Expert Report: The Iowa Research Activities Credit (RAC) and the Critical 2026 Transition: Maximizing Final Claims Before the $40 Million Cap

I. Executive Summary: The Iowa Research Activities Credit (RAC) Defined

A. Core Purpose and Mechanism

The Iowa Research Activities Credit (RAC) historically provides a refundable state tax credit for increasing qualified research activities conducted within Iowa, benchmarked against federal R&D tax credit definitions under Internal Revenue Code (IRC) $\S 41$. This powerful incentive program has served as a key mechanism for Iowa to stimulate local innovation and job creation by offering significant tax relief, primarily distinguished by its refundable nature, which provides a cash benefit to businesses regardless of their existing state tax liability.1

The RAC has operated as an entitlement program, granting the credit to all eligible businesses that meet specific industry and research criteria defined in Iowa Code $\S 422.10$ and $\S 15.335$. However, this structure is set to undergo a fundamental and critical transition. The existing, entitlement-based RAC program will sunset on December 31, 2025, and will be replaced by a competitive, fiscally constrained R&D Tax Credit Program starting January 1, 2026.3 The current period is therefore the final opportunity for companies to maximize benefits under the generous, uncapped provisions of the legacy RAC system.

B. The High Fiscal Value of Refundability (Pre-2026)

The refundability of the RAC is one of its most defining and financially valuable features, historically setting Iowa’s program apart from those in most other states. Iowa is among the minority of states (eight out of 35 nationwide) that offer a broadly refundable incremental research tax credit.2 The credit can be claimed against individual income, corporate income, and other taxes. When the credit amount exceeds the taxpayer’s liability, the excess is refunded as cash to the taxpayer.1

For innovative companies, particularly those in the startup or growth phase that are generating significant Qualified Research Expenditures (QREs) but may not yet be profitable, this refundability mechanism transforms a theoretical tax reduction into essential operating capital. The ability to turn research expenses into a direct cash infusion from the state is a potent incentive for investment in local R&D infrastructure. This mechanism, however, carried a substantial fiscal cost to the state, totaling nearly $695.4 million in revenue loss between 2006 and 2019.2 This significant fiscal commitment to research stimulation, and the associated budgetary pressures, ultimately drove the legislative decision (Iowa Senate File 657) to restructure the program, impose a substantial annual cap, and increase verification requirements effective in 2026.

II. Statutory and Regulatory Nexus: Aligning Iowa Law with IRC $\S 41$

The technical administration of the Iowa RAC is inextricably linked to federal tax law, specifically IRC $\S 41$ concerning the credit for increasing research activities.

A. Adoption of Federal Definitions and Qualified Research Expenses (QREs)

Eligibility for the Iowa credit is strictly contingent upon the taxpayer first claiming and being allowed the federal research credit under IRC $\S 41$ for the same taxable year.2 This mandatory federal linkage ensures that all research activities claimed meet the stringent four-part test established under federal guidelines.

Furthermore, Iowa Code $\S 15.335$ explicitly integrates key federal definitions. The terms “base amount,” “basic research payment,” and “qualified research expense” are defined identically to those found in IRC $\S 41$.6 For example, the definition of contract research expenses—amounts paid to third parties (non-employees) for qualified research—is defined as 65 percent of the amount paid or incurred, directly mirroring the federal provision.7 This alignment simplifies initial QRE identification but mandates precise conformity with all federal rules regarding what constitutes qualified research.

B. Iowa’s Strict Apportionment Rules and Audit Risk

While Iowa adopts federal definitions, it imposes strict geographical limitations for eligibility. The primary deviation from federal law is the requirement that QREs must be for research conducted within this state.6 This requires meticulous documentation to support the credit claim.

Specifically, wages paid to an employee for qualified services, and contract research expenses paid to a third party, must relate to services performed in this state to constitute qualified research expenses in Iowa.5 For multi-state filers, this apportionment rule demands that the company segment its R&D activities, ensuring that only the proportional costs associated with research physically performed in Iowa are included in the state credit calculation, even if the total federal QREs are higher. This creates a distinct geographical audit risk, requiring highly accurate time-tracking and locational verification for all personnel and contractors involved in research activities.

Additionally, legislative changes have placed specific restrictions on supplies. For tax years beginning on or after January 1, 2023, but before January 1, 2027, amounts paid for supplies defined under IRC $\S 41(\mathrm{b})(2)(\mathrm{C})$ only constitute qualified research expenses in Iowa if the supplies directly relate to research performed in the state and are limited by specific allowable percentages.8

C. Industry Eligibility Criteria (Pre-2026 RAC)

The eligibility criteria for the current RAC restrict the benefit to businesses that Iowa views as high-growth drivers. The business must be engaged in the manufacturing, life sciences, agriscience (which was added in 2019), software engineering, or aviation and aerospace industry.2

The Iowa Code also provides a clear list of industries that are explicitly excluded, reflecting the state’s intent to focus the incentive on specific innovation-driven activities. Excluded sectors include, but are not limited to, real estate, finance or investment companies, retailers, wholesalers, agricultural production (as defined in $\S 423.1$), and contractors or subcontractors engaged in commercial and residential repair and installation.5 The exclusion of these sectors dictates that any R&D expenditure within these industries, regardless of federal eligibility, cannot be used for the Iowa RAC.

III. Comprehensive Analysis of Calculation Methodologies

Iowa offers two primary methods for calculating the RAC, mirroring the federal system: the Regular Method and the Alternative Simplified Credit (ASC) Method. A taxpayer may elect which method to use annually, independent of the method chosen for federal income tax purposes.9

A. The Regular Research Activities Credit Method (IA 128)

The Regular Method is the original calculation approach and generally applies a higher statutory rate. The credit is computed as 6.5% of the excess of the current tax year’s qualified research expenses (QREs) over a computed fixed-base amount.4 This base amount is determined using Iowa’s apportioned share of qualifying expenditures, requiring detailed historical QRE and gross receipts data, similar to the federal Fixed-Base Percentage rules.

In addition to the incremental QRE credit, the Regular Method allows an additional 6.5% credit for basic research payments determined under IRC $\S 41(\mathrm{e})(1)(\mathrm{A})$.9 Taxpayers claiming this method use Iowa Form IA 128.4

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

The ASC Method provides a simplified approach that often favors companies experiencing recent, high-velocity growth in their R&D spending. Instead of relying on a historical fixed-base percentage dating back to the 1980s, the ASC uses a rolling average.

The credit is calculated using a rate of 4.55% applied to the difference between the current year’s Iowa QREs and 50% of the average of the prior three years’ Iowa QREs.4 This method is claimed using Form IA 128S.4

While the ASC rate (4.55%) is lower than the Regular Method rate (6.5%) 9, the mechanism for determining the base amount is often significantly more favorable for businesses rapidly scaling their research. If a company had low QREs in the prior three years, or zero QREs in one or more of those years, the resulting 50% average base amount will be low. This low base maximizes the resulting incremental QREs to which the 4.55% rate is applied, frequently leading to a higher overall credit dollar amount than the Regular Method, which is constrained by a potentially high fixed-base percentage. Accurate annual modeling is therefore essential to determine which method maximizes the taxpayer’s final credit.

Table 1: Comparison of Iowa Research Activities Credit Calculation Methods (Pre-2026)

C. The Supplemental Research Activities Credit (SRAC)

The Supplemental Research Activities Credit (SRAC) is an additional layer of incentive designed to enhance Iowa’s economic development efforts. This credit is not formula-based but is awarded by the Iowa Economic Development Authority (IEDA) to businesses that hold existing tax incentive contracts under major state programs, such as the High Quality Jobs Program or the Enterprise Zone Program.10

The value of the SRAC varies based on the company’s size:

• For businesses with annual gross revenues of $20 million or less, the maximum supplemental credit is 10% of the calculated incremental QREs.10
• For businesses with annual gross revenues exceeding $20 million, the maximum supplemental credit is 3%.10

This supplemental layer, when combined with the 6.5% Regular Credit rate, could yield a total potential incremental credit rate of 16.5% for smaller eligible businesses, positioning Iowa’s incentive package among the most highly advantageous in the United States.2 Eligibility for the SRAC, along with the specific amount and a mandatory tax credit certificate number, is provided directly through the IEDA contract and must be referenced on the tax return.10

IV. Practical Application and Compliance Example: Alternative Simplified Credit (ASC)

To illustrate the mechanism, a practical example of calculating the Alternative Simplified Credit (ASC) is provided, followed by an explanation of the complex rules governing pass-through entities (PTEs).

A. Numerical Example: Step-by-Step ASC Calculation (Tax Year 2024)

This calculation adheres to the rules for the ASC method outlined in Iowa Code $\S 422.10(1)(\text{b})$ and assumes strict adherence to the requirement that all QREs are for research performed within Iowa.9

Table 2: Alternative Simplified Credit (ASC) Calculation Example (Hypothetical)

In this scenario, the calculated Research Activities Credit for tax year 2024 is $8,645. This amount would then be reported on Form IA 128S, and subsequently on the IA 148 Tax Credits Schedule, to be applied against the tax liability or refunded.

B. Pass-Through Entity (PTE) Calculation and Apportionment

If the eligible business is structured as a partnership, S corporation, limited liability company, estate, or trust, the tax credit must be apportioned to the individual members.6 The entity itself calculates the credit amount (Lines 2 through 30 on IA 128/128S) and must file the appropriate Iowa computation form (IA 128 or IA 128S) along with Federal Form 6765.10

The PTE then reports the apportioned tax credit for each member on Schedule K-1 or an attachment thereto.10 For the individual member, administrative compliance is complex:

1. The member must report the apportioned credit on Line 32 (Pass-through RAC) of their own IA 128.
2. The credit must be reported separately on the IA 148 Tax Credits Schedule (Part II), using the specific tax credit code 58 for the passed-through RAC.10
3. For any supplemental credit received (SRAC), the member reports it on Line 33 of IA 128, uses tax credit code 59 on IA 148, and must include the tax credit certificate number received via the K-1 attachment.10
4. A separate IA 128 must be filed for each pass-through RAC or SRAC received from different entities.10

This stringent administrative requirement means that accuracy in reporting entity names, Federal Employer Identification Numbers (FEINs), and certificate numbers on the IA 148 is paramount. Failure to correctly report the pass-through credit on the individual return using the required forms, lines, and codes risks rejection of the claim by the Iowa Department of Revenue (IDR), thereby negating the intended benefit.

V. Iowa Department of Revenue (IDR) and Administrative Guidance

The IDR administers the RAC, providing guidance on compliance and application procedures.13 This administration is bound by the specific statutory limits codified in Iowa Code $\S 422.10$ and $\S 422.33$.6

A. Required Forms and Submission

To claim the RAC, taxpayers must use the appropriate computational form:

• Form IA 128: Used for the Regular Research Activities Credit.4
• Form IA 128S: Used for the Alternative Simplified Research Activities Tax Credit.4

All entities claiming the credit must include a copy of the Federal Form 6765 (Credit for Increasing Research Activities) with their Iowa return.10 Finally, the total credit claim is summarized and reported on the IA 148 Tax Credits Schedule.1 Compliance requires the credit to be claimed on a return filed by the due date for filing the return, including extensions.5

B. Application and Refundability

The order of credit application is dictated by statute to ensure proper interaction with other incentives. The RAC must be applied against tax liability after all nonrefundable credits available to the taxpayer have been applied, but before any other refundable credit.5

Crucially, the credit is refundable when claimed against individual income tax.1 If the credit exceeds the tax liability, the taxpayer may elect to receive the excess amount as a refund, or the excess may be carried forward to the following tax year.12 When a tax credit is awarded, the taxpayer is issued a tax credit certificate number (especially for the SRAC), which must be reported on the IA 148 schedule to validate the refundable claim.1

C. Statutory Linkage and Constraints

The administrative process adheres to the core principle established in Iowa Code $\S 15.335$: the regular or alternative credit is computed according to the same claim, calculation, and refund limitations detailed in sections $\S 422.10$ and $\S 422.33$.6 This structural dependency means the IDR’s interpretation and enforcement of the RAC are directly constrained by the specific parameters set forth in these Code sections, encompassing eligibility based on industry, timely filing requirements, and precise application of the refund criteria.5

VI. Strategic Planning: The RAC Sunset and Transition (2026 and Beyond)

The passage of Iowa Senate File 657, which was approved on June 6, 2025, marks a critical pivot in Iowa tax policy, replacing the established Research Activities Credit (RAC) with a significantly modified program starting in 2026.3

A. The End of Entitlement: The RAC Sunset

The current, formula-based Research Activities Credit (RAC) is scheduled to expire on December 31, 2025.3 This effective sunset means that the 2024 and 2025 tax years represent the final period during which businesses can claim the credit under the favorable, uncapped structure, which featured a maximum incremental rate of 6.5%. Businesses must take immediate steps to accelerate and meticulously document all eligible QREs within this timeframe to maximize their final claims before the restrictive new system is implemented.3

B. The New Competitive Program (Post-2025)

Effective January 1, 2026, the new R&D Tax Credit Program introduces several fundamental changes:

1. Shift to Competitive Application and Oversight: The program transitions from an automatic, formula-based entitlement to a competitive application process overseen by the Iowa Economic Development Authority (IEDA).3
2. The $40 Million Annual Cap: The new law imposes a hard fiscal control by capping annual awards at $40 million.3 This cap introduces significant financial uncertainty; if total claims exceed the cap, credits will be allocated pro rata.3 Companies calculating a specific expected credit amount must now factor in the risk that they may receive only a fraction of that value due to competition within the cap pool.
3. Rate Reduction: The maximum credit rate is substantially reduced from 6.5% to 3.5% of qualifying in-state QREs.3
4. Heightened Verification: The application process is significantly more rigorous, requiring businesses to submit CPA-verified Qualified Research Expenditures (QREs) reports to the IEDA.3 This requirement necessitates increased compliance and verification costs.
5. New Duration and Renewal: Although credits remain refundable and nontransferable, they can be secured for up to five consecutive years, contingent upon mandatory annual reapplication and certification.3

C. Revised Eligibility Criteria (Post-2025 Program)

The new program narrows and refines the list of eligible sectors, reflecting a state strategy to target specific, high-growth economic clusters for the next decade.

• New Eligible Sectors: Advanced manufacturing, bioscience, finance, insurance, technology and innovation.3 The explicit inclusion of finance and insurance activities is notable, as “finance or investment company” was previously excluded under the RAC.5 This expansion indicates a policy decision to incentivize R&D in financial and insurance technology (FinTech and InsurTech).
• Explicit Exclusions: The program explicitly excludes the real estate, agriculture, construction, retail, and wholesale industries.3

Table 3: Comparison of Iowa R&D Tax Incentive Programs (Pre- vs. Post-2025)

VII. Conclusion and Actionable Recommendations

The legislative changes replacing the RAC with a capped, competitive program fundamentally alter the tax landscape for Iowa innovators. The window between now and December 31, 2025, is critical for maximizing benefits under the current statute.

A. Immediate Action Items (2024/2025 Focus)

1. Aggressive Claim Optimization: Businesses currently eligible for the RAC must prioritize the accurate identification and documentation of all QREs to maximize claims at the current 6.5% rate. Robust annual modeling should be performed to determine the optimal claim method (Regular vs. ASC) for 2024 and 2025 tax years.
2. PTE Compliance Review: Pass-through entities and their members must conduct comprehensive reviews of their documentation and reporting procedures, ensuring strict adherence to the Schedule K-1 apportionment rules and the proper use of IA 128 (Lines 32 and 33) and IA 148 tax credit codes.
3. SRAC Documentation: Businesses receiving the Supplemental Research Activities Credit must confirm that their IEDA contract and corresponding tax credit certificate numbers are correctly referenced on the IA 148 to ensure full refundability of these substantial additional credits.

B. Forward-Looking Strategy (Post-2025 Focus)

1. Risk and Budget Modeling: Companies must immediately incorporate the risk of pro rata reduction due to the $40 million cap into their long-term financial forecasts. This uncertainty necessitates a more conservative approach to relying on the R&D credit as a guaranteed funding source starting in 2026.
2. CPA Engagement and Compliance Systems: Given the mandatory requirement for CPA-verified QRE reports under the new program, businesses must begin implementing enhanced internal accounting and tracking systems now. Securing early engagement with an independent CPA specializing in R&D credit validation will be necessary to meet the demanding application deadline for 2026 claims (January 31, 2027).3
3. Confirming Revised Eligibility: Businesses previously eligible under the RAC should confirm their inclusion in the refined 2026 targeted sectors (advanced manufacturing, bioscience, finance, insurance, technology and innovation). Conversely, businesses in newly included sectors, such as FinTech, should begin preparing documentation to establish QRE eligibility under the new IEDA criteria.3

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