Analysis of Iowa Code § 422.10: The Individual Research Activities Tax Credit and Strategic Outlook

Iowa Code $\S 422.10$ governs the Research Activities Credit (RAC) for individual income taxpayers, providing a state-level incentive based on qualified research expenses (QREs) conducted in Iowa. The credit is currently undergoing a phased reduction in refundability and is scheduled for repeal and replacement starting in 2026.

This comprehensive report provides an expert analysis of the current statutory requirements under $\S 422.10$, details local revenue office guidance, demonstrates the credit calculation and allocation process, and outlines the critical strategic transition mandated by recent legislation.

Statutory Authority and Foundational Principles of the Research Activities Credit

Iowa Code $\S 422.10$ is located within Chapter 422, which pertains to Individual Income, Corporate, and Franchise Taxes.1 Specifically, this section authorizes a reduction in the taxes imposed on individuals through a state tax credit for increasing research activities conducted within Iowa.2 The placement of the credit within the individual income tax structure highlights the legislature’s intent to provide direct tax relief or liquidity to the proprietors, partners, shareholders, or beneficiaries of eligible pass-through entities (PTEs) engaged in qualified research.5

Federal Nexus: Required Alignment with Internal Revenue Code § 41

A fundamental requirement for claiming the Iowa RAC is the necessary alignment with the federal framework for research and experimentation (R&E).

First, eligibility is contingent upon the taxpayer or the business conducting the research claiming and being allowed the federal research credit under Section 41 of the Internal Revenue Code (IRC) for the same taxable year.4 The Iowa Department of Revenue (IDR) guidance affirms that a federal credit is “allowed” if the taxpayer meets all requirements under IRC $\S 41$ and applicable IRS guidance, and the credit has not been disallowed by the Internal Revenue Service.7

Second, Iowa law generally adopts the federal definitions for key terms such as “basic research payment” and “qualified research expense” (QRE) as defined in IRC $\S 41$.10 However, a key state modification is that only expenses incurred on research conducted within the geographical boundaries of Iowa qualify for the state credit.12

The statutory linkage to the federal allowance means that Iowa leverages the federal audit mechanism. A disallowance of the federal credit by the IRS automatically jeopardizes the validity of the corresponding Iowa RAC claim. This dual compliance requirement increases the regulatory risk exposure for taxpayers, who must meticulously satisfy both federal documentation standards and specific state industry mandates.

Defining Business Eligibility: Required Industries and Explicit Exclusions

Unlike the federal R&D credit, which applies broadly across industries, the Iowa RAC is highly targeted. The statute restricts eligibility to businesses engaged in specific sectors.4

Eligible Industries

To be eligible, the business must be engaged in one of the following five industries 4:

• Manufacturing
• Life sciences
• Agriscience
• Software engineering
• Aviation and aerospace industry

Explicit Statutory Exclusions

Iowa Code $\S 422.10(1)(b)$ contains an extensive list of entities and activities that are explicitly deemed ineligible, preventing businesses in these sectors from claiming the credit even if their activities might technically meet the four-part federal R&D test.2 This list includes, but is not limited to 2:

1. A person engaged in agricultural production.
2. Contractors, subcontractors, builders, or contractor-retailers engaged in commercial and residential repair and installation (e.g., plumbing, electrical).
3. Finance or investment companies (including those organized under Iowa Code chapters 524, 533, or 533D).
4. Retailers, wholesalers, publishers, and transportation companies.
5. Professional services such as accountants and architects.
6. Real estate companies and collection agencies.

The exclusion of these service-based and non-industrial sectors demonstrates a clear legislative preference for directing the state’s tax expenditure budget toward capital-intensive industries (e.g., manufacturing and bioscience) perceived to generate high-value intellectual property and sustained economic growth, rather than service sector innovation.

Administration and Oversight: IDR and IEDA Roles

The current RAC program is administered through a partnership between the Iowa Department of Revenue (IDR) and the Iowa Economic Development Authority (IEDA).16

The IDR is the primary agency for processing tax forms (IA 128 and IA 128S) and issuing refunds.8 The IEDA is responsible for administering the Supplemental Research Activities Credit (SRAC), which is authorized under Iowa Code $\S 15.335$.5 Businesses must have an incentive contract under specific IEDA programs (like the High Quality Jobs (HQJ) Program or the now-repealed Enterprise Zone Program) to qualify for the SRAC.7 Claiming the SRAC requires a tax credit certificate number provided by the IEDA.15

Detailed Mechanics of the Current Research Activities Credit (RAC)

The calculation methodologies for the Iowa RAC align closely with the federal methods but require Iowa-specific apportionment and expense identification.

Calculation of Qualified Research Expenses (QREs)

The Iowa credit is an incremental credit, meaning only QREs exceeding a calculated base amount are eligible for the tax benefit.13 QREs eligible for the Iowa credit include in-state expenditures for wages, supplies, rental/lease costs of personal property, and contract research expenses.13

Determining the Base Amount

The base amount is calculated using the taxpayer’s historical gross receipts, following the federal model.12

$$\text{Base Amount} = \text{Fixed-Base Percentage} \times \text{Average Annual Gross Receipts (Prior 4 Years)}$$

IDR guidance clarifies that this calculated base amount is subject to a floor rule: the base amount “shall in no event be less than fifty (50) percent of the qualified research expenses for the credit year”.10 This 50% Floor Rule ensures that a business must demonstrate substantial QREs relative to its historical performance to generate a significant credit.

Research Activities Credit (RAC) Calculation Methods

Taxpayers must use the same calculation method at the state level that they elected or were required to use for federal tax purposes.11

1. Regular Method: The standard calculation provides a credit equal to 6.5% of the excess of qualified research expenses over the base amount, plus 6.5% of qualified basic research payments.4
2. Alternative Simplified Credit (ASC) Method: If the ASC method is elected federally, the taxpayer must use the state ASC method. This method yields a credit equal to 4.55% of the difference between the current year’s Iowa QREs and 50% of the average Iowa QREs from the three preceding tax years.11

Prior to recent legislation (HF 2317), Iowa taxpayers could independently elect the ASC method even if they did not use it federally. The mandate for federal-state consistency eliminates this past state tax optimization strategy.11

Supplemental Research Activities Credit (SRAC)

The SRAC, authorized under $\S 15.335$, is a critical component for businesses participating in state economic development initiatives. It provides an additional credit on top of the calculated RAC.5

Eligibility for the SRAC is determined by having an incentive contract approved by the IEDA under programs like the HQJ or Enterprise Zone.15 The SRAC calculation is tiered based on the business’s gross revenues 15:

• 10% Supplemental Rate: Applicable to businesses with annual gross revenues of less than $20 million, applied to qualifying incremental research expenditures.22
• 3% Supplemental Rate: Applicable to businesses with annual gross revenues of $20 million or more, applied to qualifying incremental research expenditures.22

The SRAC must be calculated using the same method (Regular or ASC) used for the primary RAC.13

The Individual Taxpayer and Flow-Through Entities

For the individual taxpayer, the application of $\S 422.10$ primarily involves receiving and utilizing the credit apportioned from a pass-through entity (PTE).

Reporting Requirements for Pass-Through Entities

If the research is conducted by a partnership, S corporation, limited liability company, estate, or trust, the entity calculates the total tax credit on behalf of its members.13

1. Entity Filing: The PTE must file Iowa Form IA 128 or IA 128S, detailing the calculation, and include a copy of the Federal Form 6765 with its return.8
2. Apportionment Mandate: The total calculated credit (both RAC and SRAC) is apportioned to the members. Iowa Code $\S 15.335$ and IDR guidance specify that the amount claimed by the individual must be based upon the pro rata share of the individual’s earnings of the pass-through entity.5
3. Prohibition of Special Allocations: IDR instructions explicitly state that special allocations of the credit are not permitted.8 This statutory mandate requires tax professionals to ensure that the distribution ratio for the R&D credit strictly mirrors the ratio used for allocating general taxable income, or the standard profit and loss allocations, to avoid scrutiny regarding the validity of the credit claim.

The PTE reports the allocated credit amount, along with any necessary tax credit certificate number (especially for SRAC), on Schedule K-1 or an attachment to the K-1, instructing the members to include this information with their individual returns.9

Individual Claim Process

The individual taxpayer reports the pass-through credit on their Iowa individual income tax return (Form IA 1040). They must complete lines on the IA 128 specific to pass-through credits (Line 37 on the 2024 IA 128).8

All tax credits claimed by an individual, including the RAC and SRAC, must be reported on the IA 148 Tax Credits Schedule.15 This schedule acts as the central clearinghouse for applying credits against tax liability.

Refundability, Liquidity, and Statutory Phase-Outs (HF 2317)

A crucial feature of the Iowa RAC is its partial refundability, offering an immediate cash benefit rather than just a future tax reduction. However, legislative changes enacted via House File 2317 have severely constrained this liquidity mechanism.11

Credit Excess and Refund Eligibility

Any amount of the RAC or SRAC that exceeds the individual taxpayer’s income tax liability (after accounting for nonrefundable credits) constitutes an “excess credit”.10 Iowa Code $\S 422.10$ dictates that a specific percentage of this excess credit shall be refunded with interest.2

Legislative Phase-Down Schedule

Effective January 1, 2023, the refundable percentage of the excess credit is subject to a phased reduction, significantly diminishing the financial benefit over time.10

Table 1: RAC Refundability Phase-Down Schedule

Carryforward Limitations and Financial Planning

The limitations placed on the carryforward of the RAC credit are a paramount concern for financial planning.

In lieu of claiming a refund for the statutory refundable portion, the taxpayer may elect to have that specific overpayment credited to the tax liability for the immediately following taxable year.2 This election provides a one-year carryover option for the refundable portion.

Crucially, Iowa law does not provide a standard, long-term carryforward (e.g., ten years) for any unused RAC amounts.21 Taxpayers should note the significant distinction between the RAC and other nonrefundable credits, such as the Historic Preservation Credit, which may allow for a multi-year carryforward.6

The implication of this structure is that the portion of the excess credit that is non-refundable (ranging from 10% in 2023 up to 50% by 2027) is effectively lost if it cannot be used to offset the current year’s tax liability. This financial structure necessitates aggressive, accurate annual tax forecasting to ensure maximum utilization of the expiring benefit, particularly for individuals whose primary income is derived from research activities but whose tax liability fluctuates year to year.

Case Study Example: Application for an Individual Partner (Tax Year 2024)

This example illustrates the application of the Research Activities Credit (RAC) and the Supplemental Research Activities Credit (SRAC) for an individual filing for Tax Year 2024, subject to the 80% refund limit.

Scenario Setup: Research Partnership Utilizing the Regular Method

Iowa BioTech Partners, LLC, is an eligible business (Life Sciences industry) organized as an LLC taxed as a partnership. It is approved under the High Quality Jobs (HQJ) Program, making it eligible for the SRAC. The LLC’s annual gross revenues are below the $20 million threshold. Partner Smith holds a 20% pro-rata share of the entity’s earnings.

Step-by-Step Calculation of Total Tax Credit (IA 128 at Entity Level)

1. Calculate the Base Amount

The Base Amount is determined by multiplying the Fixed-Base Percentage (5.00%) by the Average Annual Gross Receipts ($50,000,000), yielding $2,500,000. This amount is checked against the 50% floor of current QREs ($4,000,000 $\times$ 50% = $2,000,000). Since $2,500,000 is greater than the floor, the Base Amount is $2,500,000.10

2. Calculate Incremental QREs

The incremental amount is the excess of current QREs over the Base Amount:

$$\text{Incremental QREs} = \$4,000,000 – \$2,500,000 = \$1,500,000 \text{[13]}$$

3. Calculate Research Activities Credit (RAC)

Using the Regular Method rate of 6.5%:

$$\text{RAC} = \$1,500,000 \times 0.065 = \$97,500 \text{[4, 21]}$$

4. Calculate Supplemental Research Activities Credit (SRAC)

Since the LLC’s gross revenue is less than $20 million, the SRAC rate is 10% of incremental research expenditures 15:

$$\text{SRAC} = \$1,500,000 \times 0.10 = \$150,000$$

5. Total Entity Credit Available

$$\text{Total Credit} = \text{RAC } (\$97,500) + \text{SRAC } (\$150,000) = \$247,500$$

Application against Partner Smith’s Individual Tax Liability

The total credit is apportioned to Partner Smith based on his 20% pro-rata share of earnings.5

Table 2: Partner Smith Credit Allocation and Refund Calculation (2024)

Partner Smith would successfully reduce his 2024 Iowa tax liability to zero and be eligible for a refund of $7,600, or he may elect to credit this $7,600 overpayment against his 2025 tax liability.10 The remaining $1,900 of the excess credit is not recoverable and expires in the current tax year.

Strategic Transition: The 2026 R&D Tax Credit Program (SF 657)

The Research Activities Credit defined in Iowa Code $\S 422.10$ is scheduled to be repealed for tax years beginning on or after January 1, 2026.21 This change, mandated by Senate File 657, represents a comprehensive overhaul, replacing the statutory, formulaic tax credit (RAC) with a new, capped R&D Tax Credit Program administered largely by the Iowa Economic Development Authority (IEDA).30

Structural Shift and Eligibility Constraints

The new program fundamentally changes the nature of the R&D incentive from an entitlement based on formulaic calculation to a discretionary, application-based grant.30

1. Mandatory Pre-Application: Businesses seeking the credit must first pre-apply with the IEDA to determine eligibility based on industry and research activities.30
2. Narrower Focus: The new program further narrows the target industries to advanced manufacturing, bioscience, insurance and finance, and technology and innovation sectors. It explicitly excludes real estate, agriculture, construction, retail, and wholesale industries.31
3. Elimination of SRAC: The Supplemental RAC program is not included in the new incentive structure.30

New Financial and Administrative Mechanisms

The post-2026 program introduces significant financial constraints and new administrative burdens:

1. Reduced Credit Rate: The credit rate is reduced to a maximum of 3.5% of qualifying in-state QREs, a substantial decrease from the current 6.5% incremental rate.30
2. Annual Cap and Allocation Risk: The credits will be allocated from a strict statewide annual pool capped at $40 million.30 If the total demand from approved applicants exceeds this cap, credits will be allocated pro-rata. This introduces a competitive risk element that did not exist under the predictable $\S 422.10$ structure.
3. Annual Certification and Verification: Businesses must reapply annually for up to five consecutive years and are required to submit CPA-verified QRE reports to the IEDA.28
4. Refundability Status: The new credit remains refundable and non-transferable.28 However, the specific refundability percentage applicable under the new IEDA program, relative to the existing HF 2317 phase-down schedule (reaching 50% refundability by 2027), requires clarity through forthcoming IEDA rulemaking.

The shift to a discretionary, capped system under IEDA oversight creates substantial uncertainty for businesses relying on the credit. Under the current $\S 422.10$, a qualified taxpayer could reliably calculate the value of the credit. The post-2026 environment replaces that certainty with application risk, reduced benefits, and heightened administrative complexity.

Conclusion and Strategic Recommendations

Iowa Code $\S 422.10$ provides individual income taxpayers with a powerful, partially refundable credit that acts as a direct subsidy for research investments in targeted industrial sectors. However, the legal and financial landscape governing this incentive is in flux due to rapid legislative reform.

The primary strategic challenge for taxpayers is twofold:

1. Maximizing Current Benefit Under Phase-Down (2024–2025): Taxpayers must accurately calculate QREs and strategically manage their tax liability to absorb the credit while it is still calculated at the higher 6.5% incremental rate. Given the systemic, year-over-year reduction in refundability (e.g., to 80% in 2024 and 70% in 2025) and the lack of a standard multi-year carryforward, any non-refundable portion is lost. This requires intensive annual tax liability forecasting to utilize the credit immediately or through the limited one-year carryover election for the refundable portion.
2. Preparing for the Post-2025 System: Businesses must recognize that the formulaic RAC will be replaced by a competitive, capped incentive program starting in 2026. The new system carries lower rates (up to 3.5%), eliminates the Supplemental RAC, and mandates pre-approval and annual CPA verification via the IEDA. Businesses currently planning R&D investments should consider accelerating qualified expenditures into the 2025 tax year to secure the benefits under the higher rate and predictable formula of the expiring $\S 422.10$ statute. Proactive engagement with the IEDA and the implementation of robust internal controls necessary for CPA verification are essential for securing future benefits under the new program.

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