Expert Report on the Credit Limitation (25% of Total Credit) for the Kansas R&D Tax Credit (K.S.A. §79-32,182b)

I. Executive Summary: The Constraint on R&D Credit Utilization

The Credit Limitation (25% of Total Credit) dictates that a taxpayer may only use a maximum of 25% of their combined new credit generated plus any accumulated prior year carryforward balance against their current Kansas income tax liability. This statutory constraint, enforced by K.S.A. §79-32,182b(b), necessitates that the remaining 75% of the credit pool be carried forward indefinitely, realizing the full benefit over multiple, decelerating tax periods.1

Strategic Context and Intent

The Kansas R&D tax credit regime is characterized by a high generation rate paired with a strictly constrained utilization mechanism. Since Tax Year 2023, the credit rate increased to 10% of qualified expenses over the base, allowing for potentially unlimited credit generation.2 However, the 25% utilization cap prevents the full, immediate offset of tax liability, serving as a critical state fiscal control.2 The design ensures that while the state offers a generous incentive for innovation, the financial cost to the treasury is amortized over a minimum of four tax years, thereby providing greater predictability in state revenue budgeting.

Furthermore, the structure of the credit utilization mandates a long-term strategic view from the taxpayer. By guaranteeing an indefinite carryforward for the unused portion, the state encourages sustained commitment to R&D activities within Kansas, providing assurance to investors that the credit asset—though slowly realized—will not expire due to short-term business fluctuations or market cycles.2 This indefinite carryforward is paramount, as it maintains the long-term value of the tax asset despite the severe annual limitation on use.

II. Statutory and Regulatory Foundation (K.S.A. §79-32,182b)

A. Legislative History and Modern Credit Enhancements

The Kansas R&D tax credit has undergone significant enhancements, modernizing its appeal to R&D intensive industries. Effective for taxable years commencing after December 31, 2022, the state dramatically increased the credit rate from 6.5% to 10% of the amount by which qualified research and development expenditures in the taxable year exceed the three-year base period average.1 This legislative action significantly increased the potential dollar value generated by qualified research activities conducted within Kansas.

Contemporaneous with the rate increase, the legislature introduced a mechanism for credit transferability. Beginning in Tax Year 2023, the R&D credits became transferable by a taxpayer that lacks a current Kansas income tax liability.1 This allows non-taxpaying entities, such as startups experiencing net operating losses, to immediately monetize their accrued credit assets by selling them to profitable entities. This monetization process, however, is subject to strict rules: only the full credit may be transferred, and the transfer can only occur once.4

B. The Foundational Law: K.S.A. §79-32,182b, Subsection (b)

The specific mandate governing the utilization rate is codified directly within the Kansas Income Tax Act. Subsection (b) of K.S.A. §79-32,182b is the authoritative source for the 25% rule:

“In any one taxable year, the amount of such credit allowable for deduction from the taxpayer’s tax liability shall not exceed 25% of the total amount of such credit plus any applicable carry forward amount.”.3

This statutory language defines the ceiling on credit usage based not solely on the new credit generated in the current year, but rather on the aggregate pool of all available credits held by the taxpayer. The statute mitigates the impact of this severe annual constraint by confirming the mechanism for perpetual recovery: “The amount by which that portion of the credit allowed by subsections (a) and (b) to be claimed in any one taxable year exceeds the taxpayer’s tax liability in such year may be carried forward until the total amount of the credit is used”.3 KDOR guidance confirms this provision, specifying that unused credits may be carried forward indefinitely in 25% increments.1 The credit is non-refundable, meaning its value can only be realized by offsetting a positive Kansas income tax liability.2

C. KDOR Administrative Guidance and Compliance Forms

The Kansas Department of Revenue (KDOR) enforces the 25% limitation through the required compliance forms. To calculate and claim the R&D credit, the taxpayer must complete and submit Schedule K-53, Kansas Research and Development Credit, alongside their income tax return.4

The instructions accompanying Schedule K-53 precisely mirror the statute regarding the limitation: “The credit allowed in any one tax year is limited to 25 percent of the credit plus any carry forward”.1 For corporations transferring the credit after its generation (post-2023), the transferor must still complete Part A of Schedule K-53 to establish the total credit earned, and the subsequent transfer must be formally documented using Form K-260.1 This mandatory documentation ensures the KDOR can track the original value and the continuing application of the 25% limitation on the credit, regardless of who claims it.

III. Definitive Analysis of the Credit Limitation (25% Rule)

A. Formulaic Interpretation: Defining the Credit Pool

The core of the limitation calculation centers on defining the Total Available Credit Pool against which the 25% rate is applied. This pool is the combined value of all generated, yet unused, credit assets.

The maximum allowable credit for deduction from the taxpayer’s liability in any given year (D) is calculated using the following formula:

$$D = (A + B) \times 0.25$$

Where:

• $A$ = New Credit Generated in the Current Tax Year (equivalent to Schedule K-53, Line 6)
• $B$ = Prior Carryforward Balance (The cumulative unused credit from preceding tax years)
• $A + B$ = The Total Available Credit Pool

This requirement means that even if a company generates a massive credit in the current year, it cannot use more than a quarter of that asset immediately, compelling a mandatory staging of the benefit.

B. Operational Mechanics: The Requirement of Geometric Consumption

The annual percentage limitation fundamentally dictates a geometric consumption schedule, which decelerates the overall rate of realization of the tax asset. This structure ensures that the full credit value must be spread over a significant period.

Because the 25% limit is applied to the remaining balance each year, the system mandates a systematic amortization. For an entity that generates no further credits and maintains sufficient tax liability, realizing the entire credit benefit requires a minimum of four tax periods (Year 1: 25% used; 75% remains; Year 2: 25% of 75% = 18.75% of original used; 56.25% remains, and so on). This diminishing application rate means that the benefit realization slows significantly over time. For instance, after four years, 31.64% of the original credit still remains unused, necessitating years of carryforward to fully exhaust the asset, reinforcing the structure as a “Long Carry in 25% Increments”.2

C. Economic Impact: Deferral and Time Value of Money

For taxpayers, especially larger corporations and C-Corporations required to spread the usage over multiple periods, the 25% limitation creates substantive implications for financial reporting and tax asset valuation.5

The credit must be classified and managed as a deferred, non-accelerated tax asset. Because the realization of 75% of the credit value is deferred to subsequent years, the economic value of the asset is significantly reduced compared to its face value. Professional tax directors must heavily discount the asset when calculating its Present Value (PV). For example, the portion of the credit realized in years five, six, and seven must be discounted using the corporation’s internal cost of capital. This required deferral means that the time cost of capital is a critical factor, making the mandatory slow realization the chief financial consequence of the 25% rule.

Furthermore, the non-refundable nature of the credit means that its utility is entirely dependent upon the existence of Kansas income tax liability.2 If the taxpayer’s financial performance declines, or if the entity enters a long-term loss position, the credit asset, despite its indefinite carryforward, may become functionally stranded, as there will be no future liability against which to apply the restricted 25% annual usage.

IV. KDOR Compliance Guidance and Calculation Procedure

Compliance with K.S.A. §79-32,182b requires a detailed step-by-step process defined by KDOR forms, particularly Schedule K-53. The calculation involves two distinct phases: credit generation and credit utilization.

A. Credit Generation Calculation

The determination of the new credit generated (Part A of Schedule K-53) relies on calculating the expenditure increase relative to historical spending. The methodology requires the following steps:

1. Qualified Expenditure Input (Line 1): The taxpayer determines all machinery, equipment, payroll, and other R&D expenditures conducted within Kansas that are allowable under the federal Internal Revenue Code.2
2. Base Amount Determination (Lines 2a, 2b, 4): The taxpayer calculates the sum of current year QREs (Line 1) and the QREs for the two preceding tax years (Lines 2a and 2b). This total is divided by three (3) to determine the three-year average, which serves as the Base Amount (Line 4).2
3. Excess Calculation (Line 5): The Base Amount (Line 4) is subtracted from the Current Year QREs (Line 1). If the result is negative, the excess is zero.
4. Total New Credit Calculation (Line 6): The resulting Excess QREs (Line 5) are multiplied by the applicable 10% rate (0.10) for tax years commencing after 2022. This amount is the Total Research and Development Credit generated in the current year.2

B. Application of the 25% Utilization Limitation

After the new credit amount has been calculated, the utilization phase determines the maximum allowed claimable amount (Line 7), taking into account prior carryforwards.

1. Determine Total Available Pool: The New Credit Generated (Line 6) is added to any accumulated Prior Carryforward Balance brought forward from the preceding tax year.
2. Calculate Maximum Annual Claimable Credit (Line 7): The Total Available Pool is multiplied by 25% (0.25).1 This result establishes the statutory cap on utilization.
3. Final Credit Claim: The amount actually claimed and deducted from the Kansas income tax liability is the lesser of:

• The Maximum Annual Claimable Credit (25% limit).
• The Taxpayer’s current Kansas income tax liability.

C. Carryforward Generation

Any portion of the Total Available Pool that is not utilized in the current tax year due to either the 25% statutory cap or insufficient tax liability is classified as the New Carryforward Balance. This remaining unused credit is eligible to be carried forward indefinitely in 25% increments until the full amount of the original credit is used.1

V. Financial Modeling: A Multi-Year Application Example

To fully illustrate the consequences of the 25% limitation and the resulting geometric consumption pattern, a multi-year financial model is presented. This scenario assumes a one-time, large credit generation followed by zero additional R&D expenditures.

A. Scenario Parameters

For simplicity in demonstrating the limitation:

• Initial Credit Generated (Year 1, 2023): $1,000,000
• New Credit Generated (Years 2-5): $0
• Kansas Tax Liability: $500,000 annually (This level of liability ensures the 25% cap is always the binding constraint, allowing the focus to remain strictly on the utilization limitation).

B. Year-by-Year Allocation and Deferral Schedule

The calculation in the table below applies the formula $D = (A + B) \times 0.25$ to demonstrate how the credit pool is mandatorily amortized over time.

Table 3: Multi-Year Application of the Kansas R&D Credit 25% Limitation

C. Strategic Impact Assessment

The analysis confirms the inherent deferral structure. After five full years, the company has realized approximately three-quarters of the benefit, but a substantial balance of $237,304 still remains to be carried forward and utilized. This requires continued application of the same 25% rate to the ever-decreasing remaining balance. This demonstrates that the asset cannot be liquidated rapidly; even for corporations with large, stable tax liabilities, the full realization requires patience and long-term tax forecasting. The financial imperative is thus to integrate this R&D credit schedule into long-range corporate planning to accurately project the tax savings stream.

VI. Advanced Topics: Transferability and the 25% Constraint

The provision allowing for the transfer of R&D credits for tax years 2023 and thereafter introduced a significant opportunity for liquidity, particularly for non-taxable start-ups.3 However, the 25% utilization constraint applies equally to the transferee, dramatically affecting the market dynamics of credit sales.

A. Transfer Requirements and Restrictions

For a transfer to be valid, the transferor must not have a current Kansas income tax liability. Once the credit is earned and calculated via Schedule K-53, it can be transferred to any person, but only the full credit may be transferred, and the transaction is strictly limited to one occurrence.1 The transfer must be formally documented with the KDOR using Form K-260, and the transferor must still file Schedule K-53 detailing the credit generation.1

B. The Transferee’s Obligation

The most critical legal consideration for transfer is that the recipient—the buyer of the credit—inherits the credit subject to all underlying statutory limitations. The statute is unambiguous on this point: K.S.A. §79-32,182b states that the credit claimed by the transferee “may be carried forward by the transferee, and shall be subject to the limitations and requirements in place at the time the credit was earned,” explicitly referencing the restrictions laid out in subsection (b).3

This means the transfer accelerates the monetization event for the selling entity but does not accelerate the utilization schedule for the buying entity. If a transferee purchases a $1 million credit pool, they are bound to the same multi-year geometric consumption schedule detailed in Section V. They can utilize only 25% of the total pool in Year 1, 25% of the remainder in Year 2, and so forth. Consequently, the primary market for these credits consists of highly profitable, established Kansas-based corporations with tax liabilities large enough and stable enough to absorb the credit over the mandated multi-year schedule.5

C. Market Valuation and Discounting

The financial structure imposes a mandatory discount on the face value of the transferred credit. Because the transferee cannot use the asset immediately, they are essentially acquiring a stream of deferred tax savings. Market valuation models must calculate the Net Present Value (NPV) of this future savings stream, factoring in the inherent risk of the transferee’s tax liability decreasing over the amortization period.

The necessity of purchasing the full credit amount, combined with the slow 25% utilization rate, places significant capital demands on the transferee and creates a substantial discount on the face value. This valuation reality underscores the structural effect of the 25% limitation: it converts what might otherwise be a single-year tax benefit into a long-term, geometrically decaying financial instrument.

VII. Conclusion and Expert Recommendations for Compliance

The Kansas R&D tax credit, particularly with the enhanced 10% rate post-2022, offers a compelling incentive for innovation within the state. However, the Credit Limitation (25% of Total Credit) established in K.S.A. §79-32,182b(b) is the principal driver of strategic tax planning and asset valuation. It functions as a governor on the speed of credit utilization, ensuring fiscal prudence for the state while requiring rigorous multi-year forecasting from the taxpayer.

Key Compliance and Strategic Imperatives

1. Detailed Financial Modeling: Taxpayers claiming the R&D credit must move beyond simple point-in-time calculation and incorporate dynamic financial models that accurately reflect the geometric decay imposed by the 25% utilization rule. This requires integrating projected Kansas income tax liabilities and applying appropriate discount rates to determine the true economic value (NPV) of the credit asset.
2. Risk Management of Non-Utilization: Because the credit is non-refundable and realized only against tax liability, the taxpayer must continually assess the risk of generating a “stranded asset” if sustained profitability cannot be forecasted over the required amortization period. The indefinite carryforward is valuable only to the extent that future tax liability exists.
3. Transferee Due Diligence: Entities considering purchasing transferred R&D credits must conduct rigorous due diligence, verifying the underlying credit generation calculation (via Part A of K-53) and critically analyzing their own long-term tax forecasts. The acquisition decision must confirm that the transferee possesses sufficient projected tax liability—often 5 to 10 years into the future—to accommodate the slow, required amortization schedule mandated by the 25% statutory constraint.
4. Adherence to KDOR Documentation: Strict compliance with KDOR requirements, including the accurate calculation on Schedule K-53 and mandatory documentation via Form K-260 for transfers, is essential to maintain the validity of the credit claim against future audits. The utilization limitation applies universally to all holders of the credit, whether the original recipient or a subsequent transferee, solidifying the importance of accurate tracking and reporting across tax years.

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