Navigating the Supplies Phase-Out: Compliance and Strategic Shifts in the Iowa R&D Tax Credit for 2024

The Supplies Phase-Out Percentage is a critical, temporary compliance limitation imposed on the Iowa Research Activities Credit (RAC), dictating the maximum portion of qualified research supply costs that may be included in the state credit calculation. For the 2024 tax year, this mandate restricts the inclusion of otherwise qualified research supplies expenditures to only 60% of their actual cost. This represents a legislative maneuver to immediately reduce the financial exposure of the state’s refundable R&D tax credit program before its scheduled termination and subsequent replacement by a new, capped program in 2026.

This reduction is rooted in the legislative reforms initiated by Iowa House File 2317 (HF 2317) in 2022, which significantly modified the structure of the RAC program. Previously known as one of the nation’s most generous refundable research tax credits, the RAC provided substantial benefits, offering a refundable credit equal to 6.5% of Iowa’s apportioned share of qualifying incremental research expenditures.1 The legislative action taken by HF 2317 was part of a broader strategy that included lowering corporate tax rates while concurrently introducing revenue-raising measures through the modification and tightening of existing tax credits.2 The Supplies Phase-Out stands as a clear example of how the legislature sought to control the fiscal impact of the uncapped program, particularly targeting expenses in materials-intensive sectors such as advanced manufacturing and bioscience, which frequently generate substantial supply QREs.

The policy implementation of HF 2317 strategically targeted the overall value of the RAC through dual restrictive mechanisms. Firstly, the legislature decreased the definition of what constitutes eligible Qualified Research Expenditures (QREs) by introducing the Supplies Phase-Out, thereby reducing the numerator of the credit calculation. Secondly, HF 2317 simultaneously limited the cash value to the taxpayer by phasing down the percentage of the calculated credit that is refundable. The refundable amount dropped from 100% prior to 2023, to 90% in 2023, and further to 80% in 2024.2 By reducing both the expenditure base and the final refundability percentage, Iowa achieved a rapid and calculated curtailment of the program’s fiscal liabilities years before the scheduled repeal and introduction of the new R&D Tax Credit Program under Senate File 657 (SF 657) in 2026.3

II. Statutory and Administrative Framework of the Phase-Out

The specific mandates governing the Supplies Phase-Out are codified within the Iowa tax statutes, ensuring adherence to strict application schedules and methodologies tied to federal definitions.

A. The Mandate: Iowa Code § 422.10(1)(b)(3)(d)

The definitive legal foundation for the Supplies Phase-Out is found within Iowa Code Section 422.10, which governs the individual income tax credit for increasing research activities. This section contains specific statutory language that defines the limitations applied to amounts paid for supplies used in qualified research activities conducted within Iowa.

This phase-out provision is explicitly temporary, applying only to tax years beginning on or after January 1, 2023, but before January 1, 2027.5 This limited timeframe aligns precisely with the legislature’s goal of budget stabilization leading up to the program’s planned obsolescence. Specifically addressing the 2024 tax year, Iowa Code Section 422.10(1)(b)(3)(d)(ii) specifies the precise limitation 5:

“For the tax year beginning on or after January 1, 2024, but before January 1, 2025, sixty percent of the amounts paid for supplies directly related to research performed in this state.”

This statute confirms that for any tax year beginning in 2024, 40% of qualified research supply costs must be excluded from the Iowa QRE base calculation.

B. Defining “Qualified Supplies” Under Federal Law (IRC § 41)

Although the Iowa Code mandates the percentage reduction, the definition of the expenditures themselves remains linked to the federal framework. Iowa law requires that the researching business must claim and be allowed the Federal Credit for Increasing Research Activities under Internal Revenue Code (IRC) Section 41 for the same taxable year to be eligible for the Iowa credit.6

Consequently, the definition of supplies utilized in the Iowa calculation must conform to IRC Section 41(b)(2)(C). This federal definition establishes supplies as “any tangible property other than land or improvements to land, and other than property of a character subject to the allowance for depreciation.” In practice, this category encompasses materials consumed or used up during the research process, such as chemicals, specialized raw materials, components used in the construction of prototypes, and laboratory consumables. This requirement of alignment means that taxpayers must first rigorously document that their supplies meet the federal definition before applying the state-mandated 60% reduction.

C. Detailed Analysis of the Supplies QRE Phase-Out Schedule

The Supplies Phase-Out is a tiered, multi-year reduction impacting the QRE base, separate from the limitations applied to the final credit refundability. The schedule demonstrates the legislature’s systematic approach to reducing the benefit over time.

Iowa RAC Supplies QRE Phase-Out Schedule (2023-2025)

The continuity of restrictions is important for strategic planning. Taxpayers filing for the 2024 tax year operate under the 60% limitation, but they must recognize that if they plan comparable research activity involving supplies in the 2025 tax year, the allowable portion will drop further to 40%.5

D. Related QRE Limitations: Exclusion of Computer Lease/Rental Costs

The Supplies Phase-Out was not the only QRE restriction imposed by HF 2317. The legislation also introduced a statutory disallowance of computer lease or rental costs, an expenditure category that is typically allowable under IRC Section 41(b)(2)(A)(iii) for federal purposes.2 Iowa Code section 422.10 states that “Amounts paid for the right to use computers as described in section 41(b)(2)(A)(iii) of the Internal Revenue Code shall not be qualified research expenses in this state”.5

This exclusion requires taxpayers to subtract this category of expenditure entirely, establishing a 0% inclusion rate, whereas supplies are merely subjected to a percentage reduction. The existence of these two distinct, yet simultaneous, statutory modifications confirms the legislative intent to actively decouple the Iowa QRE base from the federal QRE base where those expenses were perceived as too costly to the state budget. Taxpayers must therefore apply both the 60% phase-out to supplies and the 100% exclusion to computer lease costs when calculating their Iowa QRE base.

III. Iowa Department of Revenue (DOR) Compliance and Reporting

Compliance with the Supplies Phase-Out requires careful reconciliation between the federal QRE calculation, state apportionment, and the statutory reduction mandates. The Iowa Department of Revenue (DOR) enforces these requirements primarily through the Iowa Research Activities Tax Credit form, IA 128.

A. Prerequisite and Data Integration

Eligibility for the Iowa RAC is conditional upon claiming and being allowed the corresponding federal credit.7 The Iowa calculation relies on the Qualified Research Expenses determined for federal purposes on Form 6765. The Iowa Form IA 128 (2024 version) requires the business to report its U.S. Qualified Research Expenses (QREs) and then determine the Iowa-specific QREs.8

The federal QRE amount for supplies, entered on Line 6 of the federal calculation (Form 6765), represents the total, unreduced cost of supplies used in conducting qualified research.8 However, Iowa law requires a further step: determining the portion of those QREs that were incurred in Iowa (the Iowa apportionment) and then applying the statutory limitations.

B. Applying the Phase-Out: Internal Documentation and Reporting on IA 128

The primary compliance challenge stems from the fact that the Iowa Department of Revenue does not provide a specific, separate line item on Form IA 128 for calculating or displaying the application of the 60% phase-out.

The instructions for the 2024 IA 128 specify that the taxpayer must enter “the amounts paid or incurred for supplies used to conduct qualified research in Iowa” on Line 22.7 Crucially, the amount entered on this line must be the final, reduced figure—the raw Iowa-apportioned supplies QREs multiplied by the 60% phase-out percentage.5

This design choice places the entire computational complexity and documentation burden squarely on the taxpayer. The taxpayer must:

1. Identify the total supply QREs that qualify under federal IRC § 41.
2. Apportion the total supply QREs to research activities performed specifically within Iowa.
3. Calculate the allowable Iowa QREs by multiplying the Iowa-apportioned raw amount by 60% (for 2024).
4. Enter the resulting, reduced amount onto Line 22 of Form IA 128.

The DOR is known to maintain a robust RAC audit program.9 Therefore, detailed, contemporaneous workpapers demonstrating the application of the 60% reduction, along with the corresponding Iowa apportionment methodology, are necessary to substantiate the final figure reported on Line 22. Entering the full, unreduced, Iowa-apportioned supplies cost represents a material error and significant audit exposure.

The requirement that businesses must calculate and apply this specific state modification before submitting the final QRE number is consistent with how state revenue agencies manage complexity. By modifying key federal definitions (such as the Supplies reduction and the Computer rental exclusion 2) but only requesting the final, post-adjustment number on the form, the DOR streamlines the form itself while relying on the audit process to enforce compliance with these unique statutory modifications. This approach decentralizes the compliance burden, making robust internal documentation essential for minimizing liability.

IV. Practical Application: A 2024 Calculation Example

To illustrate the concrete impact of the 60% Supplies Phase-Out Percentage, the following example details the calculation required for a qualified taxpayer using the regular (traditional) calculation method for the 2024 tax year.

A. Hypothetical Research Expenditure Profile

A mid-sized Iowa company operating in the advanced manufacturing sector, which qualifies for the RAC 6, incurred the following Iowa-apportioned QREs in the 2024 tax year:

B. Step-by-Step Application of the Supplies Phase-Out

The first critical step in calculating the allowable Iowa QREs is applying the Supplies Phase-Out Percentage to the raw supplies cost:

$$\text{Allowable Supplies QRE} = \text{Raw Supplies Cost} \times \text{Phase-Out Percentage}$$

$$\text{Allowable Supplies QRE} = \$150,000 \times 60\%$$

$$\text{Allowable Supplies QRE} = \$90,000$$

This calculation determines the final figure of $\$90,000$ to be entered on Line 22 of Form IA 128. The Supplies Phase-Out thus resulted in a direct $\$60,000$ reduction (40% of $\$150,000$) to the company’s potential QRE base in 2024.

C. Calculating the Total Credit Base

The reduction is then incorporated into the overall calculation of incremental research expenditures.

2024 Iowa Research Activities Credit Calculation

In this scenario, due to the high historical receipts reflected in the Fixed-Base Amount, the company generates a tax credit of $\$0$.

D. The Compounding Effect of QRE Restrictions

The application of the Supplies Phase-Out, combined with the exclusion of computer lease costs, introduces a critical and compounding negative effect on the final credit outcome. Since the Iowa credit calculation requires subtracting a “Base Amount” from the current year’s QREs, any arbitrary reduction of current QREs makes it significantly harder for the taxpayer to achieve a positive “Incremental (Excess) QRE” figure.10

The Base Amount calculation itself utilizes a floor, ensuring the base is never less than 50% of the current year’s QREs.10 However, the initial calculation of incremental QREs is typically compared against the historical Fixed-Base Amount. When the supplies phase-out artificially reduces the total current QREs (as seen in the calculation above), it increases the likelihood that the taxpayer’s current-year expenditures will fall below the Fixed-Base Amount, potentially leading to a complete elimination of the credit, even if the business’s true research activities have remained high or even increased. The policy thus acts as a disproportionate constraint, impacting not just the value of supplies, but the fundamental eligibility criteria for claiming an excess credit.

V. Strategic Planning: Navigating the Remaining Term of the RAC and the Future R&D Credit Program

The Supplies Phase-Out is best understood as a budgetary tourniquet applied during a regulatory transition. The most critical strategic consideration for taxpayers is planning for the subsequent reduction in 2025 and the complete overhaul of the program beginning in 2026.

A. The 2025 Tax Cliff: Preparing for the 40% Limitation

The phasing down of allowable supplies QREs is scheduled to continue in the final year of the current RAC program. For the tax year beginning January 1, 2025, the Iowa Code mandates a further restriction: the allowable percentage for research supplies QREs drops to only 40%.5

This impending restriction creates a sharp “tax cliff” for companies whose R&D activities are supplies-intensive. A company spending $\$100,000$ on supplies would have claimed $\$60,000$ in QREs in 2024, but will only be able to claim $\$40,000$ in 2025. This additional 20% reduction in QREs directly translates to lower overall credit generation in 2025. Businesses must strategically evaluate the timing of major research expenditures involving materials. Accurately modeling whether accelerating expenses into the 2024 tax year (with the 60% limitation) or deferring them until the post-2026 program is essential, especially given the upcoming uncertainty of the replacement program.

B. The Repeal and Replacement: Senate File 657 (SF 657)

The limitations imposed by HF 2317, including the Supplies Phase-Out, were temporary measures preceding the fundamental restructuring of the Iowa R&D incentives. The long-standing Research Activities Credit (RAC) is slated to be repealed and replaced by a new R&D Tax Credit Program, as defined by Senate File 657 (SF 657), effective for tax years beginning on or after January 1, 2026.3

The shift from the legacy RAC to the SF 657 program marks a policy transformation: moving from a broad, uncapped tax entitlement to a capped, highly selective economic development incentive.

C. Major Policy Changes in the Post-2026 R&D Tax Credit Program

The structural changes introduced by SF 657 are profound and require immediate planning for businesses anticipating future R&D credits in Iowa.

1. Shift in Administration and Authority

The legacy RAC program was administered by the Iowa Department of Revenue (DOR) through the tax return filing process, with audits ensuring compliance.9 Starting in 2026, the new R&D Tax Credit Program will be managed by the Iowa Economic Development Authority (IEDA).4 This change requires businesses to formally apply to the IEDA and secure an allocation of the credit before claiming it.1 This shift mandates a focus on economic development criteria and pre-claim certification, rather than merely tax compliance reporting.

2. Credit Rate Reduction

The existing RAC offered a credit rate of 6.5% of incremental QREs.1 The new program slashes the maximum credit rate by nearly half, offering up to 3.5% of qualifying in-state QREs.1 This reduction significantly lowers the financial incentive for performing research in Iowa.

3. Introduction of an Annual Cap and Allocation Risk

The legacy RAC was uncapped, resulting in substantial claims; businesses claimed $\$77.6$ million in RAC in fiscal year 2024 alone.9 The new program introduces a hard annual cap of $\$40$ million in total credits issued per fiscal year.3 Should the total requested credit amount exceed this cap, credits will be allocated on a pro rata basis.1

The implementation of a cap introduces significant financial uncertainty. While the supplies phase-out under the old RAC program provided fiscal certainty—the taxpayer knew exactly what QRE amount would qualify—the new program offers no such guarantee. A company might calculate a qualified credit amount of 3.5% of its QREs, only to see that realized value drop substantially if the $\$40$ million pool is oversubscribed. The competition for this fixed pool fundamentally changes the risk-benefit analysis for Iowa-based R&D.

4. Stricter Industry Focus and CPA Verification

The eligibility requirements have been narrowed considerably. While the old RAC covered broad industries such as manufacturing, life sciences, and software engineering 6, the new program is limited to specific sectors within advanced manufacturing, bioscience, insurance and finance, and technology and innovation.1 Critically, industries such as real estate, agriculture production, construction, retail, and wholesale are explicitly excluded.1 Furthermore, the IEDA requires businesses to submit CPA-verified QRE reports as part of the formal application process.1

VI. Conclusions and Recommendations

The Supplies Phase-Out Percentage, set at 60% for the 2024 tax year, is a non-negotiable statutory requirement rooted in Iowa Code $\S 422.10$ and enacted under House File 2317. It serves as a clear legislative signal of the state’s efforts to narrow the scope and cost of its Research Activities Credit before the program is permanently replaced. For tax year 2024, the exclusion of 40% of qualified supplies costs presents a critical compliance checkpoint and significantly reduces the total Qualified Research Expenditure base available to claimants, particularly in materials-intensive industries.

A. Key Compliance Directives for 2024 Filings

Tax leaders must ensure their 2024 RAC filings strictly adhere to the following mandates to mitigate audit exposure from the Iowa Department of Revenue:

1. Mandatory QRE Reduction: The 60% Supplies Phase-Out must be applied internally to the Iowa-apportioned raw cost of supplies, with only the resulting reduced figure reported on Line 22 of Form IA 128. Comprehensive documentation showing the application of this reduction is essential.
2. Exclusion of Computer Costs: The QRE base must be further reduced by completely excluding any amounts paid for the right to use computers for research, a distinct statutory disallowance under HF 2317.
3. Refundability Impact: The calculated credit amount is subject to the refundability phase-down, limiting the refundable portion of any excess credit to 80% for the 2024 tax year.

B. Strategic Recommendations for Program Transition

The 60% limitation is the penultimate restriction before the RAC is terminated. Forward-looking tax strategy must address the immediate challenge of the 2025 cliff and the monumental shift to the IEDA-administered program in 2026.

1. Immediate Expenditure Planning: Businesses heavily reliant on supply QREs must model the net present value difference between claiming the credit in 2024 (60% allowance) versus 2025 (40% allowance). Furthermore, they must project the potential value loss due to the lower credit rate (3.5%) and allocation risk under the new 2026 program. It is necessary to accelerate supply-related QREs into 2024 where feasible, minimizing exposure to the further reduction scheduled for 2025.
2. Re-evaluating Eligibility: Companies must assess if their current industry sector will remain eligible under the narrow criteria defined by SF 657 for the 2026 tax year. For industries that are explicitly excluded (e.g., agriculture production, retail), the 2025 tax year will represent the final opportunity to claim the Iowa R&D credit.
3. Establishing IEDA Compliance Infrastructure: Preparation for the 2026 program must begin immediately. Taxpayers must transition their compliance efforts from focusing on post-filing audit defense (required by the DOR) to pre-claim certification and administrative approval (required by the IEDA). Establishing robust, independent processes for CPA verification of QRE reports, as mandated by the new program, is now a prerequisite for accessing the state’s R&D tax incentive pool.

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