Expert Analysis of the Geographic Scope: Defining “Research Conducted Within This State (Kansas)” for the R&D Tax Credit

Executive Summary: Defining Geographic Eligibility for the Kansas R&D Credit

The statutory meaning of “Research Conducted Within This State (Kansas)” dictates that only Qualified Research Expenditures (QREs) attributable to activities physically performed within the geographic boundaries of Kansas are eligible for the state’s Research and Development (R&D) tax credit. This mandate necessitates rigorous, expense-by-expense geographic sourcing, overriding general corporate income apportionment formulas for multi-state enterprises.

This requirement compels multi-state taxpayers to perform a specific, detailed geographic analysis of all QREs—with particular emphasis on R&D wages—by applying Kansas-specific compensation sourcing statutes, which are separate from the rules used for determining overall Kansas taxable business income.

Overview of Key Findings and Structure

The Kansas R&D tax credit, codified in K.S.A. §79-32,182b, explicitly links eligibility to the location of the R&D performance.1 For multi-state entities, effective compliance requires tracing employee activity to Kansas via statutory rules that govern when compensation is “paid in this state,” utilizing tests concerning the “base of operations” and “direction or control” (K.S.A. 79-4301).2 Furthermore, the Kansas Department of Revenue (KDOR) has implemented mandatory procedures for credit certification, requiring taxpayers to secure pre-approval via Form K-204 before claiming or transferring the credit, underscoring the state’s heightened scrutiny of the reported Kansas-sourced QREs.4

I. Foundational Principles of the Kansas R&D Tax Credit (K.S.A. §79-32,182b)

A. Current Statutory Credit Mechanics (Post-2022 Enhancements)

The statutory basis for the Kansas R&D tax credit is found in K.S.A. §79-32,182b.1 This provision is designed to incentivize investment in qualified research activities performed within the state of Kansas, providing an offset against Kansas income tax liabilities.6

Significant legislative changes became effective for taxable years commencing after December 31, 2022. The most notable modification was the increase in the credit rate from 6.5% to 10% of the eligible excess expenditures.1 Concurrently, eligibility for the credit was dramatically expanded. Previously limited primarily to C corporations, the R&D credit is now available to all Kansas income taxpayers, encompassing individuals, partnerships, S corporations, limited liability companies, and other pass-through entities.4 This expansion requires many non-corporate taxpayers to adopt the rigorous documentation and geographic sourcing practices historically required only of multi-state corporations.

Kansas explicitly aligns its definition of eligible research expenditures with the federal Internal Revenue Code (IRC) of 1986, as amended.1 This means that expenditures must qualify as expenses allowable for deduction under the provisions of IRC Section 41, covering wages paid for performing, supervising, or directly supporting qualified research; costs of supplies consumed in the research process; and 65% of payments for qualified contract research services.6

The credit is calculated based on an incremental formula. The credit amount is equal to 10% of the difference by which the actual expenditures for research and development activities in the current taxable year exceed the taxpayer’s average of actual expenditures for the current year and the two immediately preceding taxable years.1 This structure, based on a three-year moving average, ensures that the incentive rewards increasing levels of in-state research investment. Crucially, the base calculation must identify and utilize only those QREs that were Kansas-specific and apportioned to the state for the current year and the prior two tax years.6

B. Credit Limitation, Carryforward, and Transferability

Kansas law imposes specific rules governing the utilization of the generated credit. In any one taxable year, the amount of the credit that may be deducted from the taxpayer’s tax liability is limited to 25% of the total generated credit amount, plus any applicable carryforward from prior years.1 This limitation governs the pace at which the credit can be utilized. Any unused portion of the credit resulting from this annual cap may be carried forward indefinitely in 25% increments until the total amount of the credit is entirely used.6

A major structural change introduced for tax year 2023 and thereafter is the transferability feature.1 Taxpayers without a current Kansas income tax liability are permitted to transfer the income tax credit to any other person.1 The key restrictions on this feature are that only the full credit may be transferred, it can only be transferred once, and only the entity that originally earned the credit is allowed to initiate the transfer.4 This provision significantly enhances the economic value of the credit for startup companies or other entities that incur substantial QREs but lack the necessary taxable income to immediately utilize the tax benefit.

The introduction of transferability carries a profound implication for state compliance and risk management. When a credit can be sold to a third-party transferee, the state must ensure the initial certification of that credit is sound and defensible. An invalid credit, once sold, creates financial damage for the transferee who relied on the credit certificate for liability offset, and opens the door for costly recovery procedures by the state. This financial risk explains why the state now mandates pre-approval via Form K-204.4 The requirement for pre-approval serves as a compliance gate, compelling strict adherence to the geographic sourcing rules to safeguard the integrity of the transferable credit.

II. The Geographic Imperative: Interpretation of “Research Conducted Within This State”

A. Statutory Meaning and Non-Conformity

The core requirement defining eligibility is the mandate that expenditures must be for R&D activities “conducted within this state”.1 This phrase establishes an explicit geographic nexus test for the R&D credit that differs fundamentally from general income tax nexus rules. It dictates that every claimed QRE must be factually traced to physical R&D activities occurring inside Kansas borders.

For multi-state businesses, this requirement prevents the common practice of simply taking the total Qualified Research Expenses calculated for federal purposes (e.g., from federal Form 6765) and multiplying that figure by the general Kansas corporate income tax apportionment factor.6 The Kansas R&D credit demands a specific, dollar-for-dollar disaggregation of QREs based solely on where the activity occurred. Tax professionals must recognize that the Kansas state R&D credit operates distinctly from both the federal credit and R&D credits offered by other states.8

B. Distinguishing QRE Sourcing from General Income Apportionment

Multi-state corporations typically determine their Kansas taxable income using an equally weighted three-factor apportionment formula: Property, Payroll, and Sales.9 This mechanism (K.S.A. 79-3279) is designed to fairly allocate business income to Kansas.11

However, the R&D credit calculation establishes a separate and specific methodology that does not rely on these general apportionment factors. A company might have a high overall Kansas payroll factor for general income tax purposes, perhaps due to a large Kansas-based administrative or sales workforce (K.S.A. 79-3283).12 If the company’s dedicated scientific research team is physically located in a laboratory outside of Kansas, zero R&D QRE wages would be eligible for the R&D credit, notwithstanding the high general payroll factor. The R&D credit is activity-specific, meaning the economic measure (the QRE) must be physically tied to the location of the performance of the qualified research. This mandates a detailed, auditable linkage between the expense and the physical location of the research activity, rather than reliance on a composite, averaging factor.6

C. KDOR Administrative Guidance on Geographic Scope

The KDOR’s administrative requirements reinforce the need for precise geographic sourcing. While detailed interpretive regulations on the sourcing of multi-state R&D activities are not extensively published, the instructions for Schedule K-53 (the form used to claim the credit) explicitly require the taxpayer to enter “expenditures for activities conducted within Kansas”.13 This instruction confirms the necessity of a physical location test.

This simple statutory requirement—”conducted within this state”—translates into a substantial audit risk. Taxpayers must rely on factual, verifiable proof of physical performance. The primary point of contention during a state R&D tax audit often revolves around tracing the QRE dollar to verifiable evidence of location, such as time logs, lab reports, or shipping manifests for supplies consumed in Kansas. The absence of comprehensive, specific KDOR regulations defining how to handle fractional research time spent both inside and outside the state compels conservative taxpayers to either use a robust time allocation model or adhere strictly to the 100% sourcing rules for compensation (discussed in Section III) where applicable.

III. Methodological Deep Dive: Sourcing Qualified Research Expenditures (QREs) to Kansas

For multi-state taxpayers, accurately sourcing QREs involves segmenting the three primary categories of eligible expenditures: wages, supplies, and contract research.

A. Sourcing Qualified Research Wages (The Highest Risk Component)

R&D wages typically represent the largest component of QREs and pose the greatest challenge for geographic sourcing in multi-state operations. The physical location of the R&D activity is generally determined by applying the Kansas payroll sourcing rules, which define when compensation is “paid in this state.” These rules are outlined in K.S.A. 79-3283 and detailed in K.S.A. 79-4301.2

Compensation for R&D employees is sourced to Kansas if any of the following statutory tests derived from K.S.A. 79-4301 are satisfied 2:

1. The Entire Service Test: The individual’s qualified R&D service is performed entirely within Kansas.
2. The Incidental Service Test: The R&D service is performed both within and without the state, but the service performed outside Kansas is incidental to the primary service within Kansas (e.g., minor travel or temporary visits).
3. The Base of Operations/Direction or Control Test: Some service is performed in Kansas and the employee’s base of operations, or if there is no base of operations, the place from which the service is directed or controlled, is located in Kansas.

For R&D personnel, the “base of operations” is typically the permanent R&D facility or laboratory where the majority of the work is conducted. If an R&D manager resides in a border state but is assigned to and works predominantly from the Kansas facility, their wages may be sourced entirely to Kansas for payroll factor purposes.

However, a technical tension exists between the general payroll sourcing rule (K.S.A. 79-4301), which might source 100% of an employee’s wages to Kansas based on administrative control (Base of Operations), and the R&D credit’s specific mandate that the expenditure be for research “conducted within this state.” If an employee’s base of operations is in Kansas, but they spend 50% of their actual research time at a non-Kansas facility, a conservative and auditable methodology for the credit requires limiting the QRE claim to only the 50% of wages correlating to the physical activity in Kansas. This application demonstrates that the R&D credit’s activity-specific requirement serves as the controlling standard, overriding the general tax allocation rules when establishing the geographic eligibility of the expense.

The following table summarizes the key Kansas sourcing criteria applied to R&D employee wages:

Kansas Sourcing Rules for Qualified Research Wages (K.S.A. 79-4301)

B. Sourcing Qualified Supplies and Leases

The sourcing of qualified supplies (materials and prototypes) is determined by the location where they are physically consumed or used in the performance of qualified research.6 This is known as the consumption/use test. Taxpayers must maintain detailed documentation, such as purchase orders and inventory logs, which demonstrate that the supplies were delivered to and utilized by the Kansas R&D facility.14

Similarly, costs related to computer rentals or equipment leases that qualify as QREs must be sourced to the physical location where the equipment is situated and used directly in the qualified research activities within Kansas.6

C. Sourcing Contract Research Expenses (65% Inclusion)

If a taxpayer pays an unaffiliated third party to conduct qualified research, 65% of those payments qualify as a QRE.6 For the Kansas credit, however, these contract research expenses are only eligible if the research activity performed by the contractor is physically conducted within Kansas. The location of the paying taxpayer’s headquarters or the contractor’s billing office is irrelevant; the critical determinant is the physical site of the research performance. For example, 65% of a payment made to a contract research organization (CRO) for work performed in a Kansas lab would qualify as a Kansas QRE.6

IV. KDOR Compliance, Certification, and Claim Procedures

The Kansas Department of Revenue requires a specific, multi-step process for claiming the R&D credit, which has become more stringent since the credit’s expansion and introduction of transferability in 2023.

A. Mandatory Pre-Approval: Form K-204 (Research and Development Credit Application)

For tax years beginning after 2022, taxpayers must submit Form K-204, the Research and Development Credit Application, to the KDOR for certification prior to claiming the credit on their return.4 This is a fundamental procedural shift, transforming the process into a pre-approval system.5

Form K-204 serves as a critical pre-audit function. It allows the state to review and certify the computation of the credit, specifically validating the taxpayer’s methodology for sourcing and calculating the Kansas QREs, before the credit is monetized either through offset or transfer.5 The application requires the taxpayer to detail the types of expenditures claimed (wages, supplies, contract research) and the computation used to arrive at the total credit amount.5 The form also mandates that the taxpayer specify any shareholders, partners, or members to whom the credit will flow through. Upon successful review, the state issues a tax credit certificate number, which is necessary for claiming the credit on the tax return.5

The mandated K-204 pre-approval process establishes a high-stakes compliance environment. The certification process verifies the data used in Part A of Schedule K-53, creating a closed compliance loop. Since the credit can be transferred to an unrelated third party (K-260), the KDOR must ensure the underlying QREs are correctly sourced to Kansas. This procedural complexity underscores the state’s intent to mitigate the financial risk associated with transferable credits by validating geographic compliance at the earliest possible stage.

B. Claiming the Credit: Schedule K-53 (Computation and Claim)

Once certified via Form K-204, the credit is formally claimed using Schedule K-53, which must be submitted with the taxpayer’s income tax return.6

Schedule K-53 requires the taxpayer to perform the statutory calculation in detail:

• Line 1: Requires the entry of the meticulously Kansas-sourced QREs for the current tax year.13
• Lines 2a and 2b: Require the Kansas-sourced QREs for the two preceding tax years, which establish the historical baseline.13
• Line 4 (Average Expenditures): The three-year total is divided by three to determine the base amount.13
• Line 5 (Excess Expenditures): The base is subtracted from the current year’s QREs.13
• Line 6 (Total Credit): The excess expenditures are multiplied by the 10% rate.13
• Line 7 (Maximum Allowable Credit): The total generated credit is multiplied by 25%, representing the maximum amount claimable in the current year.13

C. Transferring the Credit: Form K-260 (Notification)

For taxpayers electing to transfer their certified credit, the process involves Form K-260, the Kansas Tax Credit Transfer Notification Form.4 This process is only available to the entity that earned the credit and must be utilized if the taxpayer has no current tax liability.1

If the credit is transferred, the transferor stops completion of K-53 at Line 7 and provides the completed Part A to the transferee.13 The transferee, after notification via K-260, claims the credit against their Kansas income tax liability in the tax year it was transferred. Any unused portion of the credit claimed by the transferee may be carried forward, subject to the annual 25% limitation established when the credit was originally earned.7

V. Practical Case Study: Calculating the Kansas R&D Credit for a Multi-State Manufacturer

This case study illustrates the necessity of specific geographic sourcing for R&D expenditures in a multi-state scenario, demonstrating the application of K.S.A. 79-4301 to QRE wages.

A. Scenario Setup: Innovative Solutions Inc. (ISI)

Profile: Innovative Solutions Inc. (ISI) is a manufacturing company with R&D operations located in both Kansas (Wichita HQ and primary R&D Lab) and a satellite facility in Oklahoma. ISI files a combined Kansas tax return and has sufficient Kansas taxable income to utilize the credit.

QRE Data Summary (Federal Total):

Personnel Sourcing Challenge: ISI employs two R&D personnel crucial to its claim:

1. Engineer A: Works 100% of their time physically in the Wichita R&D Lab. Salary is $150,000.
2. Engineer B: Is directed and controlled from the Wichita HQ (Base of Operations in KS), but commutes regularly, spending 40% of their time conducting specialized testing at the Oklahoma satellite lab and 60% of their time at the Wichita lab. Salary is $150,000.
3. Support Staff: $600,000 in wages, all based and working in the Wichita facility.

B. Step-by-Step Determination of Kansas-Apportioned QREs

The total QRE calculation must be disaggregated and sourced specifically to Kansas activity.

1. Wages Sourcing Analysis (K.S.A. 79-4301 Application)

The analysis applies the most rigorous standard of physical activity, prioritizing “conducted within this state” over the administrative sourcing rules for maximum audit defensibility.

• Engineer A & Support Staff: These employees satisfy the Entire Service Test.2

• Kansas QRE Wages: $150,000 + $600,000 = $750,000.

• Engineer B (Hybrid): While K.S.A. 79-4301 might source 100% of the wage to Kansas because the base of operations/direction is in Wichita, claiming 100% would be highly susceptible to audit, as 40% of the activity was performed out-of-state. To satisfy the credit’s geographic mandate, the claim is limited to the physical activity in Kansas.

• $150,000 wage $\times$ 60% physical time in KS = $90,000 Kansas QRE wage.

• Total Kansas QRE Wages: $750,000 + $90,000 = $840,000.

2. Supplies and Contract Research Sourcing

• Supplies: ISI’s records show $100,000 of supplies were consumed directly in the Wichita lab, and $50,000 were consumed in Oklahoma.

• Kansas QRE Supplies: $100,000.

• Contract Research: ISI paid $50,000 to a lab in Topeka (KS) and $50,000 to a lab in Dallas (TX). Only the activity performed in Kansas qualifies, multiplied by the 65% statutory rate.

• Kansas QRE Contract Research (65%): $\$50,000 \times 0.65 = \$32,500.$

• Total Current Year Kansas QREs (K-53 Line 1): $\$840,000 \text{ (Wages)} + \$100,000 \text{ (Supplies)} + \$32,500 \text{ (Contract)} = \$972,500.$

C. Calculation of the Eligible Excess and the Final Credit Amount

The Kansas-sourced QREs must be tracked over the three-year period to determine the base amount.

Historical Kansas-Sourced QRE Data:

• TY 2023 (Y-1): $750,000
• TY 2022 (Y-2): $650,000

Calculation of Kansas R&D Tax Credit (Tax Year 2024)

Utilization and Carryforward:

ISI generates a total credit of $\$18,167$ for TY 2024. The maximum amount claimable in 2024 is $\$4,542$ (25% of the total credit). The unused portion of $\$13,625$ $(\$18,167 – \$4,542)$ is carried forward indefinitely in 25% increments until fully utilized.1

VI. Strategic Recommendations and Conclusion

The Kansas R&D tax credit offers a significant incentive, especially following the 2023 expansion of the rate and eligibility. However, the restrictive geographic mandate—”conducted within this state”—requires a level of documentation and expense segregation far more detailed than that required for federal or general state income tax compliance.

A. Best Practices for Documentation and Audit Defense

To minimize audit risk, especially for multi-state or hybrid R&D operations, the following best practices are essential:

1. Contemporaneous Location Tracking: Taxpayers must maintain documentation created at the time the R&D activity is performed that verifies the physical location of the work.14 This includes detailed time logs for R&D employees, specifically noting hours spent inside and outside Kansas. Relying solely on year-end estimations or projections is highly discouraged.
2. Segregation and Apportionment Methodology: Accounting systems must be robust enough to clearly segregate federally qualified expenses into Kansas-sourced and out-of-state categories for all three QRE elements (wages, supplies, and contract research).6 Taxpayers must be prepared to articulate the exact methodology used to apportion the QREs for hybrid employees, demonstrating why the allocation is appropriate under the “conducted within this state” rule, even if it deviates from a simplistic K.S.A. 79-4301 (Base of Operations) outcome.
3. Formal R&D Policy for Multi-State Workers: Establishing clear, written policies regarding the base of operations, reporting structures, and official work location assignments for hybrid R&D employees helps to support the application of K.S.A. 79-4301 and provides evidence of managerial direction that aligns with the claimed QREs.

B. Strategic Considerations for Optimizing Kansas R&D Claims

The procedural changes introduced in 2023 require taxpayers to integrate compliance early into their planning cycle:

1. Early Certification via K-204: Given the mandatory nature of the pre-approval process, taxpayers should submit Form K-204 early in the tax filing process. This proactive approach allows the KDOR time to review the geographic sourcing methodology and computation before the income tax return filing deadline, ensuring the credit certificate is secured and valid.5
2. Leveraging Transferability for Liquidity: For businesses with high QREs but minimal current tax liability, the transferability feature is a powerful tool for monetization.1 These taxpayers should prioritize the meticulous documentation and certification process (K-204) necessary to prepare the credit for a transfer (K-260). A well-documented, certified credit is highly liquid and maximizes the return on R&D investment.
3. Strategic R&D Placement: Companies undertaking research and development should recognize that the R&D credit is strictly a location-based incentive. Strategically concentrating high-cost QRE activities, such as core scientific research and highly paid R&D personnel, physically within Kansas borders is the most direct method to maximize the Kansas-sourced QRE total and, consequently, the state tax credit generated.

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