Senate File 657 and the Statutory Transformation of the Iowa Research and Development Tax Credit Regime

I. Executive Summary: Senate File 657 and the Iowa R&D Tax Credit Transformation

Iowa Senate File 657 (SF 657) repeals the uncapped, formula-based Research Activities Credit (RAC), effective for tax years beginning on or after January 1, 2026, replacing it with a new, stringent Research and Development Tax Credit Program. The new program, capped annually at $40 million and administered by the Iowa Economic Development Authority (IEDA), significantly reduces the available credit rate and narrows eligibility exclusively to state-targeted, high-growth industries.

Detailed Overview of the Paradigm Shift

The enactment of Senate File 657 represents a comprehensive restructuring of Iowa’s state taxation and economic incentive statutes.1 Signed by Governor Kim Reynolds on June 6, 2025 4, this legislation addresses several financial divisions, modifying, creating, and eliminating various tax credit and incentive programs across 21 divisions.5

The primary catalyst for overhauling the R&D incentive structure was the unpredictable and uncapped nature of the former RAC. Historical data demonstrated that claims under the RAC routinely exceeded legislative budget forecasts; businesses claimed approximately $77.6 million in the Research Activities Credit in fiscal year (FY) 2024 6, and annual claims often surpassed $70 million in recent periods.4 The legislature determined that such volatility required decisive action to achieve fiscal predictability. Consequently, the new structure is designed to enforce tight fiscal control by establishing a firm annual allocation limit of $40 million, thereby directing benefits toward strategically defined high-growth sectors.4

This legislative mandate initiates a profound administrative and structural change. Oversight of the R&D incentive mechanism is transferred entirely from the traditional taxing authority, the Iowa Department of Revenue (DOR), to the economic development and grant-making agency, the Iowa Economic Development Authority (IEDA).4 This organizational transfer reflects a critical philosophical shift: the R&D credit moves from operating as an automatic, formula-based tax reduction calculated on the tax return to functioning as a competitive economic development award contingent upon external agency approval.

The core implication of this policy decision is the shift from an entitlement model to a competitive landscape. R&D expenses incurred after January 1, 2026, no longer guarantee a calculable tax credit merely through the performance of qualified activities. Instead, the realization of the credit is dependent on formal IEDA approval, the competitive merit of the application, and, most importantly, the aggregate volume of claims submitted by all applicants in a given year. The introduction of the pro-rata allocation mechanism means that the financial risk associated with high claim volume is transferred entirely from the state treasury to the participating business community.4

II. Legislative History and Structural Context of SF 657

A. Enactment Timeline and Applicability

Senate File 657 was approved by the Iowa legislature in May 2025 and signed into law on June 6, 2025.4 The bill specifies various effective and applicability dates for its numerous divisions.1

Regarding research incentives, the following statutory timeline applies:

1. RAC Sunset: The long-standing Research Activities Credit (RAC), codified under Iowa Code Chapter 422, is repealed for tax years beginning on or after January 1, 2026.8 Therefore, the existing RAC program is set to expire on December 31, 2025.4
2. New Program Commencement: The new R&D Tax Credit Program (Iowa Code § 15.524), which replaces the RAC, is effective for tax years beginning on or after January 1, 2026.8
3. Full Statutory Repeal: The RAC is scheduled for full repeal from the Iowa Code on January 1, 2027.10 However, provisions related to the ability of taxpayers to carry forward previously awarded credits may necessitate the DOR maintaining administrative tracking for pre-2026 claims potentially until January 1, 2031.5

B. Repeal of Ancillary Programs and Aggregate Cap Reduction

SF 657 is a sweeping legislative measure that modifies or eliminates numerous economic incentive programs beyond the R&D credit. Notable repeals include the High Quality Jobs (HQJ) Program and the Investments in Qualifying Business (Angel Investor) Tax Credit.5

The elimination of the HQJ program is particularly relevant for historical RAC claimants. The previous RAC structure permitted businesses approved under the HQJ or Enterprise Zone programs to claim a significant Supplemental Research Activities Tax Credit.11 This supplemental benefit provided an additional credit, which could range up to 10% for small firms (under $20 million in gross revenues) or 3% for larger firms on qualifying incremental research expenditures.12 In some instances, this supplemental credit effectively allowed qualifying firms to claim close to double the standard credit amount. The new R&D Tax Credit Program contains no statutory mechanism for such supplemental credits, meaning the effective rate reduction for high-growth or smaller corporations is magnified by the loss of these stacking incentives.

Furthermore, Division I of SF 657 drastically revises the aggregate fiscal limit for state economic development incentives. Starting in FY 2026, the aggregate tax credit limit for certain business development programs is decreased from $170.0 million to $110.0 million.5 This reduction of $60 million in the overall statewide cap confirms the legislative intent to broadly reduce state fiscal exposure across all major incentive packages.

III. The Repealed Framework: The Research Activities Credit (RAC) (Pre-2026)

The details of the RAC framework remain critical for compliance, audit defense, and the proper calculation of claims for tax years ending on or before December 31, 2025.

A. Administration, Eligibility, and Scope

The RAC was administered by the DOR and was claimed by filing Iowa forms IA 128 (Regular Method) or IA 128S (Alternative Simplified Method).12 Eligibility hinged on the taxpayer claiming the corresponding federal R&D credit under Internal Revenue Code (IRC) Section 41 and conducting qualified research activities (QRAs) within Iowa.12 The previous industrial scope was notably broad, explicitly covering taxpayers engaged in manufacturing, life sciences, agriscience, software engineering, and aviation and aerospace.6 Historically, the DOR administered a well-known RAC audit program, indicating its active oversight of compliance under the formulaic framework.6

B. Detailed Calculation Methodology (Iowa Code § 422.33(5))

The Iowa credit amount was based on the Iowa-apportioned share of research expenses. Taxpayers were required to use the same calculation method (Regular or ASC) for the state credit that was elected for the corresponding federal credit.10

1. The Regular Method (Form IA 128): This method allowed a credit of 6.5% of the excess of qualified research expenses (QREs) over a calculated base amount.11 The base amount calculation was complex, determined by multiplying the fixed-base percentage by the average annual gross receipts of the taxpayer for the four preceding taxable years. Crucially, the base amount could not be less than 50% of the QREs for the credit year.11
2. The Alternative Simplified Method (ASC) (Form IA 128S): This calculation method allowed a credit of 4.55% of the difference between the current year’s Iowa QREs and 50% of the average of the prior three years’ Iowa QREs.11

The RAC was refundable, meaning taxpayers could receive cash back for the credit portion exceeding their state tax liability. While refundability was subject to statutory percentage limits (e.g., 80% for the regular RAC and 90% for the supplemental credit), there was generally no provision for carrying forward excess credit amounts.12 The high utilization of the refundable feature demonstrates its value: in 2023, approximately $35.3 million, or 42% of total claims processed, were paid out as direct refunds to firms that owed no state income tax liability.15

Table 1: Key Financial and Structural Parameters of the Repealed RAC (Pre-2026)

IV. The New Era: The R&D Tax Credit Program (Post-2026)

The new R&D Tax Credit Program, effective January 1, 2026, fundamentally transforms the mechanism by which research activities are subsidized in Iowa.

A. The Central Shift: IEDA Program Management and Pre-Approval

The most significant change under SF 657 is the transfer of administrative authority to the Iowa Economic Development Authority (IEDA).4 The receipt of the credit is now contingent upon the business being determined to be a “qualified business” by the IEDA.8 This requires a formal pre-application process where the business must demonstrate that it fits within one of the targeted sectors and is actively engaged in qualifying research activities.6

Once approved, a business can secure the credit for up to five consecutive years. However, to receive the allocated credit for a given year, annual reapplication and certification are strictly required.4

Furthermore, the compliance requirements have been amplified. The process mandates that approved businesses submit CPA-verified Qualified Research Expenditures (QREs) reports to the IEDA.4 This new external verification requirement imposes a significant and mandatory annual administrative hurdle and cost on claimants. Under the former RAC structure, external verification, often via a forensic CPA, was primarily required only in response to a DOR audit. This mandatory, annual, independent CPA review acts as a high degree of compliance friction, ensuring that only businesses with substantial, meticulously documented claims are likely to proceed through the competitive application and allocation process.

B. Narrowed Eligibility and Strategic Targeting

SF 657 implements highly stringent eligibility criteria to strategically focus state resources on sectors deemed vital for economic growth and modernization.4

• Targeted Industries: Eligibility is significantly restricted, limited only to businesses primarily engaged in four broad sectors: advanced manufacturing, bioscience, insurance and finance, and technology and innovation.4
• Specific Eligible Sub-Sectors: The legislation goes beyond broad industry definitions, requiring applicants to fit into specific sectors defined by the IEDA. These include, but are not limited to: Second-generation food innovation, Food ingredients and supplements, Crop Production, Hybrid Seed Technologies, Diagnostic analytics and immunotherapies, Chip technology and microelectronics, Medical equipment and supplies, Software and technology, Aerospace, Pharmaceuticals, and Consumer products.6 The inclusion of specific agricultural technology sectors, such as Hybrid Seed Technologies and Second-generation food innovation, demonstrates a legislative intent to support high-tech, value-added agricultural inputs (agriscience). This contrasts sharply with the exclusion of general agriculture production.
• Explicit Exclusions: The statute explicitly bars certain industries from participating, including real estate, agriculture production, construction, retail, and wholesale industries.4

C. New Program Mechanics and Fiscal Controls

The fiscal design of the new program introduces critical limitations previously absent under the RAC.

• Reduced Credit Value: The maximum available credit rate is lowered substantially to up to 3.5% of qualifying in-state QREs.4 This represents a reduction of 3 percentage points from the previous 6.5% rate used in the Regular Method calculation.
• The $40 Million Hard Cap: To ensure fiscal control, the total amount of credits authorized by the IEDA in any single fiscal year is strictly limited to $40 million.4 This represents a significant reduction from historical claims, often reducing the overall available pool by $30 million to $45 million compared to recent RAC utilization.4
• Pro-Rata Allocation Mechanism: The legislation mandates that if the aggregate amount of eligible expenditures submitted by all IEDA-approved qualified businesses, multiplied by the 3.5% rate, exceeds the $40 million annual cap, the IEDA must approve tax credit awards by apportioning the available funds on a pro-rata basis.4 This allocation system ensures the state’s budget is never exceeded, but it introduces substantial uncertainty regarding the final realized value of the credit for any given business. If, for instance, total calculated claims reach $80 million, every business’s award is automatically reduced by 50%. This structure transforms the credit into a highly variable incentive, decreasing its reliability for long-term capital investment planning.
• Credit Structure and Bonus: The credits remain refundable (allowing taxpayers to receive a refund for the portion exceeding their tax liability) or can be carried forward to offset future liability. However, they are strictly defined as non-transferable.4 Additionally, the IEDA is authorized to reserve up to five percent of the total available tax credits to award as supplementary credits to qualified businesses that can demonstrate a documented increase in eligible expenditures.8

Table 2: New R&D Tax Credit Program Key Parameters and Eligibility (Post-2026)

V. Local State Revenue Office Guidance and Transition Requirements

The shift mandated by SF 657 requires careful navigation of administrative responsibilities between the retiring DOR-administered code and the emerging IEDA-administered rules.

A. IDR/DOR Administrative Guidance on Program Sunset

The Iowa Department of Revenue (DOR) has clarified that the Research Activities Tax Credit (RAC) is no longer awarded effective January 1, 2026.10 Businesses must ensure that claims related to 2025 QREs are filed under the old RAC statutes, as the new program commences for tax years beginning on or after January 1, 2026.8

Taxpayers should note the initial application deadline for claims based on 2026 QREs is January 31, 2027.4 This date is critical for businesses seeking allocation from the initial $40 million pool.

A core transition compliance rule is the explicit prohibition against dual claiming. The statute specifies that a qualified business that claims the repealed RAC pursuant to Iowa Code sections 422.10 or 422.33 (Code 2025) shall not claim the new R&D tax credit awarded by the IEDA on the same tax return.8 This prevents confusion and the receipt of dual benefits during the sunset/commencement period.

B. The DOR’s Continuing Role in Auditing and Enforcement

The DOR retains complete authority and responsibility for administering and auditing all previously filed RAC claims (pre-2026), subject to the relevant statute of limitations. Businesses must continue to prepare for and defend against the established DOR RAC audit program for prior years.6

A critical legal intersection is established regarding enforcement: SF 657 creates a mechanism where IEDA determines the compliance status, but the DOR is charged with tax collection for failures. The IEDA is responsible for monitoring compliance with the new program requirements. If a qualified business fails to comply with the program or the agreement, the IEDA may revoke its certification or require the repayment of any tax credit issued.8

The statute then grants the DOR enhanced collection power by specifying that after a final determination by the IEDA, the required repayment of a tax credit “shall be considered a tax payment due and payable to the department of revenue”.8 This provision is significant because it grants the DOR full tax collection authority—including the use of liens, levies, penalties, and interest—to retrieve incentives that were initially awarded and administered by the economic development agency. This bypasses typical contract law remedies and ensures the IEDA’s compliance and monitoring efforts are backed by the state’s primary tax enforcement infrastructure.

VI. Comparative Analysis of RAC vs. New Program (Policy and Financial Impact)

A. Quantitative Impact: Comparison of Calculation Methods

The old RAC formula (6.5% of incremental QREs over a complex historical base) was specifically structured to reward research growth.12 Conversely, the new program (up to 3.5% of total QREs) is structured to reward gross research spending but at a heavily discounted rate and under a volume ceiling.4

For companies with substantial QRE growth and a low fixed-base amount, the 6.5% rate on the incremental research expenditures often yielded a far higher credit value than the new fixed 3.5% rate on total QREs. While the new calculation method is simpler, the $40 million cap introduces a catastrophic element of financial uncertainty. If historical claim volumes persist (e.g., $70 million to $80 million), the expected return on every dollar of qualified research spending drops from a reliable, formula-based rate (e.g., up to 6.5% incremental) to an uncertain, potentially low realized rate (e.g., $40M cap on $80M in claims means a 50% realization factor), severely compromising the financial justification for capital-intensive R&D projects.

B. Qualitative Impact: Predictability, Control, and Industry Focus

The restructuring represents a clear shift in legislative purpose. The previous RAC was a broad, reliable tax incentive—a “tax expenditure”—designed for general economic stimulus and focused primarily on tax compliance and accurate record-keeping. The new R&D Tax Credit Program is a tool of targeted economic policy, prioritizing strategic industries (advanced manufacturing, bioscience, etc.) with the explicit objective of ensuring fiscal certainty for the state.4 This mandates that businesses move from a tax-filing approach to an incentives management approach, requiring them to demonstrate economic justification and alignment with IEDA goals, rather than merely proving the existence of qualifying research activities.

Table 3: Comparative Analysis of R&D Tax Credit Regimes in Iowa

VII. Illustrative Financial Example and Strategic Modeling

To illustrate the financial impact of SF 657, a comparative analysis demonstrates the reduction in realized benefit for a qualifying business.

A. Scenario Definition

We examine the position of Iowa Innovate Corp., an Advanced Manufacturing firm whose activities qualify under both the old RAC and the new R&D Tax Credit Program. We use hypothetical financials for comparison in a single tax year (2026 context).

• Current Iowa QREs: $1,000,000
• Prior 4-Year Average Gross Receipts: $10,000,000
• Fixed-Base Percentage (RAC): 5%
• Statewide Total Estimated Eligible Claims (Hypothetical for 2026): $80,000,000 (Based on historical utilization 4).

B. Detailed Calculation Example

1. Calculation Under Old RAC (Pre-2026 Regular Method)

The calculation is based on the 6.5% rate applied to incremental QREs over the fixed base amount.12

2. Calculation Under New R&D Tax Credit Program (Post-2026)

The calculation is based on the 3.5% rate applied to total QREs, subject to the annual cap and pro-rata adjustment.4

C. Financial Conclusion

The calculated benefit for Iowa Innovate Corp. decreases from a predictable $32,500 under the old RAC regime to an estimated $17,500 under the new program, assuming significant competition for the capped funds. This represents a 46% reduction in realized incentive value. The effective subsidy rate for the company drops from a predictable 3.25% of total QREs to an uncertain 1.75% of total QREs, demonstrating the financial consequences of the legislative push for fiscal restraint.

VIII. Conclusion and Strategic Recommendations

The enactment of SF 657 definitively marks the end of the uncapped, formula-driven Research Activities Credit in Iowa. Companies involved in R&D must recognize that the mechanism for receiving state R&D subsidies has shifted from a tax calculation to a competitive, agency-managed grant program.

Actionable Steps for Businesses in Targeted Industries (Post-2025)

1. Prioritize Strategic Alignment with IEDA: Transition planning must immediately involve strategic alignment. Companies must engage with the IEDA to ensure their R&D activities and classification strictly adhere to the narrow, eligible sub-sectors defined in the statute, such as Diagnostic analytics or Chip technology.4 Pre-approval is a prerequisite for generating a claim.
2. Bolster Compliance Infrastructure: Due to the annual reapplication cycle and the mandatory expense of obtaining CPA-verified QRE reports, businesses must develop robust internal compliance and budgeting infrastructures capable of managing these increased administrative demands.4 The cost of compliance must be factored into the overall economic benefit analysis.
3. Conservative Financial Modeling: Given the profound impact of the $40 million hard cap and the pro-rata allocation risk, future R&D budgets and cash flow projections should not rely on the theoretical 3.5% credit rate. Instead, conservative models should utilize a lower, risk-adjusted realized credit rate (e.g., 1.5% to 2.5% of QREs) to mitigate potential financial disappointment resulting from high claim volume.
4. Manage Bifurcated Liability Risk: Taxpayers must recognize the unique enforcement liability where the IEDA determines compliance but the DOR enforces repayment. Failure to comply with IEDA program requirements can lead to the repayment obligation being treated as a tax deficiency, subject to the DOR’s aggressive collection powers (liens, penalties, and interest).8

Recommendations for Firms in Excluded Industries

Firms in explicitly excluded sectors, such as general agriculture production, real estate, construction, retail, and wholesale 12, must recognize that the state R&D incentive expires after the 2025 tax year. These businesses should focus on maximizing the benefits of the Federal IRC § 41 credit and aggressively exploring alternative, non-R&D specific state incentives, such as specialized manufacturing sales tax exemptions or local property tax abatements, to compensate for the lost cash flow previously provided by the refundable RAC.

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