Expert Report: The Itemized Schedule of Expenditures (Required Documentation) and Compliance for the Kansas R&D Tax Credit (Schedule K-53)

Executive Summary: The Mandate for Detailed Documentation

The Itemized Schedule of Expenditures is the required forensic breakdown of all Qualified Research Expenditures (QREs) claimed, supporting the annual calculation of the Kansas R&D tax credit (K-53). This documentation validates that the machinery, payroll, and supply costs claimed meet both state and federal IRC Section 41 standards for qualified research activities conducted solely in Kansas.

This critical supplemental document bridges the gap between a company’s financial ledgers and the aggregated totals reported to the Kansas Department of Revenue (KDOR), serving as the first line of defense during any compliance audit.

I. Foundational Overview of the Kansas Research and Development Tax Credit Ecosystem

The Kansas Research and Development (R&D) Tax Credit incentivizes investment in innovation within the state’s borders. Understanding the legal structure and recent administrative shifts is essential for compliance teams tasked with preparing the required expenditure documentation.

A. Statutory Authority and Calculation Mechanics (K.S.A. 79-32,182b)

The authority for the Kansas R&D credit is derived from K.S.A. 79-32,182b, which allows a taxpayer who makes qualifying expenditures in R&D activities conducted within Kansas to claim an income tax credit.1

1. The Incremental Calculation Model: Kansas employs an incremental calculation based on a three-year lookback period. The amount of the credit is computed on the difference between the actual QREs expended in the current tax year and the average of the expenditures made during the current year and the two immediate preceding tax years.2 This structure requires robust historical data tracking to establish the base amount.
2. Post-2022 Rate Enhancement and Limitation: Effective for all taxable years commencing after December 31, 2022, the credit rate was significantly increased from 6.5% to 10% of the eligible incremental expenditures.2 Notwithstanding this increased incentive, the credit allowed in any one tax year is strictly limited to 25% of the total credit earned plus any available carry forward.2 Any remaining unused credit may be carried forward indefinitely in 25% annual increments until the total amount is utilized.2

B. The Federal Nexus: Defining Qualified Research Expenditures (QREs)

A cornerstone of Kansas R&D compliance is the mandatory linkage to federal law. State statutes explicitly qualify expenditures only if they “must be allowable under the provisions of the federal internal revenue code of 1986”.2

This mandate confirms that Kansas adopts the rigorous definition of QREs defined under Internal Revenue Code (IRC) Section 41, including the necessity of meeting the federal four-part test for qualified research (i.e., activities must be technological in nature, designed to eliminate uncertainty, involve a process of experimentation, and relate to a new or improved business component). Therefore, the Kansas Itemized Schedule of Expenditures (ISE) must provide sufficient transactional detail to implicitly prove the satisfaction of the federal criteria, regardless of its primary role in calculating the state credit. Any expenditure failing the federal substantiation threshold is automatically ineligible for the state credit.

C. Administrative Compliance Shifts and Eligibility Expansion

The Kansas legislature instituted major changes for the 2023 tax year and beyond, fundamentally altering who can claim the credit and how the claim must be initiated.

1. Expanded Taxpayer Eligibility: Prior limitations that largely restricted the credit to C corporations were removed. For tax year 2023 and all subsequent years, any Kansas income taxpayer, including individuals, partnerships, S corporations, limited liability companies, and other pass-through entities, may claim the credit.3 This expansion dramatically increases the universe of potential claimants.4
2. Mandatory Pre-Certification and Transferability: Taxpayers must now complete and submit Form K-204, the Research and Development Credit Application, to the KDOR for certification prior to claiming the credit on Schedule K-53.3 Furthermore, effective for 2023 and thereafter, new credits are transferable by a taxpayer without a current tax liability to any person, provided the transferor uses Schedule K-53 and the transferee uses Form K-260 to document the transaction.2

The expansion to pass-through entities (S-Corps, LLCs) and the introduction of credit transferability inherently increase the scrutiny and risk associated with the ISE. Pass-through entities often rely on less formalized, centralized record-keeping systems compared to larger C-corporations, creating a vulnerability regarding documentation adequacy.6 Additionally, because a transferee relies entirely on the transferor’s documentation of QREs to defend the earned credit, KDOR will necessitate a highly forensically sound ISE from the transferor. This structural change shifts the compliance burden toward meticulous initial documentation, as the validity of the credit must be demonstrable regardless of how many years it is carried forward or whether it has been transferred.

II. Deconstructing the Itemized Schedule of Expenditures (ISE)

The Itemized Schedule of Expenditures is not a stand-alone, numbered KDOR form but rather the essential documentation supporting the aggregated numbers reported on Schedule K-53.

A. The Interpretation of “Required Documentation” in KDOR Guidance

The instruction for Schedule K-53, the primary mechanism for claiming the credit, implicitly mandates the ISE. Line 1 of Part A requires the entry of aggregated expenditures for machinery and equipment, payroll, and other expenditures.1 KDOR instructions explicitly state: “If additional columns are necessary, please enclose a separate schedule”.1 This separate schedule is the required Itemized Schedule of Expenditures.

The purpose of the ISE is to provide the required transactional substantiation and audit trail. It must transform the three aggregated figures on K-53, Line 1, into hundreds or thousands of individual, verifiable cost entries, linking each expenditure to a source document and a qualified research activity.

B. The ISE and the Principle of Geographic Nexus

A critical function of the Itemized Schedule is to rigorously enforce the state-level research requirement. Kansas statutes require that QREs must be for activities “conducted within Kansas”.1 The Itemized Schedule must provide documentation confirming the physical location of the research activity for every claimed expenditure. For payroll, this means verifying the employee performed the services within Kansas. For contract research, this necessitates confirmation that the third-party services were performed in the state. This location specificity is a key documentation differentiator between state and federal R&D claims.

C. Primary Audit Risks Mitigated by a Robust ISE

Inadequate or insufficient documentation is a persistent challenge in R&D tax credit claims and a primary trigger for audit disallowance.6 A properly constructed Itemized Schedule proactively addresses the common deficiencies by forcing the linkage between costs and qualified activities.

III. Detailed Guidance on QRE Categorization and Substantiation

The Itemized Schedule must provide the transactional evidence necessary to validate the three categories of QREs allowed under federal law and claimed on Schedule K-53, Line 1: qualified wages, supplies, and contract research.

A. Qualified Research Wages (QRW): The Allocation of Personnel Cost

Qualified research wages often represent the largest component of the R&D tax credit claim and are subject to the highest audit scrutiny. The ISE must not only itemize the total wages but also justify the allocated portion for R&D purposes.

1. Defining and Allocating Qualified Services: Only wages paid for direct performance, direct supervision, or direct support of qualified research activities in Kansas are eligible. The ISE must summarize project allocation data, which must originate from reliable source documents such as detailed time tracking systems, project logs, or functional interviews.6 The data must consistently demonstrate how an employee’s time was partitioned between qualified and non-qualified activities.
2. Substantiation Requirements: The Itemized Schedule must include, at a minimum, the employee identification, the specific R&D project being worked on, the total hours or percentage of time allocated to R&D, and the calculation resulting in the final qualified wage expenditure. This level of granular detail allows KDOR auditors to trace the aggregated payroll total on K-53, Line 1, back to individual employee contributions and their corresponding source time records.

B. Qualified Supplies and Machinery Expenditures

This category includes costs related to tangible property used or consumed during the qualified research process.

1. Supplies vs. Depreciable Property: The ISE must clearly differentiate between supplies (consumed materials) and expenditures for “machinery and equipment”.1 Expenditures for land or improvements used for R&D are strictly excluded. For supplies, the itemization must include the vendor, the date, the invoice number, and a detailed description of how the material was consumed in the R&D activity (e.g., raw material used to test a new production process).
2. Documentation for Dual-Use Machinery: If specialized machinery or equipment is utilized for both qualified R&D activities and commercial production or other non-qualified uses, only the portion of the cost attributable to R&D is eligible for inclusion in QREs. The Itemized Schedule is required to list the asset identification number, the full cost of the asset, and the documented methodology (e.g., utilization logs, run-time meters) used to calculate the R&D allocation percentage claimed.

C. Contract Research Expenses (CREs)

Expenditures paid to third parties for performing research on behalf of the taxpayer are subject to specific limitations.

1. The 65% Rule: Only 65% of the total amount paid or incurred to an external organization for qualified research is eligible to be counted as a QRE. The ISE must itemize the total contract amount and provide the calculation that yields the 65% eligible amount.
2. In-State Verification: For the Kansas R&D credit, the Itemized Schedule documentation is required to affirm that the contracted activities were performed within Kansas, meeting the geographic nexus requirement.1 Compliance requires retaining contracts, invoices, and confirmation that the subcontractor performed the services at an in-state location.

IV. Developing an Audit-Ready Itemized Schedule Methodology

The integrity of the Itemized Schedule relies on formal systems, clear documentation, and consistent methodology.

A. Establishing a Formal Cost Allocation System

A robust cost allocation methodology, consistently applied and formally documented, is essential for successfully defending any audit challenge concerning the apportionment of costs.6

1. Methodology Documentation: The ISE must be supported by a comprehensive written policy that dictates how indirect costs, dual-use assets, and shared personnel time are measured, calculated, and apportioned to qualified activities. This policy provides the necessary structure to justify the percentage allocations used in the itemized data.
2. Reconciliation with KDOR Forms: The final summation of all itemized costs across all eligible projects must precisely reconcile with the aggregated total QREs reported on Schedule K-53, Line 1.1 Any discrepancy between the itemized detail and the aggregated total will immediately compromise the claim’s credibility during an audit.

B. Required Data Elements for the Itemized Schedule (ISE)

For the ISE to function as an effective audit defense document, it must include granular data elements that allow KDOR auditors to trace expenses from the claim form back to the source financial and project records. The structure below represents the minimum detail required for audit-readiness:

Itemized Schedule of Expenditures: Required Data Elements

The inclusion of these elements ensures that the Itemized Schedule acts as a centralized index for all underlying documentation, providing organized, immediate access to the evidential basis of the claim.

V. Practical Example: Implementation and Calculation Flow

This example demonstrates how data derived from the Itemized Schedule of Expenditures flows into the required calculation on Schedule K-53.

A. Scenario Setup and Base Period Data

Assume Kansas Advanced Manufacturing, Inc. (KAMI) is claiming the credit for the 2024 tax year.

• Prior Years’ Actual QREs (K-53 Line 2a & 2b Data):

• 2023 QREs: $1,200,000
• 2022 QREs: $800,000

B. Step-by-Step Generation of Itemized Schedule Totals (2024)

KAMI completed its Itemized Schedule of Expenditures (ISE) for 2024, detailing project allocation, time tracking, supply consumption, and contract verification for all activities conducted in Kansas.

Itemized Schedule Aggregation for Kansas Advanced Manufacturing, Inc. (Tax Year 2024)

C. Translating Itemization into Schedule K-53 Computation

The aggregate total from the ISE ($1,672,500) is entered on K-53, Line 1. The calculation proceeds based on the 10% rate (post-2022).1

Schedule K-53 Computation Example (Tax Year 2024)

KAMI may utilize up to $11,208 of the credit in 2024. The unused portion, amounting to $33,625 ($44,833 – $11,208), is eligible for indefinite carryforward, subject to the annual 25% utilization limitation.2

VI. Conclusion and Strategic Recommendations

The Kansas R&D tax credit is a powerful incentive, particularly following the 2023 statutory changes that increased the rate to 10% and expanded eligibility to all Kansas taxpayers. However, the successful monetization and defense of this credit are entirely dependent upon the quality of the underlying Itemized Schedule of Expenditures (ISE).

A compliant ISE is a strategic compliance tool that moves beyond mere aggregation and provides forensic evidence of qualified activities. Given the expansion of credit transferability, the reliability of the ISE is not merely an internal concern but a fiduciary obligation to potential transferees who rely on the original documentation. Furthermore, since unused credits are carried forward indefinitely, the taxpayer must be prepared to defend the credit’s creation years later.

To ensure long-term compliance and audit preparedness, taxpayers should adopt the following recommendations:

1. Implement Integrated Record-Keeping: Establish mandatory input fields in internal accounting and project management systems to capture the critical ISE data elements (Project ID, R&D Allocation Percentage, Location) at the time the cost is incurred. Reliance on retrospective studies significantly increases documentation vulnerability.7
2. Formalize Allocation Policy: Document a written policy detailing the cost allocation methodology for all shared resources, ensuring adherence to federal tax accounting standards. This policy serves as the justification for the percentage claims within the Itemized Schedule, mitigating risk of disallowance due to inaccurate apportionment.6
3. Mandatory Pre-Filing Reconciliation: Prior to submitting Form K-204 for certification and filing Schedule K-53, the Itemized Schedule must be rigorously reconciled to ensure a perfect match with K-53, Line 1. This internal review step minimizes clerical errors that often trigger administrative audits.
4. Maintain the Audit Defense File: The original taxpayer (transferor or claimant) must maintain the Itemized Schedule of Expenditures and all supporting source documents (time cards, invoices, utilization logs) indefinitely. Even if the credit is transferred, the burden of proof for the credit’s initial qualification remains with the entity that earned it.2

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