The Limited Liability Company (LLC) and the Transformed Kansas Research and Development Tax Credit Landscape (Post-2022)

A Limited Liability Company (LLC) is a U.S. business structure that protects its owners (members) from personal liability for business debts or obligations. For federal income tax purposes, the LLC structure inherently facilitates pass-through taxation, meaning the entity itself does not pay corporate income tax, and all profits and losses are reported directly on the owners’ personal returns.1

This report provides a comprehensive analysis of the eligibility and mechanics governing the Kansas Research and Development (R&D) tax credit (K.S.A. §79-32,182b) as it pertains to Limited Liability Companies, focusing entirely on the significant legislative amendments effective for taxable years commencing after December 31, 2022. The post-2022 environment introduced three fundamental changes: a credit rate increase, expansion of eligibility to all income taxpayers (including LLCs), and the introduction of credit transferability, profoundly altering the strategic value of R&D investments within the state.

I. Executive Synthesis: The Definitional Role of the LLC and the New Kansas R&D Landscape (Post-2022)

1.1. Simple Definition and Immediate Tax Implication

The Limited Liability Company structure is defined primarily by its liability shield. However, its immediate tax implication relies on the concept of pass-through taxation, where the business entity avoids corporate income tax. Instead, once the LLC has satisfied its operating expenses and debts, the remaining revenue flows directly to the owners or members, who then assume the tax liability at the personal level.1

For federal income tax purposes, a single-owner LLC is typically taxed as a sole proprietorship, requiring the owner to report income and expenses using Form 1040 Schedule C. Conversely, an LLC with two or more members is generally taxed as a partnership, necessitating the filing of a partnership information return (Form 1065) and the issuance of Schedule K-1s to the members, who then incorporate this information into their personal Form 1040 filing.2 A key advantage of this pass-through structure is the avoidance of double taxation—the scenario where traditional corporations pay tax at the corporate level, and shareholders pay tax again on distributions.2

1.2. Summary of 2023 Legislative Changes and Strategic Importance

The amendments enacted for taxable years beginning after December 31, 2022, dramatically reshaped the utility and accessibility of the Kansas R&D credit.3 Prior to these changes, eligibility was often restricted, favoring C-corporations subject to Kansas corporate income tax, which marginalized many of the state’s innovative small and mid-size enterprises (SMEs).4

The key legislative shifts are summarized as follows:

• Credit Rate Increase: The statutory credit rate increased from 6.5% to 10% of the excess Qualified Research Expenditures (QREs).3
• Expanded Eligibility: Eligibility was opened to all Kansas income taxpayers, explicitly including LLCs, S corporations, individuals, and partnerships, overturning the decade-long C-Corporation restriction.3
• Transferability: A significant new provision allows the income tax credit to be transferable by a taxpayer without a current tax liability, significantly enhancing the liquidity and immediate economic value of the credit generated by early-stage or non-profitable entities.5

The expansion of eligibility, particularly to LLCs and other pass-through entities, represents a pivotal correction in Kansas tax policy. Historically, many high-growth, innovative companies selected the LLC or S-Corp structure to leverage pass-through benefits and the federal Qualified Business Income (QBI) deduction.2 By restricting the R&D credit to C-Corporations, Kansas forced these companies to choose between optimal entity structure and utilizing a valuable R&D incentive. The post-2022 policy, by making the credit available to LLCs, strategically aligns the state incentive structure with the actual operational profile of innovative businesses, thereby broadening the tax base eligible for the credit and encouraging job creation and economic growth in the state.6

II. The Limited Liability Company (LLC) as a Qualified Taxpayer in Kansas

2.1. Federal Tax Classification of LLCs and Flow-Through Principles

The federal tax classification of an LLC dictates how the Kansas R&D credit, once calculated, flows through to its owners. While an LLC provides legal liability protection separate from its owners, its income and corresponding credits are generally treated as income of the members.1

For single-member LLCs treated as disregarded entities, the R&D credit would flow directly to the individual owner’s Schedule C income reported on Form 1040.2 For multi-member LLCs taxed as partnerships, the credit is first computed at the entity level, and then the details are passed through to the partners via federal Schedule K-1s, where the information is then transferred to relevant personal tax forms.2 Although LLCs are typically pass-through entities for income tax purposes, they retain the flexibility to elect to be taxed as a corporation (C-corporation) by filing federal Form 8832, Entity Classification Election, or as an S-corporation by filing Forms 8832 and 2553.2

2.2. Statutory Basis for LLC Eligibility Post-2022

The removal of the previous restriction limiting the R&D credit primarily to C-corporations is codified in the amendment to K.S.A. 79-32,182b(d). This amendment ensures that for tax years commencing after December 31, 2022, the credit is available to “any Kansas income taxpayer, including individuals, partnerships, S corporations, limited liability companies, other pass-through entities, and C corporations”.3

This statutory expansion implies that the credit must follow the same flow-through rules as income. The credit is calculated by the LLC, which determines the full, potential tax asset generated. The ultimate claimant of the credit is the member, who uses their proportionate share of the credit to offset their individual Kansas income tax liability (Form K-40). For other similar pass-through entity credits, such as the Historic Preservation Credit (Schedule K-35), members utilize their proportionate share percentage in the credit calculation, establishing a clear procedural precedent for the R&D credit allocation.9

A crucial compliance point arises for LLCs that were operating prior to 2023. The statutory calculation method requires factoring in the current year and the two preceding years’ QREs (the base period).12 An LLC that existed prior to 2023 but was previously excluded from claiming the credit must still retain detailed documentation of its 2021 and 2022 QREs conducted within Kansas to accurately compute the base average for the 2023 tax year. If the LLC was newly formed, it would use zero for any missing prior years when calculating the three-year average.11 This imposes a significant historical documentation obligation on newly eligible entities.

III. Definitive Calculation Methodology for the 10% Kansas R&D Credit

The calculation of the Kansas R&D tax credit is based on an incremental formula, where the credit is generated only on the amount of current-year spending that exceeds a three-year average base.

3.1. Defining Qualified Research Expenditures (QREs)

The foundation of the credit calculation rests on identifying qualified research expenditures. The term “expenditures in research and development activities” is defined by the statute as expenses that are allowable for deduction under the provisions of the Federal Internal Revenue Code (IRC) of 1986, as amended.5 Specifically, these expenditures must comply with the requirements of IRC Section 41, generally covering costs related to activities aimed at eliminating uncertainty concerning the development or improvement of a product, which includes any process, technique, formula, or invention.4

It is imperative that the expenditures used in the Kansas calculation relate exclusively to activities conducted within the State of Kansas.7 QREs typically include machinery and equipment costs, payroll expenses for employees performing research activities, and other relevant expenses.12

3.2. Calculation Protocol: Three-Year Base Period (Schedule K-53, Part A)

The LLC must perform the following calculation, formalized in Part A of Schedule K-53, to determine the total credit generated for any taxable year commencing after December 31, 2022 12:

1. Line 1 (Current QREs): Enter the total qualified expenditures for activities conducted within Kansas for the current tax year.
2. Lines 2a and 2b (Preceding QREs): Enter the total allowable Kansas QREs for the first preceding tax year (Line 2a) and the second preceding tax year (Line 2b).
3. Line 3 (Sum of QREs): Add Lines 1, 2a, and 2b to determine the aggregate QREs over the three-year period.
4. Line 4 (Average Base Expenditures): Divide the result from Line 3 by three (3). This result establishes the base amount of expenditures.11
5. Line 5 (Excess QREs Eligible for Credit): Subtract the Average Base Expenditures (Line 4) from the Current QREs (Line 1). This difference represents the expenditures eligible for the credit. If the current year’s expenditures (Line 1) are less than or equal to the base average (Line 4), the eligible amount is zero.12

3.3. Determining the Total Generated Credit and Annual Limit

Once the excess QREs are determined, the credit is calculated and limited as follows:

1. Line 6 (Total Credit Generated): Multiply the Excess QREs (Line 5) by 10% (.10). This figure is the total credit generated in the current taxable year.5
2. Line 7 (Maximum Allowable Claim): The amount of the credit that can be utilized in any single tax year is statutorily capped. Multiply the Total Credit Generated (Line 6) by 25% (.25). This result is the maximum amount of the current year’s credit allowed to be claimed before accounting for any prior carryforwards.7

The structural property of this incremental calculation dictates that sustained or accelerated growth in R&D investment is required to generate a credit. An LLC that maintains flat QRE spending year-over-year will ultimately generate no credit, as the current year’s QREs will equal the three-year average. This structure encourages businesses to aggressively scale R&D investment, linking the tax benefit directly to expansion efforts. However, a high-spend year subsequently increases the base amount (Line 4) for the following two years, necessitating continued growth to avoid reducing or eliminating the credit in future periods.11

A comparison of the calculation components is necessary to understand the procedural requirements for an LLC claiming the credit.

Table A: Schedule K-53 Part A: Calculation of Total Allowable Credit (Post-2022 10% Rate)

IV. KDOR Guidance: Mandatory Procedures and Forms for LLC Compliance

The Kansas Department of Revenue (KDOR) has established specific compliance procedures for the R&D credit, which are significantly more involved than in prior years, particularly due to the new transferability feature.

4.1. The Critical Requirement for Credit Certification: Form K-204 Application

For tax years 2023 and thereafter, a taxpayer wishing to claim the R&D credit, whether directly or for transfer, must first complete and submit an application for certification.3 This mandatory pre-claim requirement utilizes Form K-204, Research and Development Credit Application.3

The necessity of the K-204 application arises directly from the introduction of transferability. The Department of Revenue requires certification of the generated credit amount before the tax asset is either claimed against a tax liability or transferred to a third party.3 This administrative requirement ensures that the statutory calculation (Schedule K-53, Part A) is substantiated and approved before the credit, now a potentially liquid asset, is used or sold, which mitigates future audit risk once the credit has changed hands.

4.2. Detailed Compliance Instructions for Schedule K-53 (Computation and Claiming)

Schedule K-53 is the primary form for computing and claiming the R&D credit and must be submitted with the taxpayer’s income tax return.11 For an LLC, the responsibilities regarding the K-53 are divided based on whether the credit is retained by the members or transferred externally.

• Role of the LLC (Transferor): If the LLC intends to transfer the credit, the entity must complete Part A of K-53 (Lines 1 through 7) to determine the Total Credit Generated.12 Once Part A is finalized, the LLC provides this documentation to the transferee and files Form K-260 (see Section V).5
• Role of the Taxpayer (Claimant): The claimant (whether an LLC member or a transferee) completes the subsequent sections:

• Part B (Allowed Credit): The taxpayer enters their Kansas tax liability (Line 8) and determines the allowed credit for the current year (Line 9), which is the lesser of the maximum credit allowed (Line 7) or the current tax liability (Line 8).12
• Part C (Carry Forward): The amount of the credit generated but not utilized in the current year is calculated on Line 10 (Line 6 minus Line 9) and is carried forward.12
• Part E (Total Claimed): This section determines the final amount claimed against the tax return, totaling the allowed current credit and any remaining carryforwards from prior years.12

4.3. The 25% Annual Credit Limitation and Indefinite Carryforward Mechanics

The state limits the amount of credit that can be utilized in any single tax year to 25% of the total amount of the generated credit, plus any applicable carry forward from prior years.5 This 25% limitation prevents the full immediate offset of tax liability using a single year’s generated credit.

The crucial compensatory mechanism is the indefinite carryforward. Any unused portion of the credit (the excess over the annual utilization limit or the current tax liability) may be carried forward in 25% increments until the total amount of the credit is fully exhausted.5 This feature is particularly valuable for innovative LLCs in their early stages that may generate substantial credits but have little or no taxable income in the initial years, ensuring the tax asset does not expire.

Taxpayers with existing carryforward credits must complete Part D of Schedule K-53, which requires meticulous tracking of the original tax year the credit was generated, the original credit amount, and amounts previously claimed. The credit claimed by the transferee or carryforward credit remains subject to the limitations and requirements that were in place at the time the credit was originally earned.5

V. Allocation and Transferability of Credits by LLCs

5.1. Allocation of the R&D Credit to LLC Members

If an LLC chooses to retain the R&D credit rather than transfer it, the credit is allocated to the individual members. As a pass-through entity, the total calculated credit (K-53 Line 6) is distributed to members in proportion to their ownership share, or as specified in the operating agreement, provided such allocation adheres to state tax rules.9 The LLC reports this information to its members via a state equivalent of Schedule K-1.

Each member, receiving their allocated share, must then individually apply the 25% annual utilization limit (K-53 Line 7) against their personal Kansas income tax liability (Form K-40).

5.2. Eligibility for Transfer: The “No Current Tax Liability” Provision

The 2023 legislative change introduced transferability for taxpayers “without a current tax liability”.5 This provision acknowledges that R&D-intensive businesses often operate at a net loss or have minimal income tax liability in their initial, highest-spending years. By allowing the transfer (sale) of the credit, the state enables the LLC to convert a non-refundable, potentially long-deferred tax asset into immediate working capital, which can be critical for funding further research or expansion.3

5.3. Procedural Requirements for Transfer Notification: Completing Form K-260

Transferring the R&D credit necessitates the use of Form K-260, Tax Credit Transfer Notification Form.5 This form must be completed jointly by the transferor (the LLC that earned the credit) and the transferee (the party receiving the credit) and submitted to the Department of Revenue.13

The statute imposes strict limitations on the transfer process:

1. Only the full credit generated in the current year may be transferred.5
2. The credit may only be transferred one time.5
3. Only the entity that originally earned the credit (the LLC) is permitted to initiate the transfer.5

The requirement that only the full credit may be transferred, and only once, significantly impacts the market for these tax assets. It necessitates that the LLC find a single buyer with sufficient tax appetite to fully utilize the asset over its potentially indefinite carryforward period. This simplifies regulatory tracking for KDOR but places a high due diligence requirement on both the transferor and the transferee.

5.4. Transferee Limitations and Utilization

The transferee claims the transferred credit against their Kansas income tax liability.7 The credit remains subject to the same limitations as if the original earning entity had utilized it; specifically, the 25% annual limitation and carryforward rules remain tied to the time the credit was earned.5

A fundamental restriction for the transferee is that the credit is explicitly not refundable.14 If the transferee cannot fully utilize the maximum allowable 25% portion in the tax year it was transferred, the remainder must be carried forward, subject to the annual utilization limits in future tax years.

Table C: Required KDOR Forms for LLC R&D Credit Compliance

VI. Comprehensive Case Study: Calculation, Allocation, and Transfer Scenario

6.1. Scenario Setup: Kansas-Based Software LLC (Tax Year 2024)

Innovate Software LLC, a Kansas-based entity taxed as a partnership, employs engineers conducting qualified research within the state. The LLC is equally owned by Member A and Member B (50% each). The LLC has no entity-level tax liability.

QRE History (Kansas-Only):

• TY 2022 (Year -2): $200,000
• TY 2023 (Year -1): $500,000
• TY 2024 (Current Year): $800,000

6.2. Detailed Completion of Schedule K-53, Part A (Computation for TY 2024)

The LLC performs the calculation to determine the total tax asset generated:

The LLC successfully generates a total R&D credit of $30,000. The maximum amount that can be claimed in 2024 by any single claimant (whether the members or a transferee) is $7,500.

6.3. Analysis of Utilization vs. Transfer Decision

Option A: Internal Allocation (Retention by Members)

If Innovate Software LLC retains and allocates the credit, the total $30,000 credit is passed through to the partners based on their 50% ownership split.

• Member A: Receives a $15,000 share of the total credit. Maximum annual claim is $3,750 (25% of $15,000).
• Member B: Receives a $15,000 share of the total credit. Maximum annual claim is $3,750 (25% of $15,000).

Each member would apply their maximum available claim against their personal Kansas income tax liability (K-40). The remaining $11,250 for each member must be tracked and carried forward indefinitely until utilized. This option maximizes the economic benefit but defers the realization of the full value.

Option B: Full Transfer to Third Party (Liquidation)

Since the LLC is a pass-through entity without a current tax liability, it is eligible to transfer the credit. The LLC must complete Form K-204 for certification and then execute Form K-260 to transfer the full $30,000 credit to a single Transferee Corporation.

• The transfer price is negotiated (e.g., 90% of face value, yielding $27,000 immediate cash to the LLC).
• Transferee Corporation utilizes the credit. The maximum claim for the Transferee in TY 2024 is $7,500 (Line 7 limitation).
• The Transferee Corporation must carry forward the unused balance of $22,500 indefinitely (K-53 Line 10).

This option provides immediate liquidity for the LLC, allowing the use of the tax asset to fund current operations or expansion, overcoming the constraint of the slow 25% annual utilization limit.

VII. Strategic Tax Planning and Audit Considerations

7.1. Nexus and Apportionment Issues for Multi-State LLCs

For LLCs operating both inside and outside Kansas, strict adherence to nexus and apportionment principles is mandatory. Only expenditures for research activities physically conducted within the geographical boundaries of Kansas are considered qualified for the state credit.7 This requires the LLC to maintain rigorous, auditable records differentiating between in-state and out-of-state QREs, particularly concerning multi-state payroll, materials procurement, and equipment usage.

7.2. Audit Documentation and Retention

The Kansas R&D credit hinges entirely on compliance with the federal definition of QREs under IRC Section 41. Taxpayers must retain documentation substantiating that the expenses satisfy the four-part test for qualified research: the activity must aim to eliminate uncertainty, involve a process of experimentation, be technological in nature, and serve a qualified purpose (i.e., the development or improvement of a product or process).4

Furthermore, the new pre-claim certification (Form K-204) and transferability provisions place enhanced scrutiny on the original calculation (K-53 Part A). Documentation must not only support the current year’s QREs but also provide verifiable evidence for the QREs used in the two preceding years to accurately establish the base amount.

7.3. Strategic Decision Point: Allocation vs. Transfer

The choice between retaining the credit for member allocation and transferring the credit for liquidity is a crucial strategic decision for any eligible LLC.

The Allocation Advantage is maximized when the LLC members have consistently high Kansas income tax liabilities. By retaining the credit, the members capture the full 100% economic value of the tax asset without the discount typically required in a transfer market.

The Transfer Advantage is preferred when the LLC is capital-constrained, operating at a net loss, or when members have minimal Kansas tax liability. Transferring the credit converts a non-refundable, potentially long-deferred tax asset into immediate cash proceeds, thereby accelerating the benefit of the R&D investment.

In summary, the 2023 legislative changes have transformed the Kansas R&D credit into a powerful incentive for LLCs, but they have also introduced complex compliance requirements related to certification (K-204), allocation, and one-time, full-credit transferability (K-260). Mastery of the incremental calculation (K-53) and adherence to federal QRE documentation standards are essential for maximizing the credit’s benefit and maintaining compliance.

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