The Process of Experimentation: The Technical Foundation for the Kansas Research and Development Tax Credit

I. Executive Summary: The Dual Mandate of Qualification

The Process of Experimentation (PoE) is the systematic, documented methodology used to eliminate technical uncertainty inherent in developing or improving a product or process. For the Kansas R&D credit, the PoE is the non-negotiable federal gateway required to qualify expenditures conducted within the state.

The Kansas Research and Development Tax Credit, established under K.S.A. 79-32,182b, is fundamentally tethered to the eligibility standards set forth by the federal Internal Revenue Code (IRC) Section 41.1 This means that regardless of Kansas’s generous incentive structure—including the 10% incremental credit and the ability to transfer the credit (for post-2022 claims) 1—the foundational requirement remains the technical documentation proving the systematic application of the Process of Experimentation. This critical standard dictates that technical uncertainty must exist at the project’s outset and be resolved through an evaluative process involving the testing of alternatives.3 Failure to satisfy the Process of Experimentation requirement at the federal level voids the underlying technical merit of the expenditure, resulting in the disallowance of the corresponding state claim, independent of state-specific calculation and filing compliance (Forms K-204 and K-53).

II. Defining the Process of Experimentation (PoE): The Federal Foundation (IRC § 41)

The technical qualification for any expenditure claimed under the Kansas R&D credit is derived entirely from the federal definition of Qualified Research Expenditures (QREs) as set forth in IRC § 41.

A. The Simple Standard and the Substantially All Rule

The core statutory mandate adopted by Kansas requires that for research to qualify, “substantially all” of the activities must constitute elements of a process of experimentation.4 This experimentation must be explicitly related to achieving a new or improved function, performance, reliability, or quality of a business component.4

The “substantially all” rule represents a qualitative hurdle, not merely a quantitative threshold for expenditure tracking. Compliance professionals recognize that focusing solely on input documentation, such as aggregating payroll costs for a development project, is insufficient. The law requires evidence proving the scientific methodology used. If an activity is classified as qualified research, the vast majority of that activity must demonstrably involve systematic testing to resolve technical doubt. If documentation fails to show this systematic process—for example, if research appears to be routine engineering or simple problem-solving without formal evaluation of alternatives—the entire expenditure fails the PoE test, even if the financial costs are readily trackable.

B. The Four-Part Test of Qualified Research (IRC § 41)

To be deemed a QRE, an expenditure must satisfy all four requirements of the federal test:

1. Section 174 Requirement (Expenditures): The costs claimed must be of the type allowable as expenses under IRC § 174, typically covering wages paid for qualified services, the cost of supplies consumed in research, and 65% of contract research costs.2
2. Technological Information Test: The objective of the activity must be the discovery of information that is technological in nature, relying upon the principles of hard sciences such as engineering, chemistry, physics, or computer science.3
3. Business Component Test: The research must aim to produce a new or improved function, performance, reliability, or quality in a business component (which includes products, processes, techniques, or formulas).6 It is crucial to note that research related to style, taste, cosmetic factors, or seasonal design is explicitly excluded from qualified research.6
4. The Process of Experimentation Test (The Core Requirement): Substantially all qualified activities must systematically involve the testing of alternatives designed to resolve the technical uncertainty inherent in the development or improvement.

C. Detailed Examination of the Process of Experimentation

The Process of Experimentation (PoE) is initiated by the presence of technical uncertainty—a state where the taxpayer cannot know, based on current public knowledge or readily available information, whether a proposed design is feasible, how to achieve the specific technical objective, or what the optimum design parameters should be.3

The experimentation process must be systematic and disciplined. It must involve an “evaluative” approach, usually demonstrating the capacity to evaluate and compare more than one potential alternative solution.3 This transforms routine engineering or data collection into auditable qualified research. For audit defense, documentation must clearly articulate:

• The technical uncertainties that triggered the research.
• The hypotheses formulated to resolve those uncertainties.
• The design, execution, and results of the testing protocols, including the data gathered from failed tests or iterations.
• The conclusions drawn that ultimately led to the final, improved specification of the business component.

If documentation only traces the successful design path, it fails to demonstrate the systematic evaluation of technical risk and alternatives, which is the necessary prerequisite for PoE compliance.

D. Activities Explicitly Excluded from Qualified Research (IRC § 41(d)(4))

Because K.S.A. 79-32,182b mandates federal conformity 1, all federal exclusions defined in IRC § 41(d)(4) automatically apply to the Kansas credit:

• Post-Production Research: Any research conducted after the commencement of commercial production of the business component is excluded.6
• Adaptation and Duplication: Research related to adapting an existing component to satisfy a particular customer’s requirement or need, or research involving the reproduction of an existing component from public plans, specifications, or physical examination, is excluded.6
• Excluded Purposes: Non-technical activities such as efficiency surveys, market research, advertising, promotions, routine data collection, routine or ordinary testing for quality control, or activities relating to management functions or techniques are not qualified research.6
• Internal-Use Software (IUS): Research related to computer software developed primarily for the taxpayer’s internal administrative functions is generally excluded unless it meets a high-threshold of innovation test or is used directly in an activity that otherwise qualifies as research or a production process that meets the PoE requirements.6

III. Kansas Statutory Basis and Conformity to Federal Law

A. K.S.A. 79-32,182b: The Legal Framework

K.S.A. 79-32,182b allows an income tax credit for expenditures in research and development activities, provided they are conducted within this state.2 This geographic specificity means that QREs—wages, supplies, and contract research costs—must be carefully sourced to R&D activities physically performed in Kansas.

The Kansas statute relies heavily on federal law. Subsection (c) of K.S.A. 79-32,182b defines eligible expenditures as those “allowable for deduction under the provisions of the federal internal revenue code of 1986, as amended”.2 This mandate establishes the federal Process of Experimentation as the binding technical standard for Kansas credit eligibility.1 Consequently, any technical failure identified during a federal audit related to the PoE standard will directly result in the disallowance of the corresponding Kansas credit. The rigor of federal compliance is thus the floor for state compliance.

B. Recent Legislative Enhancements (Tax Year 2023 and Beyond)

Effective for tax years commencing after December 31, 2022, Kansas significantly enhanced the R&D credit, as outlined in KDOR Notice 23-09.7 These changes were implemented to strategically incentivize increased innovation and economic growth, particularly targeting the state’s dominant small and medium-sized enterprises.8

The primary changes include:

• Increased Credit Rate: The credit rate was raised from 6.5% to 10% of the incremental increase in QREs.1
• Expanded Eligibility: Eligibility was broadened from C corporations to include all Kansas income taxpayers, specifically naming individuals, partnerships, S corporations, and limited liability companies (LLCs).7 This expansion allows pass-through entities, which traditionally drive a significant portion of state R&D activities, to directly claim the credit.
• Transferability: New credits earned in 2023 and subsequent years may be transferred by a taxpayer without a current tax liability.2 This provides a vital liquidity mechanism for start-up R&D companies that generate credits but are not yet profitable enough to use them against current tax obligations.

Table 1: Comparison of Kansas R&D Credit Rules (Pre- and Post-2022)

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

KDOR guidance clarifies the mandatory procedural steps required for the enhanced, transferable credit.

A. The Two-Step Compliance Process: Application and Claiming

For credits earned in 2023 and subsequent years, the compliance process involves two mandatory steps:

1. Application (Pre-certification): Taxpayers seeking to claim the credit must first complete and submit Form K-204, Research and Development Credit Application, to the KDOR prior to claiming the credit on their income tax return.7 The introduction of this mandatory pre-certification application is an administrative measure to mitigate the financial risk associated with the credit’s new transferability feature.7 By reviewing the application, KDOR establishes a preliminary audit checkpoint, ensuring a basic level of validity is met before the credit can be monetized by a transferee.
2. Claiming: The final credit amount is calculated on Schedule K-53 and must be filed with the income tax return.10 This schedule is typically supported by documentation equivalent to the federal Form 6765.11

B. Required KDOR Forms and Documentation

The KDOR forms link the quantitative financial data to the qualitative technical requirements (PoE) and the geographic limitations.

• Schedule K-53 (Computation of the R&D Credit): This form requires detailed inputs and descriptions 12:

• Itemization of current year QREs into Machinery and Equipment, Payroll, and Other expenditures.
• QRE data for the two preceding taxable years used in the incremental calculation.
• A mandatory Description of the Research or Development activity. This description is a key area of audit inquiry, requiring taxpayers to clearly articulate activities that satisfy the technical information and PoE tests while avoiding terminology that suggests excluded purposes.6
• The specific Street Address, City, and County where the R&D activities were physically conducted, confirming the “conducted within this state” limitation.

• Form K-260 (Kansas Tax Credit Transfer Notification): This form must be completed by the transferor to document the transfer of the credit.1 The entity that earned the credit is the only party permitted to transfer it.1 The transferor must also submit the Schedule K-53 related to the transferred credit with their own income tax return.1 The Secretary of Revenue requires documentation from both the taxpayer and the transferee to support any credit acquired by transfer.5

V. Mechanics of the Kansas R&D Credit Calculation

The Kansas credit utilizes an incremental methodology based on the growth of QREs within the state.

A. Defining Qualified Research Expenditures (QREs) for Kansas

QREs used in the Kansas calculation must first successfully pass the federal IRC § 41 four-part test, including the Process of Experimentation, and must also be geographically sourced to activities physically conducted in Kansas.2 Eligible expenses, allowable under IRC § 174, include wages for qualified research services, supply costs, and 65% of contract research costs.

B. The Incremental Calculation Methodology

The calculation compares current-year QREs to a moving base amount derived from the current year and the two preceding years.2 This structure incentivizes businesses to achieve sustained growth in their R&D spending.

The methodology for calculating the total available credit (G) is as follows:

1. Identify Current Year QREs (A).
2. Identify QREs for 1st Preceding Year (B) and 2nd Preceding Year (C).
3. Calculate the Three-Year Average Base (E):
   
   $$E = \frac{A + B + C}{3}$$
4. Calculate the Incremental Increase (F):
   
   $$F = A – E$$
5. Calculate the Available Credit (G): The credit rate is 10% of the incremental increase.1
   $$G = F \times 10\%$$

C. Case Study: Illustrative Example of Credit Calculation and Limitation (2025 Tax Year)

A Kansas-based manufacturing company, certified by KDOR for their R&D activities, calculates their 2025 credit utilization.

Table 2: Illustrative Kansas R&D Credit Calculation and Utilization (2025)

For 2025, the company generated $\$26,667$ in new credit. The maximum allowable deduction is 25% of the total available credit, or $\$14,896$.1 Since the tax liability (K) is only $\$10,000$, the company utilizes $\$10,000$, carrying forward the remaining $\$49,584$ indefinitely until fully used.1

VI. Monetizing the Credit: Limitations and Transferability Rules

A. Credit Utilization Limitation and Carryforward

The utilization of the Kansas R&D credit is constrained by an annual limitation: the allowable deduction in any single tax year cannot exceed 25% of the sum of the current year’s credit plus any carryforward amount.1 This limitation governs the rate at which the credit can be applied. Any unused credit amount that exceeds the taxpayer’s current liability may be carried forward in 25% increments until the total amount of the credit is fully utilized.1

B. Transferability of Credit (Effective 2023)

For tax year 2023 and thereafter, new R&D credits may be transferred by a taxpayer, particularly those without a current tax liability, to any person.2 The transferee may then claim the credit against their own Kansas income tax liability in the tax year of the transfer.2

Specific restrictions apply to ensure the integrity of the transferred asset:

• Only the full credit generated by the transferor may be transferred; partial transfers are disallowed.1
• The credit may be transferred only one time.1
• The transferee is explicitly prohibited from receiving a refund for the transferred credit, although they may carry it forward subject to the 25% annual limitation.5

A significant liability risk is created by the statutory provision stating that the transferred credit is subject to all limitations and requirements “in place at the time the credit was earned”.1 This necessitates rigorous due diligence by the transferee. If the original transferor failed to adequately document the Process of Experimentation required by IRC § 41, a subsequent KDOR audit could invalidate the technical basis of the credit, making the transferred asset worthless to the buyer. Transferees must therefore require comprehensive technical documentation, in addition to Forms K-204 and K-260, to validate the integrity of the credit.

VII. Strategic Considerations and Documentation Best Practices

For Kansas taxpayers, securing the R&D credit involves adopting a documentation strategy that integrates federal technical compliance with state procedural requirements.

A. Audit Preparedness: Linking Expenditures to the Process of Experimentation

The central requirement for audit defense is establishing the technical nexus between the Qualified Research Expenditures and the systematic activities that satisfy the PoE. Taxpayers must develop project-specific technical narratives that articulate the four-part test for each project. These narratives must be created contemporaneously with the research and should clearly outline the technical uncertainties present and how the disciplined, evaluative steps (the PoE) resolved them. Preparing these technical narratives pre-emptively, before filing, strengthens the defensibility of the claim significantly.

B. Importance of Time Tracking and Project Documentation

Since payroll costs are typically the largest component of QREs, they require the strongest support. Contemporaneous time tracking records are essential, clearly differentiating between time spent on activities that satisfy the Process of Experimentation and time spent on excluded activities, such as routine quality control or management tasks.6

Furthermore, the required description of the R&D activity on Schedule K-53 12 must be technically precise. Taxpayers should ensure that this public documentation avoids generalized or business-centric language that could be misconstrued as market research or an efficiency survey—activities explicitly excluded under IRC § 41.6

C. Integrating Federal and State Documentation Strategies

Given the explicit conformity requirements, the most efficient approach is to build the documentation from the federal level upward. The federal R&D claim (Form 6765) establishes the foundational technical compliance regarding the Process of Experimentation. The Kansas claim (K-53) then overlays the state-specific parameters, such as geographic sourcing of QREs and the incremental calculation. Any documentation prepared for the IRS regarding technical eligibility serves as the primary defense against potential KDOR inquiries, ensuring consistency and minimizing the administrative burden.

VIII. Conclusion: Navigating the R&D Landscape in Kansas

The Kansas Research and Development Tax Credit, particularly since its enhancement in 2023, provides a strong financial incentive to drive innovation within the state, marked by a 10% incremental rate and crucial transferability provisions. However, the realization of this benefit is entirely conditional upon meeting the stringent federal requirement for the Process of Experimentation (PoE).

The PoE serves as the indispensable gatekeeper. Taxpayers must commit to establishing and maintaining meticulous technical documentation that proves not just the costs incurred, but the systematic methodology used to resolve technical uncertainty. This documentation must precede the procedural steps of the KDOR, including the mandatory Form K-204 application and the Schedule K-53 calculation.

The increased transferability of the credit requires both transferors and transferees to emphasize diligence concerning the credit’s technical history. Strategic R&D tax planning in Kansas therefore requires a unified approach: demonstrating rigorous technical compliance under IRC § 41 (PoE) and executing flawless administrative adherence to KDOR’s application, calculation, and transfer notification procedures.

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