying activity. This guidance is essential for compliance and audit defense.

The definitive description is found within the Iowa Administrative Code rule 701—304.11.4 The official citation explicitly states: “Aviation and aerospace means the design, development or production of aircraft, rockets, missiles, spacecraft and other machinery and equipment that operates in aerospace”.3

Analysis of Key Terms

The language used in the code is critical because it defines the scope of acceptable activities.

1. Design, Development, or Production: This phrasing restricts eligibility to the processes of creation, innovation, and high-value manufacturing. It signals that routine operations, maintenance, repair of existing systems, or simple assembly of non-proprietary components are typically outside the scope of the credit. This aligns with the federal IRC § 41 requirement that QREs must be undertaken to discover information that is technological in nature and aimed at the development of a new or improved product or process, specifically by eliminating technological uncertainty.9
2. Aircraft, Rockets, Missiles, Spacecraft: This list provides the primary high-level outputs targeted by the incentive program, clearly focusing on vehicles and systems designed for air and space travel.
3. Other Machinery and Equipment that Operates in Aerospace: This is a broad, yet crucial, component of the definition. It extends eligibility beyond the final vehicles themselves to specialized, complex components, such as advanced avionics, specialized flight control surfaces, new composite materials, and integrated cabin systems, provided the research activity meets the technological advancement criteria.12

C. The Critical “Engaged In” Standard and Audit Risk

A significant regulatory gap exists regarding the “engaged in” requirement stipulated by Iowa Code § 422.10. While the Code demands that the business be “engaged in” the qualifying industry 1, the IDOR guidance does not detail what constitutes being “engaged in” the Aviation and Aerospace industry, specifically lacking a codified primary business activity test or a minimum revenue threshold.3

This regulatory omission shifts the burden of proof in an audit. Since the state defines a long, detailed list of ineligible business types—including transportation companies, retailers, wholesalers, publishers, and various types of contractors 1—the primary focus of an IDOR audit will be to prove that the claimant falls into one of these explicitly excluded categories. Consequently, the claimant must preemptively demonstrate why they are not a transportation company or a contractor, and why their main operational purpose aligns instead with the narrow, affirmative definition of “design, development, or production” of aerospace equipment provided in the administrative rules.4

For businesses with mixed activities, compliance necessitates establishing clear legal and operational boundaries. The organizational structure must emphasize the separation of the R&D/manufacturing unit (which qualifies) from non-qualifying revenue streams (such as logistical transportation services or general construction/installation contracting). A pure product development or research center focused solely on the IAC definition provides the highest level of audit certainty.

III. Compliance Boundaries and Qualifying Aerospace Activities

For an aerospace business to successfully claim the RAC, it must not only conduct activities that meet the four-part test for qualified research (experimental, technological in nature, eliminate uncertainty, permitted purpose) 9, but also ensure that the entity itself is not primarily defined by an explicitly excluded industry.

A. Specific Business Exclusions and the Boundary Condition

The Iowa Code provides an extensive, non-exhaustive list of business types that are ineligible for the RAC, regardless of whether they conduct some degree of R&D.1 Navigating these exclusions is crucial for aerospace firms:

• Transportation Company: This is the most common point of conflict. A commercial airline that maintains or slightly modifies its fleet is performing transportation services, even if some internal engineering is involved. The Code explicitly excludes a “transportation company”.1 Qualification hinges on whether the entity’s primary identity is designing new vehicles or components, rather than transporting goods or passengers.
• Contractor/Subcontractor: General contractors, subcontractors, builders, or contractor-retailers are ineligible, particularly those engaged in commercial and residential repair and installation, such as heating/cooling installation, plumbing, or electrical work.1 While R&D related to designing new specialized manufacturing processes or creating custom machinery (jigs, fixtures, tools) for aerospace components is generally permissible, general construction or repair contracts are explicitly barred.12
• Retailer/Wholesaler: Businesses primarily focused on the resale of goods are excluded.1 Aerospace R&D, by definition, must involve the development of new or improved products or processes, not merely the distribution chain of existing commercial items.

B. Differentiating R&D from Routine Operations in a Mixed Entity

The lack of a defined “primary business activity” test means that IDOR auditors will evaluate the entity holistically based on its revenue streams, asset base, and employee functions. Consider a company that manufactures proprietary avionics systems (a qualifying activity under the “production of equipment that operates in aerospace” definition 4) but also generates significant revenue from providing routine, standardized maintenance and repair services on third-party avionics systems. The maintenance activities could potentially be classified as non-qualifying service or general contracting activities.

The vulnerability of the RAC claim increases if the maintenance revenue dominates the business profile, suggesting the entity’s primary function is service provision, rather than design and production. To defend the claim, the aerospace business must clearly demonstrate that its core purpose, measured by investment and mission focus, is anchored in the “design, development, or production” mandate found in the Iowa Administrative Code. This requires robust internal documentation linking employee time and expenditures specifically to the creation of new knowledge and proprietary products, thereby distinguishing the entity from the explicitly excluded service categories.4

C. Examples of Qualified Aerospace R&D Activities

The R&D activities of a qualifying aerospace firm must meet the federal four-part test for QREs, proving technological uncertainty and experimentation. In the context of the Iowa credit, these activities often include:

• Advanced Materials and Processes: Conducting research to develop or test new composite materials, alloys, or specialized heat-treatment profiles required for high-stress or extreme thermal environments within aircraft or spacecraft.12
• System Integration and Avionics: Engineering the design, testing, and generation of prototypes for novel avionics, advanced sensors, flight control algorithms, aircraft automation technology, or cyber resiliency improvements for digital safety systems.12
• Manufacturing Process Innovation: Developing new or improved manufacturing plans, machines, fixtures, jigs, and precision tools necessary to produce aircraft components with stringent specifications and tight tolerances demanded by industry and regulatory bodies.12
• Cabin Systems Design: Conducting engineering design or creating kits for the integration of customized galleys, specialized seating, or complex in-flight entertainment systems into an aircraft.12

The table below summarizes the crucial boundary between acceptable and non-acceptable business functions under the RAC framework.

Table 3: Defining the Boundary: Excluded vs. Qualifying Activities

IV. Financial Mechanics of the Current RAC (Through 2025)

Aerospace companies should prioritize the comprehensive utilization of the existing RAC program before its sunset after the 2025 tax year, as the current framework offers superior financial advantages, particularly regarding rate and refundability.

A. Overview of Current RAC Calculation Methods

Iowa requires QREs to adhere to IRC § 41 definitions, but only expenses incurred in Iowa qualify for the state credit.5 Taxpayers may choose annually between two calculation methods, regardless of the method chosen federally 5:

1. Regular Method: This method applies a 6.5% rate to the excess of current-year Iowa QREs over a computed historical base amount, plus 6.5% on qualified basic research payments made to universities or nonprofits.6 This is typically the preferred method for established firms demonstrating consistent QRE growth.
2. Alternative Simplified Credit (ASC) Method: This optional method calculates the credit at 4.55% of the difference between the current year’s Iowa QREs and 50% of the average Iowa QREs incurred over the preceding three taxable years.6

B. The Supplemental Research Activities Tax Credit (SRAC)

Beyond the base RAC, qualifying businesses can also claim the Supplemental Research Activities Tax Credit (SRAC), provided they receive an award from the IEDA under either the High Quality Jobs (HQJ) Program or the Enterprise Zone Program.6

The SRAC enhances the overall incentive, particularly for smaller enterprises, by offering tiered rates:

• An additional 10% of qualifying incremental research expense is available for firms with gross revenues less than or equal to $20 million.6
• A 3% supplemental rate is available for companies with gross revenues exceeding $20 million.6

C. Refundability and Cash Flow Implications

A key advantage of the current Iowa RAC is its refundability feature, which significantly improves cash flow for companies, particularly startups and those in capital-intensive sectors like aerospace.6 Any credit amount that exceeds the taxpayer’s state tax liability can be refunded. The limits are set at 80% for the regular RAC and 90% for the supplemental credit.6

However, the Iowa RAC imposes a critical restriction on the non-refunded portion. Unlike the federal credit, which allows for substantial carryforwards, the residual portion of the Iowa credit—20% of the regular RAC or 10% of the Supplemental Research Activities Credit—is neither refunded nor carried forward to offset future tax liabilities.6 This structure creates a “use it or lose it” mandate for this residual amount. Strategic financial assessment is necessary to model the optimal tax filing position (credit vs. liability) to minimize the loss of this non-carryforward percentage, especially for large, highly profitable aerospace firms that might otherwise generate significant carryforwards in other jurisdictions.

V. Practical Case Study: Advanced Manufacturing for Spacecraft Components

To illustrate how the industry definition is applied, consider a high-technology manufacturing scenario that falls under the expansive “other machinery and equipment that operates in aerospace” component of the law.4

A. Scenario Setup: Space Composites, LLC

Space Composites, LLC (SC) is an Iowa entity specializing in the production of proprietary, lightweight structural components for launch vehicles and orbital spacecraft, including specialized thermal shielding tiles used during atmospheric reentry. SC is indisputably engaged in the “design, development, or production of… spacecraft and other machinery and equipment that operates in aerospace”.4

In the tax year 2024, SC initiated a research project focused on developing a novel, fatigue-resistant attachment methodology for its shielding tiles, requiring extensive material stress testing and the design of custom fabrication jigs and tooling.12

The expenses incurred in Iowa for this qualified research are as follows:

B. Credit Computation Example (Regular Method)

Assuming SC is an established firm and calculates its historical Base Amount for 2024 to be $4,500,000 based on the fixed-base percentage formula.6

1. Excess QREs: Current QREs $(\$7,000,000)$ minus Base Amount $(\$4,500,000)$ equals $2,500,000.
2. Regular RAC Calculation (6.5%): $$2,500,000 \times 6.5% = $162,500.

C. Supplemental Credit Calculation (If HQJ Approved)

If SC successfully secured approval under the High Quality Jobs (HQJ) Program and its gross revenues were below the $20 million threshold 9:

1. Supplemental QREs (Incremental): $\$2,500,000$ (The same excess amount used for the RAC).
2. Supplemental RAC Calculation (10%): $$2,500,000 \times 10% = $250,000.
3. Total Potential Credit (Refundable): $$162,500 + $250,000 = $412,500.

D. Compliance Requirement: Documentation of Qualification

To withstand IDOR scrutiny, SC must meticulously document that its core activities—designing the attachment method, developing fabrication processes, and testing materials—are directly tied to the definition of “design, development or production” of spacecraft equipment.4 SC must ensure this R&D focus is not overshadowed by any unrelated activities, such as general contract material sales or routine repair services.

VI. Strategic Planning for the Future: The 2026 Transition (SF 657)

The Iowa Legislature’s enactment of Senate File 657 (SF 657) in 2025 initiates a complete overhaul of the R&D tax credit system, effective for tax years beginning on or after January 1, 2026.7 This change demands immediate strategic evaluation by all aerospace firms relying on the credit.

A. The Repeal of the Existing Entitlement

The long-running Research Activities Credit (RAC), which was an uncapped entitlement program based on the tax return filing (IA 128 or IA 128S) 5, is officially repealed under SF 657.8 The scale of the former program was substantial; businesses claimed approximately $77.6 million in RAC benefits in fiscal year 2024 alone, demonstrating the popularity and financial magnitude of the uncapped structure.8 This era of automatic, uncapped claims ends after the 2025 tax year.

B. The New IEDA-Managed R&D Tax Credit Program

The new program transfers administration and oversight from the Iowa Department of Revenue to the Iowa Economic Development Authority (IEDA).7 The new structure imposes strict limitations:

• Reduced Incentive Rate: The maximum credit rate available to qualifying businesses is substantially lowered to 3.5% of Iowa QREs.7
• Competitive Cap: The program operates under a stringent, competitive $40 million annual statewide allocation cap.7 This transformation introduces allocation risk. If the total QREs applied for by all eligible businesses exceed the statutory limit, credits will be allocated pro rata, meaning a company may not receive the full 3.5% rate.18
• Formal Application Process: Claiming the credit shifts from a passive tax filing requirement to an active, competitive application process managed by the IEDA. Businesses must pre-apply to determine eligibility and must submit CPA-verified QRE reports to the IEDA. Approval is granted for up to five years, but businesses must reapply annually for the allocation of the credit.7

C. Aerospace Continuity and Policy Targeting

Despite the systemic overhaul, the legislative intent behind SF 657 confirms the state’s continued prioritization of the aerospace sector. The new IEDA program focuses narrowly on targeted industries, explicitly including Aerospace within the broader Technology and Innovation sector.8

This transition represents a major policy shift from merely subsidizing R&D volume toward strategically incentivizing R&D value aligned with state economic growth goals. Under the new capped, competitive structure, aerospace companies can no longer rely solely on technical compliance. Future application success will depend heavily on the strength of the business’s narrative—how effectively the firm articulates the economic merits of its research, including job creation, capital investment, and technological leadership, to justify securing a portion of the limited $40 million annual pool.7 Therefore, compliance strategies must immediately be broadened to integrate IEDA application criteria into annual financial planning and documentation cycles, focusing equally on economic justification and technical QRE adherence.

Table 4: Strategic Implications of the SF 657 Transition for Aerospace

VII. Conclusion and Strategic Recommendations

The Iowa Research Activities Credit provides essential financial leverage for businesses engaged in the specific, high-technology activities of the Aviation and Aerospace industry. Compliance requires strict adherence to the definition established in IAC 701—304.11, focusing on the design, development, or production of aerospace machinery.4 This mandate necessitates rigorous self-assessment to ensure the entity is not primarily a transportation company, retailer, or general contractor, as these exclusions are the most likely grounds for denial during an audit.1

The passage of SF 657 marks a pivotal strategic inflection point. Aerospace firms operating in Iowa are strongly advised to take the following actions:

1. Maximize Current Claims (Through 2025): Aggressively identify and document all eligible QREs incurred in Iowa through the end of the 2025 tax year. This period offers the highest rate (6.5% regular, up to 10% supplemental) and the least allocation risk. Financial teams must model their current-year tax liabilities to maximize the refundable portion of the credit and minimize the loss of the non-carryforward percentage.6
2. Immediate IEDA Program Preparation: Even with the current program running, businesses must immediately begin preparing for the 2026 application cycle. This requires shifting internal reporting to generate CPA-verified QRE reports that meet IEDA standards and developing a strong narrative justifying the economic impact of the research activities to secure an allocation within the competitive $40 million cap.7
3. Bolster Compliance Documentation: Given the non-existence of a formal “primary business activity” test, all documentation should emphasize the core mission of the business as defined by the administrative code (design, development, or production) and establish clear operational distinctions between qualifying R&D and non-qualifying service or logistical operations.

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