Strategic Analysis of the Kansas Research and Development Tax Credit: The Post-2022 10% Credit Percentage and Base Calculation

1. Executive Summary: The 10% Credit in Context and Policy Shift

The Kansas Research and Development (R&D) tax credit is calculated at a 10% rate on the amount by which current year qualified expenditures exceed a statutorily defined three-year average base. This significant rate increase, effective for all taxable years commencing after December 31, 2022, dramatically enhances the state’s incentive to promote in-state innovation and investment.1

This quantitative change is part of a broader, transformative legislative reform aimed at boosting economic competitiveness. Prior to the statutory amendment, the credit rate stood at 6.5%.1 The elevation to 10% was codified through the 2022 Legislative Session with the passage of House Bill (HB) 2239.3 This policy shift was not merely an adjustment of the incentive level but a qualitative expansion of the program, extending eligibility beyond C corporations to all Kansas income taxpayers—including partnerships, S corporations, limited liability companies, and individuals—and introducing the powerful mechanism of credit transferability.3 The central technical challenge for taxpayers involves navigating the unique methodology for calculating the base, which uses a three-year historical average that includes the current year’s expenditures, setting it apart from standard federal computation methods.1

Legislative Intent and Economic Stimulus

The aggressive increase of the credit rate and the expansion of its applicability suggest a deliberate strategy to catalyze R&D activity within the state. Historically, the level of research and development activity in Kansas has been relatively low, often constrained by the small business nature of its industry base.5 By dramatically increasing the incentive rate to 10% and, crucially, making the credit transferable, the legislature provided mechanisms to deliver immediate capital to businesses that lack a current tax liability. This mitigation addresses the limitation imposed by the state’s utilization cap, which restricts the annual claim to 25% of the total generated credit.2 The 10% rate serves as the primary attractor for R&D investment, while transferability ensures that innovative startups and growing businesses, often operating as pass-through entities without immediate profits, can monetize the incentive immediately, converting a future tax benefit into present working capital.

2. The Statutory Foundation: K.S.A. 79-32,182b and the Definition of Qualified Research Expenditures (QREs)

The legal foundation for the current R&D tax credit is established under K.S.A. 79-32,182b, which explicitly details the credit amount, calculation, and utilization rules.

2.1 The Quantitative Leap: Transition to the 10% Rate

The statute is clear regarding the applicable credit rate. K.S.A. 79-32,182b(a) states that for all taxable years commencing after December 31, 2022, the credit allowed against the Kansas income tax is an amount equal to 10% of the qualifying excess expenditures.1 This represents a decisive elevation from the former 6.5% rate.1 The 10% rate is applied not to the total annual Qualified Research Expenditures (QREs) but specifically to the difference between the actual QREs for the current tax year and a calculated historical average, referred to as the base amount.1 This incremental approach ensures that the state is rewarding growth in research spending rather than merely subsidizing existing activity levels.

2.2 Defining Kansas Qualified Research Expenditures (QREs)

The determination of eligible expenditures for the Kansas credit closely aligns with federal standards, requiring taxpayers to adhere to the provisions of Internal Revenue Code (IRC) Section 41. K.S.A. 79-32,182b(c) defines “expenditures in research and development activities” as those treated as expenses allowable for deduction under the provisions of the federal IRC of 1986, as amended.2

Federal IRC Section 41 generally includes in-house research expenses (wages paid for qualified services, and costs of supplies used in research) and 65% of contract research expenses paid to third parties for qualified research.7 A critical state-specific limitation is the geographic requirement: only expenditures for research and development activities conducted within this state qualify for the Kansas credit.2 Furthermore, the definition includes specific exclusions, such as expenditures derived from moneys made available pursuant to federal or state law, and any expenditures related to abortion services for taxable years commencing after December 31, 2013.2

The alignment with IRC Section 41 provides regulatory consistency for businesses already claiming the federal R&D credit. However, it requires careful consideration of any divergence in timing rules between the federal and state tax codes. While the federal tax framework introduced mandatory five-year amortization for Section 174 R&D costs, the Kansas credit mechanism relies on the underlying nature of the expenditures as defined by IRC Section 41. Taxpayers must ensure that their documentation rigorously supports the eligibility of these expenses under the federal four-part test, alongside verifying that the research activities themselves were physically conducted within Kansas to meet the state-specific geographic mandate.

3. Decoding the Advanced Base Amount Calculation Methodology

The core mechanism of the Kansas R&D credit, which dictates the effective tax benefit, rests on the calculation of the “excess,” which serves as the base amount to which the 10% rate is applied.

3.1 The Principle of Incremental Growth

The credit is fundamentally designed to incentivize incremental growth in research activities. By subtracting a historical baseline from the current year’s QREs, the statute ensures that taxpayers are rewarded only for new or increased investment in R&D within the state.1

3.2 The Unique Three-Year Averaging Formula

The methodology prescribed by K.S.A. 79-32,182b(a) is distinctive. The base amount is calculated as the average of the actual expenditures made during the current taxable year and the next preceding two taxable years.2

The statutory calculation for determining the creditable amount is:

$$\text{Creditable Amount} = \text{Current Year QRE} – \frac{(\text{Current Year QRE} + \text{Year -1 QRE} + \text{Year -2 QRE})}{3}$$

If the current year’s QREs are less than or equal to the resulting average, the creditable amount is zero, and no credit is generated for that year.9 For new businesses or those without prior Kansas R&D history, the base calculation simplifies, as any missing years are counted as zero expenditure years.6 For example, a company in its first year would set the prior two years’ QREs to zero, meaning its creditable amount would be approximately 66.67% of its current QREs, resulting in an effective credit rate of roughly 6.67% (10% of 66.67%) of total QREs.6

This formula provides a substantial initial advantage for startups and rapidly expanding businesses, allowing them to capture a generous portion of their current spending immediately. For more established firms with stable QREs, however, this calculation structure requires constant, measurable growth in R&D investment to generate any credit. If a mature company maintains a constant level of QREs year-over-year, the current year’s expenditure will equal the three-year average, yielding no excess expenditure and thus no credit. The calculation methodology compels businesses to elevate R&D budgets continually to harvest the state incentive.

3.3 Utilizing the Credit: The 25% Annual Limitation

Once the total credit amount has been calculated (10% of the excess QREs), the taxpayer faces a utilization constraint. K.S.A. 79-32,182b(b) stipulates that the amount of the credit allowable for deduction from the taxpayer’s tax liability in any one taxable year shall not exceed 25% of the total amount of such credit plus any applicable carry forward amount.2

This limit dictates that the financial benefit of the credit is realized gradually. While the credit is non-refundable, any portion of the credit allowed by the statute that exceeds the taxpayer’s tax liability in that year may be carried forward indefinitely until the total credit is utilized.2 This indefinite carryforward provision is highly beneficial, as it protects the value of the credit even when the mandatory 25% annual cap prevents immediate full utilization.

4. Local State Revenue Office Guidance and Compliance Requirements

The transition to the 10% rate and the expanded eligibility necessitated clear administrative direction from the Kansas Department of Revenue (KDOR) to ensure proper compliance and administration.

4.1 KDOR Notice 23-09: Official Interpretation and Scope

The KDOR provided comprehensive guidance in Notice 23-09, released on September 6, 2023.10 This notice summarized the key legislative changes enacted by HB 2239, confirming the increase in the credit percentage and, importantly, the removal of the previous limitation to C corporations.3 The notice clarified that, starting in Tax Year 2023, the credit is available to all Kansas income taxpayers, including pass-through entities.9 Notice 23-09 also detailed the newly introduced rules governing the transferability of the credit.3

4.2 Mandatory Compliance Forms and Process

For tax years subject to the 10% rate, KDOR requires specific forms to document the credit generation and utilization, replacing the simpler processes of previous years.

1. Form K-204 (Research and Development Credit Application): Unlike prior periods, where claims could be made directly on the tax return, the K-204 application must now be completed and submitted before the credit is claimed or transferred.3 This new requirement is necessitated by the credit’s transferability, allowing KDOR to officially track and validate the credit generation amount before it is exchanged between parties.3
2. Schedule K-53 (Research and Development Credit): This is the core computational form used to determine the exact credit amount. The instructions for Schedule K-53 guide the taxpayer through the calculation of the three-year average (Line 4), the excess expenditures (Line 5), the application of the 10% rate to find the total generated credit (Line 6), and the determination of the 25% maximum annual claim (Line 7).9 The K-53 is required for all taxpayers claiming the credit, and if the credit is transferred, the generating taxpayer must complete the form through Part A (QRE identification) and provide it to the transferee.9
3. Form K-260 (Kansas Tax Credit Transfer Notification Form): This mandatory form provides the required documentation for any credit acquired or transferred. It ensures the Secretary of Revenue is notified of the transfer details.3

The necessity of filing the K-204 application prior to claiming or transferring the credit introduces a critical compliance step. This procedural shift reflects the KDOR’s emphasis on establishing a robust audit trail, treating the transferable R&D credit as a tracked financial asset. If a business fails to submit the K-204 application correctly, the resulting credit calculation, even if properly documented on the K-53, could be invalidated, potentially jeopardizing the credit’s value, particularly in a transfer scenario. Therefore, businesses must integrate the K-204 filing requirement into their overall tax planning calendar.

5. Program Administration and Strategic Utilization Features

The value proposition of the 10% credit is significantly amplified by the strategic utilization rules enacted through HB 2239.

5.1 Expanded Eligibility and Pass-Through Entities

A major element of the reform, effective starting in Tax Year 2023, was the expansion of eligibility to all Kansas income taxpayers.3 Previously, the credit was largely limited to C corporations.3 This change allows flow-through entities—such as S corporations, LLCs, and partnerships—to utilize the 10% credit, significantly broadening the number and type of innovative Kansas companies that can access the incentive.9

5.2 The Non-Refundable Nature and Indefinite Carryforward

The credit generated under K.S.A. 79-32,182b is non-refundable; it cannot result in a direct cash refund from the state.2 It can only be used to offset Kansas income tax liability. However, the legislation provides substantial relief through the carryforward mechanism. Any portion of the credit that cannot be claimed in the current year due to either insufficient tax liability or the 25% annual utilization cap may be carried forward indefinitely until the total credit is fully utilized.2 This indefinite carryforward distinguishes the Kansas R&D credit as a long-term asset, providing security that the generated value will eventually be realized.

5.3 The Transferability Mechanism (K.S.A. 79-32,182b(d))

The transferability provision is perhaps the most strategic aspect supporting the 10% rate, particularly for emerging technology and manufacturing businesses. For tax years 2023 and thereafter, a taxpayer generating the credit who has no current Kansas income tax liability may transfer the credit to another party.2

Transferability is subject to strict conditions:

1. Only the full credit may be transferred; partial transfers are prohibited.2
2. The credit may only be transferred one time.3
3. The transferee claims the credit against their own Kansas income tax liability in the year it was transferred, subject to the same 25% annual utilization limit and indefinite carryforward rules.2

The combination of expanded eligibility (including pass-through entities) and transferability creates a powerful, quasi-refundable marketplace for the R&D credit. Because many innovative startups and fast-growing pass-through entities often operate at a loss or have minimal tax liability in their early years, a non-refundable credit would otherwise be inaccessible. Transferability allows these entities to sell the $0.10 credit (or 10%) for immediate cash (often at a slight discount), effectively providing non-dilutive financing for R&D activities. This mechanism is crucial for realizing the economic stimulus goals of the higher 10% rate by ensuring that the incentive is valuable immediately, irrespective of the generating entity’s current profitability.6

6. Detailed Example: Calculating the 10% Credit and Utilization

This example illustrates the calculation of the 10% credit for a growing business, demonstrating the application of the unique base calculation methodology and the annual utilization limit mandated by Schedule K-53.9

6.1 Scenario Setup

A Kansas software company, TechGrowth Inc. (a corporation), has QREs conducted within the state over a three-year period. The company is calculating its credit for Tax Year 2023.

6.2 Step-by-Step K-53 Calculation for TY 2023

The calculation of the total credit generated adheres strictly to the instructions on Schedule K-53, Part B.9

Table 1: R&D Credit Generation Calculation (Tax Year 2023)

The total credit generated by TechGrowth Inc. for its incremental growth in R&D activity in 2023 is $20,000.

6.3 Application Against Tax Liability (Utilization and Carryforward)

The generated credit is subject to the 25% annual utilization limit.2

Table 2: R&D Credit Utilization and Carryforward (Tax Year 2023)

In Tax Year 2023, TechGrowth Inc. can claim $5,000 of the R&D credit against its $15,000 liability, reducing its tax obligation. The remaining $15,000 is carried forward indefinitely, to be claimed in future years, subject to the annual 25% cap.2

6.4 The Transferability Decision Point

If TechGrowth Inc. had incurred a net operating loss and had zero Kansas income tax liability in TY 2023, the full $20,000 credit would be available for transfer. The company would assess whether to carry the credit forward indefinitely, waiting for sufficient future tax liability, or transfer the full $20,000 credit immediately to an unrelated taxpayer for cash proceeds. The ability to monetize the full credit generated, even if at a discounted value, provides immediate liquidity, which is often a more attractive option for entities prioritizing cash flow over future tax savings.2

7. Strategic Implications and Final Compliance Overview

7.1 Key Administrative Requirements Checklist

Effective management of the Kansas R&D credit requires careful adherence to the administrative sequence established by KDOR. Compliance failures, particularly concerning the mandatory application requirement, can negate the value of the 10% incentive.

Table 3: Kansas R&D Credit Compliance Checklist (Post-2022)

7.2 Conclusion: The Elevated Value Proposition of Kansas R&D

The legislative enactment increasing the Kansas R&D tax credit rate to 10% for tax years commencing after December 31, 2022, serves as a significant economic stimulus designed to encourage substantial, incremental research investment within the state.

The structure of the credit, particularly the inclusion of the current year’s QRE in the three-year base average, ensures the incentive is most impactful for companies demonstrating genuine growth in their R&D spending, providing the highest marginal benefit to rapidly scaling businesses and startups. For established entities, the 10% rate provides a powerful financial mandate to continually expand their research budgets.

Furthermore, the coupling of the high rate with expanded eligibility (to pass-through entities) and the introduction of credit transferability transforms the credit from a modest tax reduction tool into a critical source of non-dilutive capital for innovative, yet potentially non-profitable, companies. Although the 25% utilization cap paces the benefit, the indefinite carryforward and the option for immediate monetization via transferability significantly mitigate liquidity constraints. Strategic tax management dictates that businesses thoroughly understand and comply with KDOR’s administrative procedures, particularly the mandatory K-204 application, to maximize the value derived from this elevated 10% state incentive.

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