Maximizing the Kansas R&D Tax Credit through Pass-Through Entities (K.S.A. §79-32,182b): A Detailed Tax Compliance and Strategy Report

Executive Summary: The Strategic Opportunity in Kansas R&D

A Pass-Through Entity (PTE) is a legal business structure—such as a partnership, S corporation, or limited liability company (LLC)—whose income is not taxed at the entity level but is instead “passed through” directly to the owners for tax reporting. The State of Kansas strategically restructured its Research and Development (R&D) Tax Credit (K.S.A. §79-32,182b) to allow these dominant business structures to claim and utilize a significantly enhanced, and uniquely transferable, incentive starting in tax year 2023.1

The expansion of the Kansas R&D credit to include PTEs represents a major shift in state tax policy designed to bolster innovation across the broadest segment of the Kansas economy. Effective for tax years commencing after December 31, 2022, the credit rate was increased from 6.5% to 10%, and critically, eligibility was extended to virtually all Kansas income taxpayers, including individuals, partnerships, S corporations, and LLCs.1 Furthermore, the introduction of transferability for credits earned by taxpayers without a current liability provides an essential liquidity mechanism for growth-stage companies.1 Maximizing this incentive requires a comprehensive understanding of the flow-through mechanics and strict adherence to the guidance published by the Kansas Department of Revenue (KDOR).

I. Defining the Pass-Through Entity (PTE) in Kansas Taxation

A. The Fundamental Structure of PTEs: The Flow-Through Mechanism

A Pass-Through Entity (PTE) is a legal business structure—such as a partnership, S corporation, or LLC—whose income is not taxed at the entity level but is instead “passed through” directly to the owners for tax reporting.

This structure ensures that the business itself is generally not subject to corporate income tax; rather, the gains, losses, and, importantly, tax credits are shifted to the owners or partners, who then report the items on their individual income tax returns (e.g., Kansas Form K-40) and pay tax at individual income tax rates.4

This flow-through mechanism fundamentally contrasts with the taxation of C-corporations, where income is taxed first at the entity level, and then dividends are taxed again when distributed to shareholders (a system known as double taxation). PTEs are the dominant form of business enterprise in the United States, representing the vast majority of private business establishments and employing over half of the private-sector workforce.4 By expanding eligibility for the R&D credit to include these entities, the Kansas legislature activated a much larger segment of the state’s business base, dramatically increasing the potential reach and effectiveness of the R&D policy as an economic driver.

B. PTEs vs. C-Corporations: Tax Incidence and Reporting

Historically, the Kansas R&D credit was primarily limited to C corporations.1 C-corporations claim the credit directly against their corporate tax liability (Kansas Form K-120).

The modern Kansas R&D credit, however, specifically addresses PTEs. For tax year 2023 and thereafter, the KDOR has confirmed that “individuals, partnerships, S corporations, limited liability companies, other pass-through entities, and C corporations may claim the credit”.1 While the PTE calculates the credit amount using Schedule K-53, Part A, the resulting tax credit is an asset that is allocated to the owners based on their distributive share or ownership percentage. These owners then utilize the credit against their personal Kansas income tax liability.5

C. KDOR Confirmation of PTE Eligibility

The critical statutory amendment to K.S.A. 79-32,182b(d) explicitly removed the former limitation that allowed only C corporations to claim the credit. This change makes the credit available to all income taxpayers in Kansas. The effective date of this sweeping expansion was January 1, 2023.1 This expanded eligibility is coupled with the increased credit rate, making the incentive significantly more valuable for businesses utilizing a pass-through structure.

II. The Modern Kansas R&D Credit Landscape (K.S.A. §79-32,182b)

A. Legislative History: Evolution and Expansion

Prior to the legislative reforms, for taxable years beginning before January 1, 2023, the Kansas R&D credit was calculated at a rate of 6.5% of the excess qualified research expenditures.3 The restrictive eligibility often meant that growing companies structured as partnerships or S-corporations could not leverage the incentive.

The 2023 legislative shift marked a significant transformation. Amendments to the statute (K.S.A. 79-32,182b) achieved two primary goals: first, increasing the credit rate from 6.5% to 10% for all tax years commencing after December 31, 2022 2; and second, democratizing eligibility to include all Kansas income taxpayers.1 Furthermore, new language added to subsection (d) introduced transferability, a mechanism that dramatically alters the strategic value of the credit.2

Table 1 provides a clear comparison of the key characteristics before and after the critical statutory changes.

Table 1: Key Legislative Changes to the Kansas R&D Tax Credit (K.S.A. §79-32,182b)

B. Defining Qualified Research Expenditures (QREs): Alignment with IRC Section 41

To be eligible for the Kansas R&D tax credit, expenditures must meet stringent definitions. K.S.A. 79-32,182b(c) mandates that “expenditures in research and development activities” must align with expenses allowable for deduction under the provisions of the federal Internal Revenue Code of 1986.1 This specifically references the criteria established under IRC Section 41, which generally covers wages paid to researchers, costs of supplies used in the research process, and payments for contract research, provided the research is experimental in nature and intended to eliminate uncertainty regarding the development or improvement of a product or process.

A crucial Kansas-specific requirement is that the activities must be conducted within this state.2 This ensures that the economic activity being incentivized—the payroll, equipment, and supplies—must be physically located or performed in Kansas.

C. Apportionment for Multi-State PTEs

For a PTE that conducts business across multiple jurisdictions, the state mandates that only Qualified Research Expenditures (QREs) directly attributable to activities physically conducted in Kansas are eligible for the credit base calculation.7 This requires sophisticated tracking and apportionment methods to isolate the in-state QREs from the overall federal QRE base.

Furthermore, the structure of the Kansas R&D calculation—which relies on a three-year average of QREs—necessitates consistent and accurate apportionment for the base period. The credit is 10% of the difference between the actual QREs for the current year (Year 3) and the average of the current year and the two preceding tax years (Year 1 and Year 2).3 If a multi-state PTE historically tracked QREs globally but is now claiming the state credit, it must rigorously audit the QREs for Year 1 and Year 2 to ensure they represent accurately sourced Kansas activity. If historical QREs are not properly sourced to Kansas, using unapportioned figures in the base calculation (Line 4) can artificially lower the baseline spending requirement, potentially leading to an inflated credit claim that may be challenged upon audit.7 Thus, accurate apportionment is not just a compliance step but a fundamental factor in calculating the valid credit amount.

III. KDOR Compliance Guidance: Generating and Calculating the Credit

A. Administrative Requirements for Claiming the Credit

The Kansas Department of Revenue (KDOR) requires specific documentation and application steps for taxpayers to claim the R&D credit, especially following the 2023 amendments.

1. Mandatory Pre-Claim Application (Form K-204): For tax year 2023 and all years thereafter, taxpayers wishing to claim the credit must first complete and submit an application form, Form K-204, Research and Development Credit Application.1 This new requirement is necessitated by the transferability rules introduced in the same year, allowing the Department to track the credit asset before it is potentially transferred.
2. Computation Form (Schedule K-53): This is the primary schedule used to calculate the R&D credit amount, manage the annual utilization limitation, and track the indefinite carryforward.3 The completed Schedule K-53 must be submitted with the income tax return.3
3. Transfer Documentation (Form K-260): If the earning entity (the transferor) elects to transfer the credit, Form K-260 must be completed and submitted to the KDOR to document the transaction.3

B. The Calculation Methodology: Schedule K-53 Part A (PTE Responsibility)

The statutory formula for the Kansas R&D credit is an incremental calculation, designed to reward increases in research spending beyond a historical base. The formula is administered through Part A of Schedule K-53 and determines the total credit generated by the PTE.

The calculation steps for Part A are as follows 5:

• Line 1: Enter current year’s R&D expenditures (QREs) conducted within Kansas (categorized as machinery and equipment, payroll, and other expenditures).5
• Lines 2a and 2b: Enter the QREs for the first and second preceding taxable years, respectively.5
• Line 3: Sum Lines 1, 2a, and 2b to find the total expenditures over the three-year period.5
• Line 4 (Average Expenditures/Base): Divide the result of Line 3 by three (3).5 This amount establishes the taxpayer’s average baseline spending required to trigger the credit.
• Line 5 (Eligible Excess): Subtract Line 4 (Average Base) from Line 1 (Current Year QREs). If the result is negative, zero must be entered, as the credit only applies to expenditures exceeding the base.5
• Line 6 (Total Research and Development Credit): Multiply the Eligible Excess (Line 5) by the credit rate of 10% (.10).5 This represents the total credit asset generated in the current year.
• Line 7 (Maximum Allowable Credit): Multiply the Total Credit (Line 6) by 25% (.25).5 This figure establishes the maximum portion of the newly generated credit that can be claimed or utilized in the current tax year.

C. The 25% Annual Utilization Limitation and Indefinite Carryforward Rule

A significant feature of the Kansas R&D credit is the limitation on its annual use. In any one taxable year, the amount of the credit allowable for deduction from the taxpayer’s liability cannot exceed 25% of the total generated credit (Line 6), plus any applicable carryforward amounts from prior years.2

This 25% limitation dictates that, even if a taxpayer has sufficient tax liability, they can only utilize a portion of the newly generated credit each year. This requirement means the credit is realized over a minimum of four years. However, any remaining unused credit due to the limitation or insufficient tax liability may be carried forward indefinitely in 25% increments until the total amount of the credit is fully used.2

This structure establishes a tension between generating a large, valuable tax asset and the immediate liquidity of that asset. The 25% limitation ensures the state smooths out the utilization, providing a predictable, long-term tax benefit. However, for emerging or high-growth PTEs that often generate significant QREs but have little to no current tax liability, this restriction can make the credit a dormant asset. This inherent constraint is precisely the strategic factor that makes the transferability provision so vital, as it allows companies with trapped credits to immediately monetize a significant portion of their R&D asset.3

IV. The Flow-Through Mechanism: Distributing Credits to Owners

The process of claiming the credit shifts from the entity level to the owner level once the total credit is calculated in Part A of Schedule K-53.

A. PTE Responsibilities (Transferor Role)

The PTE’s primary role is computation and allocation. Once the total credit (K-53 Part A, Line 6) is determined, the entity allocates this credit to its partners or shareholders based on their ownership percentage. This allocated credit amount would typically be communicated to the owners via a state equivalent of the federal Schedule K-1.

If the PTE determines it has no current tax liability (which is common for partnerships and S-corporations unless they have residual entity-level taxes) and chooses to sell the credit, it becomes the Transferor.3 In this scenario, the entity completes Part A of Schedule K-53 to establish the credit value and then stops, providing the partially completed form to the Transferee.5 The PTE must then submit the required transfer documentation, Form K-260, to the KDOR with its tax return to legalize the transfer.3 Only the entity that earned the credit is permitted to transfer it.3

B. Owner Responsibilities (Transferee/Partner Role): Schedule K-53 Parts B through E

The individual owner (Partner or Shareholder), or the external party who purchased the credit (Transferee), is responsible for completing the subsequent parts of Schedule K-53 to apply the credit against their Kansas income tax liability (Form K-40).5

• Part B: Computation of Allowed Credit For This Year’s Expenditures: The individual taxpayer determines the actual current-year utilization. Line 8 requires the taxpayer to enter their Kansas tax liability for the year, after accounting for all other credits.5 Line 9 then determines the utilized portion, which is the lesser of the owner’s share of the Maximum Allowable Credit (25% portion calculated in Part A, Line 7) or the taxpayer’s actual tax liability (Line 8).5
• Part C: Computation of Carry Forward Credit: This part calculates the portion of the current year’s generated credit that is not used. Line 10 subtracts the utilized credit (Line 9) from the owner’s total share of the generated credit (Line 6), establishing the new carryforward balance.5
• Part D: Computation of Credits From Prior Years: This section is utilized to track and manage R&D credits generated in prior tax years. It calculates the total amount of carryforward credit available (Line 18).5
• Part E: Computation of Total Credit Claimed This Tax Year: The final step involves calculating the total credit that can be claimed against the current year’s tax bill. Line 20 is the lesser of the taxpayer’s total available credit (Line 9 + Line 18) or the total remaining tax liability.5 This final amount is the deduction applied to the taxpayer’s Form K-40 (Kansas Individual Income Tax Return).

The procedural complexity—separating calculation (Part A) from utilization (Parts B-E)—confirms that sophisticated tax planning must occur at the individual owner level. The individual owner’s income level and tax profile dictates how quickly their allocated portion of the 25% credit share can be utilized, resulting in potentially different carryforward management strategies for each partner.

C. Strategic Implications: The Transferable Credit Provision

The transferability of the Kansas R&D tax credit is a significant strategic tool, offering immediate liquidity for companies that generate credits but lack sufficient tax liability to utilize them within the 25% annual limitation.

The rules governing transferability are strict:

1. No Current Tax Liability: Transfer is only permitted if the earning taxpayer has no current tax liability.1 This focuses the benefit on startups and emerging businesses that are intensely researching but may be operating at a loss.
2. Full Credit Transfer: Only the full credit generated (Part A, Line 6) may be transferred.3 This prevents the transferor from cherry-picking the most attractive portion for internal use while selling the remainder.
3. One-Time Transfer: The credit may only be transferred once.3 The transferee must then manage the 25% annual utilization limit and the indefinite carryforward.3

This provision effectively solves the common problem for R&D intensive companies of having valuable tax assets trapped by a lack of income. By selling the credit (often at a discount), the PTE immediately gains liquid capital, which can be reinvested in further research, effectively accelerating the financial benefit of the incentive and driving further economic growth in Kansas.7 The legislative decision to impose strict transfer restrictions (no current liability, full transfer, one time) ensures that the transfer market is reserved for genuinely cash-strapped firms, focusing the policy benefit on accelerating liquidity for growth-focused entities.

V. Comprehensive Example: Calculation and Flow-Through for a Kansas LLC (PTE)

This example illustrates the required calculation steps for a Kansas-based LLC (taxed as a partnership) generating and flowing the credit through to a 50% partner. The example assumes all Qualified Research Expenditures (QREs) were conducted entirely within Kansas.

A. Scenario Setup: LLC QRE History (Kansas QREs Only)

Assume the LLC has two equal partners, A and B (50% interest each).

B. Step-by-Step K-53 Part A Calculation (PTE Responsibility)

The LLC completes Part A of Schedule K-53 to determine the total credit generated.

Kansas R&D Credit Generation (Schedule K-53, Part A)

Result: The LLC generated a total R&D credit asset of $35,000 for the 2024 tax year. The maximum portion of this credit that can be utilized by all parties (either the partners or a single transferee) in 2024 is $8,750.

C. Illustration of Partner Utilization (Schedule K-53, Parts B & C)

The LLC allocates 50% of the total credit to Partner A. Partner A must then complete the relevant parts of Schedule K-53 and attach it to their Kansas Form K-40.

• Partner A’s Total Credit Share (50% of Line 6): $17,500
• Partner A’s Maximum Allowable Credit Share (50% of Line 7): $4,375

Assume Partner A has a Kansas income tax liability of $6,000 after claiming all other available credits (This value is used for K-53, Line 8).5

Partner A’s Utilization Calculation

Result: Partner A successfully reduces their tax liability by $4,375, utilizing the full 25% portion of the newly generated credit available to them this year. They possess a remaining R&D tax credit asset of $13,125 that carries forward indefinitely, subject to the 25% annual limitations in future years.5

VI. Conclusion: Navigating the Enhanced Kansas Tax Opportunity

The enhancement and expansion of the Kansas Research and Development Tax Credit (K.S.A. §79-32,182b) to include Pass-Through Entities is a landmark legislative move designed to make the state highly competitive in attracting and retaining innovative businesses. The increase to a 10% rate and universal eligibility means that the incentive now applies to the dominant economic structures in the state (partnerships, S-corporations, and LLCs).

For PTEs, successful utilization of this credit requires meticulous planning and adherence to KDOR administrative guidance. The compliance burden involves three key phases:

1. Generation: Accurately tracking and apportioning Kansas QREs over the three-year base period and completing Form K-204 and Schedule K-53, Part A.
2. Allocation/Transfer: Properly flowing the credit to the owners via state K-1s or electing to transfer the full credit using Form K-260 if the no-tax-liability criteria are met.
3. Utilization: Managing the 25% annual utilization cap and tracking the indefinite carryforward through K-53, Parts B through E, at the individual owner level.

The 25% annual utilization restriction necessitates a long-term strategy, as the credit is realized over multiple tax cycles. However, the unique provision allowing the one-time transfer of the full credit asset provides an immediate and powerful liquidity option for high-growth, R&D-intensive PTEs that might otherwise wait years to realize the full tax benefit. Firms must carefully assess their current tax liability and future capital needs to determine whether internal utilization or credit transfer offers the greatest economic advantage.

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