Historical Analysis of the Prior Credit Percentage (6.5%) in the Kansas Research and Development Tax Credit

I. Executive Summary: The Meaning of the Prior 6.5% Kansas R&D Credit

1.1 The Prior Credit Percentage Defined

The 6.5% rate determined the magnitude of the nonrefundable income tax credit available to eligible taxpayers on Qualified Research Expenditures (QREs) that exceeded their unique three-year rolling average spending threshold. For periods prior to 2023, the credit was generally limited to C corporations and designed to incentivize significant year-over-year growth in Kansas-based research activities.

1.2 Overview of the Pre-2023 Incremental System

The Kansas Research and Development (R&D) Tax Credit, established under K.S.A. 79-32,182b, has historically operated on an incremental calculation basis to reward growth in research spending within the state.1 For taxable years commencing after December 31, 1987, but prior to January 1, 2023, the mechanism utilized a fixed rate of 6.5% applied to the amount of Qualified Research Expenditures that exceeded a calculated base amount.1 This structure ensured that the state provided a benefit only for newly generated research activity, not for stable or decreasing expenditures.

The core calculation method required the determination of the difference between the actual QREs incurred in the current taxable year and a base amount.1 This base amount was derived from the unique methodology of averaging the actual expenditures made during the current year and the two immediate preceding tax years.2 This statutory requirement, confirmed by guidance from the Kansas Department of Revenue (KDOR) in Notice 23-09, dictated that the credit was equal to 6.5% of “the amount by which the amount expended for such activities in the taxable year… exceeds the taxpayer’s average of the actual expenditures… made in such taxable year and the next preceding two taxable years”.3

While the 6.5% rate was relatively modest compared to incentives offered by other jurisdictions, the resulting credit was non-refundable but highly valuable due to its indefinite carryforward provision.1 The ability of taxpayers to deduct the credit from their income tax liability was limited to 25% of the total generated credit plus any applicable carryforward amount in any given year, ensuring the benefit was amortized over time.1 This combination of a modest generation rate (6.5%) and a restrictive base calculation suggests that, historically, Kansas lawmakers pursued a conservative fiscal policy. The system was structurally designed to minimize immediate state revenue risk while still maintaining a formal incentive program for companies demonstrating substantial, aggressive growth in their Kansas-based R&D investment.

II. Statutory and Historical Context (Pre-2023 Framework)

The application of the 6.5% rate was inextricably linked to specific legislative definitions and severe limitations on who could claim the benefit under K.S.A. 79-32,182b.

2.1 Legislative Basis and Qualified Expenditures

The statutory foundation for the 6.5% credit was K.S.A. 79-32,182b, with Subsection (a) defining the specific incremental calculation that produced the credit amount.3 Eligibility required that the research and development activities were conducted within the state of Kansas.5

For expenses to qualify for the 6.5% credit, they had to align with federal standards, meaning expenditures for research and development activities were defined as those allowable as expenses for deduction under the provisions of the federal Internal Revenue Code of 1986, specifically referencing IRC Section 41.1 This federal alignment requires adherence to the strict four-part test for qualified research. The statute also placed exclusions on certain expenditures, barring expenses made available through federal or state laws, and specifically prohibiting expenditures related to the performance of abortions for tax years commencing after December 31, 2013.5

2.2 Eligibility Restrictions: The C-Corporation Mandate

A defining characteristic of the 6.5% historical regime was the strict exclusion of most growing business types. For tax years spanning from 2013 up until the 2023 amendments, the incentive was restricted only to “corporations that are subject to the Kansas corporate income tax, i.e., C corporations”.6

This mandate meant that the 6.5% credit was entirely unavailable to pass-through entities, including individuals, partnerships, S corporations, and Limited Liability Companies (LLCs).6 This historical restriction meant that the benefit was primarily focused on established, generally larger corporate structures that paid corporate income tax.3 Many high-growth, venture-backed companies and small businesses in the innovation sector utilize flow-through structures; their exclusion from the 6.5% incentive suggests that the initial policy goal was to favor established corporate industrial sectors over the creation of a dynamic, broad-based innovation economy. The structural limitation to C-corporations fundamentally constrained the intended economic impact of the 6.5% rate. The subsequent legislative efforts in 2023, which targeted expansion to all income taxpayers, addressed this historical structural inequity, recognizing that excluding pass-through R&D enterprises was limiting the state’s potential for economic diversification.7

III. In-Depth Analysis of the 6.5% Calculation Methodology

The calculation of the 6.5% credit is entirely dependent on an incremental formula designed to measure sustained increases in Kansas-based research investment.

3.1 The Incremental Calculation Structure

The central tenet of the calculation is that a credit is only generated when current QREs exceed a historical threshold.3 The resulting difference, referred to as the Excess QREs, is the creditable base amount, to which the 6.5% rate is applied.1 If the current year’s QREs are equal to or less than the computed base amount, the amount eligible for the credit is zero.10

The specific generation formula used prior to 2023 was:

$$\text{Total Credit Generated} = (\text{QRE}_{\text{Current Year}} – \text{Base Amount}) \times 6.5\%$$

3.2 The Unique Base Amount Calculation

The Kansas methodology for determining the base amount is distinct because it incorporates the current year’s QREs into the three-year average, which significantly raises the bar for credit generation. This methodology is consistently defined in K.S.A. 79-32,182b(a).3

The Base Amount is precisely defined as the average of the “actual expenditures for such purposes made in such taxable year and the next preceding two taxable years”.3 This calculation is mathematically expressed as:

$$\text{Base Amount} = \frac{\text{QRE}_{\text{Current Year}} + \text{QRE}_{\text{Year}-1} + \text{QRE}_{\text{Year}-2}}{3}$$

4

The inclusion of the current year’s QRE in the denominator (divided by three) acts as an internal restraint on credit generation. For a company to generate any credit, its current-year QREs must significantly surpass the average spending of the previous two years. If a company maintains flat QRE spending year-over-year (e.g., $1M QREs for three consecutive years), the Base Amount will equal the Current QREs, resulting in zero Excess QREs and thus no credit, despite incurring substantial research costs. This structural hurdle confirms that the 6.5% incentive was explicitly designed not to reward sustained, stable R&D activity, but strictly to subsidize accelerated growth and ambitious R&D expansion.4

For new taxpayers, where data for the two preceding years may be unavailable, the KDOR methodology requires using available data, effectively treating non-existent QRE years as zero expenditures, and dividing the sum by three to calculate the average.4 This provides a structural advantage for new businesses, as their base amount is inherently lower in their early years of operation, allowing them to qualify for the 6.5% rate with less overall QRE growth.

IV. Kansas Department of Revenue (KDOR) Guidance and Compliance

Compliance procedures for the 6.5% credit were established through official KDOR notices and the mandatory use of state tax schedules, ensuring consistency in calculation and utilization.

4.1 KDOR Administrative Guidance

The Kansas Department of Revenue has historically provided guidance confirming the statutory framework.1 Specifically, KDOR Notice 23-09, while addressing the 2023 changes, serves as the primary administrative confirmation of the pre-2023 requirements, including the C-Corp eligibility limitation and the 6.5% rate applied to the incremental calculation base.3 This notice is crucial for taxpayers needing to defend audits related to historical credit generation under the 6.5% regime.

4.2 Claiming the Credit: Schedule K-53

The required mechanism for claiming the 6.5% credit was the completion and submission of Schedule K-53, the Kansas Research and Development Credit form, which must be filed alongside the annual income tax return.1

The standardized structure of Schedule K-53 was used to document the calculation:

• Line 3 calculates the total three-year QRE sum.
• Line 4 determines the Base Amount by dividing Line 3 by three.
• Line 5 calculates the Excess QREs by subtracting Line 4 from the Current Year QREs (Line 1).10

Taxpayers claiming the historical 6.5% rate utilized this framework and multiplied the resulting Excess QREs (Line 5) by the 6.5% rate (.065) to arrive at the total credit generated. The preservation of this underlying calculation structure in the K-53 form, even after the rate increase to 10%, demonstrates the administrative consistency in the KDOR’s approach. This simplifies ongoing compliance for taxpayers managing long-term credit carryforwards generated under the prior 6.5% rule.10

4.3 Credit Utilization and Carryforward

The utilization rules imposed a major fiscal constraint on the taxpayer, regardless of the 6.5% generation rate. The statutory limit dictated that the amount of the generated credit that could be utilized against the taxpayer’s liability in any one tax year could not exceed 25% of the total amount of the credit generated, plus any applicable carryforward amount.1 This utilization cap ensured that the tax benefit was amortized gradually.

Any portion of the credit exceeding the annual 25% limit, or the taxpayer’s tax liability in that year, was eligible to be carried forward indefinitely until the total credit was fully used.1 This indefinite carryforward provision added certainty and substantial long-term value to the 6.5% credit, serving as a critical feature that compensated for the immediate utilization cap. The carryforward credits generated at the 6.5% rate remain subject to the ongoing 25% annual utilization restriction.10

V. Computational Case Study: Application of the 6.5% Credit (Pre-2023)

This computational example demonstrates the step-by-step application of the 6.5% rate and the utilization limits for a taxpayer operating under the pre-2023 statutory regime.

5.1 Scenario Setup: R&D Innovators Inc. (2022 Tax Year)

The scenario involves a C-Corporation, R&D Innovators Inc., reporting its qualified expenditures for the 2022 tax year:

5.2 Step-by-Step Numerical Calculation

The calculation proceeds according to the incremental method defined in K.S.A. 79-32,182b(a).3

Table Title: Pre-2023 R&D Credit Calculation (6.5% Rate) – Tax Year 2022

5.3 Determination of Annual Claimable Credit

The utilization of the newly generated credit is constrained by the 25% limitation defined in the statute.1

1. Maximum Allowable Credit from 2022 Generation:
   The maximum amount of the newly generated credit of $6,500 allowed for use in 2022 is limited to 25%.
   
   $$\$6,500 \times 0.25 = \$1,625$$
2. Total Available Credit for Use in 2022:
   The maximum allowable new credit is combined with any prior credit carryforward.
   
   $$\text{Max. New Credit } + \text{ Prior Carryforward } = \$1,625 + \$1,000 = \$2,625$$
3. Credit Used in 2022:
   The credit claimed is the lesser of the Total Available Credit ($2,625) or the Kansas Tax Liability ($25,000).
   
   $$\text{Credit Claimed: } \textbf{\$2,625}$$
4. Carryforward Calculation:
   The portion of the 2022 credit that was generated but could not be utilized immediately must be carried forward indefinitely.
   
   $$\text{Total Credit Generated } – \text{ Max. New Credit Used } = \$6,500 – \$1,625 = \textbf{\$4,875}$$
   
   This remaining amount of $4,875 is carried forward to 2023 and subsequent years, where it continues to be subject to the 25% utilization cap alongside any future credit generation. The 25% limitation meant that only a small portion of the total available benefit was realized in the claim year, confirming that the 6.5% system enforced long-term, non-immediate fiscal relief for the taxpayer.

VI. The Contextual Shift: Transition to the 10% Era

The historical 6.5% rate serves as a direct point of comparison to the significant liberalization of the Kansas R&D credit framework enacted for tax years beginning after December 31, 2022.

6.1 Legislative Rationale and Statutory Changes

The legislative package (House Bill 2239) fundamentally restructured the Kansas R&D incentive, transitioning away from the conservative 6.5% system.8 The amendments, effective for tax year 2023 and all years thereafter, were primarily driven by a need to improve the state’s competitiveness and broaden the economic impact of the incentive.4

The key statutory changes include:

1. Increased Rate: The credit percentage was raised from 6.5% to 10% of the excess QREs.1 This substantial increase amplified the incentive for incremental spending by over 50%.
2. Expanded Eligibility: The previous limitation confining the credit to C-corporations was removed.8 Starting in 2023, the credit became available to all Kansas income taxpayers, including individuals, partnerships, S corporations, and LLCs, allowing a much wider array of innovative businesses to participate.2
3. Transferability: A major policy shift was the introduction of credit transferability.5 New credits earned post-2022 may be transferred once by a taxpayer without a current tax liability, allowing growing companies to immediately monetize the full value of the generated credit.4 Taxpayers must now complete and submit Form K-204, the Research and Development Credit Application, before claiming or transferring the credit.8

6.2 Key Differences: 6.5% vs. 10%

The comparison between the historical and current regimes emphasizes the strategic policy change from a targeted, conservative incentive to a robust, fiscally flexible program.

Table Title: Kansas R&D Credit Key Structural Differences (Pre- and Post-2023)

A critical distinction for historical compliance is that credits generated at the 6.5% rate are “grandfathered” under the original rules.3 They retain their non-transferable status, even if they are carried forward into a year where 10% credits are generated and transferred. This separation in treatment necessitates careful tracking by C-corporations managing a dual pool of transferable (10%) and non-transferable (6.5%) credit carryforwards.

VII. Conclusion: Strategic Implications for Tax Planning

The analysis of the 6.5% Prior Credit Percentage reveals a deliberate structure designed to limit immediate fiscal exposure while encouraging aggressive growth in R&D spending.

The methodology associated with the 6.5% rate—the inclusion of the current year QREs in the three-year rolling average—remains the fundamental core of the Kansas R&D credit, continuing to apply even with the current 10% rate.4 This structural element dictates that strategic tax planning must prioritize QRE growth over stable R&D investment, as only substantial, year-over-year increases result in a creditable base.

For taxpayers managing historical assets, the 6.5% credit carryforwards remain valuable but require adherence to several legacy limitations. These credits continue to be subject to the 25% annual utilization cap, which defers the realization of the tax benefit over several years.1 Furthermore, these legacy credits, having been generated prior to the statutory change, are non-transferable. Taxpayers must ensure meticulous record-keeping, supported by KDOR guidance such as Notice 23-09, to defend the original C-corporation eligibility and calculation methods in the event of an audit.

The fact that the Kansas legislature increased the rate to 10% and introduced transferability, but chose to preserve both the challenging incremental calculation method and the 25% utilization cap, indicates a clear policy objective: to provide a powerful incentive for R&D expansion while simultaneously enforcing long-term budget stability for the state. This strategy ensures that even highly valuable credits generated at the 10% rate are gradually realized, spacing the state’s fiscal exposure over an extended period and making the Kansas R&D credit a powerful, yet phased, component of corporate tax strategy.

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