The 5% Credit Percentage in Kentucky R&D Tax Policy: Analysis of the Qualified Research Facility Tax Credit

The 5% credit percentage represents the immediate dollar-for-dollar reduction in Kentucky tax liability derived from capital investments in research infrastructure. This rate is applied directly to all eligible costs for constructing, remodeling, expanding, or equipping a qualified research facility located within the Commonwealth.1

The Kentucky Qualified Research Facility Tax Credit (QRFTC), authorized under Kentucky Revised Statute (KRS) 141.395, provides a fixed incentive for companies committing to long-term technological development within the state.2 This structure differs fundamentally from the federal R&D tax credit (IRC § 41), which typically addresses operational costs like wages and supplies.1 The Kentucky credit is nonrefundable, meaning it can only offset existing tax liability, but any unused portion provides sustained value through a generous ten-year carryforward period.1

Statutory and Contextual Framework: KRS 141.395 and Legislative Intent

The primary legislative objective behind KRS 141.395 is to incentivize the physical investment in infrastructure essential for technological advancement, fostering long-term economic stability and technological growth within Kentucky.1

The credit authority is explicitly detailed in KRS 141.395, which permits a nonrefundable credit against two primary Kentucky tax liabilities: the Individual Income Tax (KRS 141.020) or Corporate Income Tax (KRS 141.040), and the Limited Liability Entity Tax (LLET, KRS 141.0401).3 This applicability against both income and gross receipts-based taxes (LLET) broadens the utility for various entity types operating in Kentucky. The credit is permitted for the construction of research facilities, and any amount not utilized in the year the facility is placed in service may be carried forward for ten years.1 This carryforward provision is vital, particularly for significant capital expenditures, where the 5% credit amount generated often exceeds the current year’s tax liability, allowing the benefit to be realized over an extended period.1

Detailed Analysis of the 5% Calculation Base

The calculation of the credit is governed by KRS 141.395(3), which specifies that the credit shall equal five percent (5%) of the qualified costs of construction of research facilities.3 The simplicity of this flat 5% application rate, coupled with the generous base definition, makes the Kentucky QRFTC a highly attractive incentive for capital projects.

Defining “Construction of Research Facilities”

The application of the 5% rate is highly dependent on accurately identifying the qualified costs that constitute the base. “Construction of research facilities” covers constructing, remodeling, and equipping facilities physically located in Kentucky or expanding existing facilities in Kentucky for qualified research.1

Tangible, Depreciable Property Requirement

The most crucial constraint on the 5% base is that costs must only include expenditures for tangible, depreciable property.4 This encompasses capitalized investments such as the building itself, structural improvements, and the machinery and equipment utilized directly in the qualified research function.1 To generate the credit, the qualified property must be placed in service in Kentucky.1 The definition of “qualified research” aligns with the federal standard set forth in Section 41 of the Internal Revenue Code (IRC § 41).3

Explicit Exclusions

The Kentucky statute specifically excludes amounts paid or incurred for replacement property from the 5% calculation base.3 This legislative precision ensures that the incentive is designed to reward net new growth, expansion of capacity, and technological modernization within the Commonwealth, rather than subsidizing routine capital maintenance or the simple cycling of existing assets. Costs related to operational R&D activities—which include labor, supplies, contract research, and computer rentals—are also strictly excluded, as the credit is focused solely on the facility infrastructure.1

Strategic Advantage: Absence of a Complex Base Amount

A significant strategic advantage of the Kentucky 5% calculation, particularly for companies familiar with federal tax compliance, is the elimination of the complex base amount calculation. The federal R&D tax credit calculation (traditional method) necessitates determining a fixed-base percentage by dividing historical Qualified Research Expenses (QREs) by gross receipts over a base period, and then calculating a minimum base amount (typically 50% of the current year’s QREs or a fixed-base percentage multiplied by average receipts).6

Kentucky, by contrast, requires no prior year averaging or fixed-base percentage.1 This simplified structure means that all eligible current-year costs for the research facility construction and equipping qualify fully for the 5% credit, irrespective of whether the spending represents an incremental increase over previous years.1 This direct calculation simplifies forecasting and modeling the financial impact of large capital projects.

Table 1: Qualified vs. Non-Qualified Expenditures for the 5% Base (KRS 141.395)

Claiming the Credit: Kentucky Department of Revenue (DOR) Guidance and Forms

Compliance with the Kentucky Department of Revenue (DOR) mandates strict adherence to filing specific schedules and maintaining meticulous documentation to substantiate the base calculation and tracking the utilization of the 5% credit.4

Schedule QR: Substantiating the 5% Calculation

The primary compliance document for the credit is the Schedule QR, Qualified Research Facility Tax Credit.4 This schedule must be filed with the income tax return (or LLET return) in the year the construction/equipping project is completed.4 The Schedule QR serves not only to determine the initial credit amount but also to track the credit balance for the duration of the carryforward period. A copy of the Schedule QR must be attached to the tax return each year the credit is claimed until the full balance is utilized or the ten-year carryforward expires.4

To substantiate the calculation of the 5% credit base, the taxpayer must include a mandatory supporting schedule.4 This schedule must meticulously list all tangible, depreciable property that comprises the qualified costs, detailing the date purchased, the date placed in service, a description of the asset, and its associated cost.4 Given the simplicity of the 5% rate, the primary focus of DOR compliance review is the verification of these underlying capital expenditures. Poor segregation of qualified facility costs from general corporate capital expenditures poses the greatest risk of audit adjustments. Furthermore, a separate Schedule QR must be filed for each new project that qualifies for the credit.4

Claiming Forms Hierarchy

Once the credit is calculated and documented on Schedule QR, the claiming process depends on the entity structure:

• Business Entities (Corporations and Pass-Through Entities): These entities utilize Schedule TCS (Tax Credit Summary) to enter the amount of the research facility credit claimed against their LLET or income tax liability.4
• Individuals: Individuals, including sole proprietors claiming the credit on Schedule C of their federal Form 1040, or those receiving flow-through credits from pass-through entities, use Schedule ITC (Individual Tax Credit Summary).4

For all claimants, either Schedule TCS or Schedule ITC must be accompanied by a copy of the foundational Schedule QR attached to the return.4

Pass-Through Entity (PTE) Rules

The credit is fully accessible to pass-through entities (PTEs) such as partnerships, S-Corporations, and LLCs.4 When a PTE incurs qualified costs, the resultant 5% credit is generated at the entity level and then passed through to the partners, members, or shareholders (PTE owners).4 This flow-through amount is reported on the Kentucky Schedule K-1, allowing the owners to apply their proportionate share of the credit against their individual income tax or corporate income tax and LLET liability.4 Special rules apply to married couples; if both spouses constructed the facility and file separately, the credit must be split, though it may be claimed wholly by the listed spouse if only one name appears on the application.4

Application Against Kentucky Tax Liabilities and Credit Ordering

Taxes Affected and Nonrefundable Nature

The Qualified Research Facility Tax Credit is specifically designated as a nonrefundable credit.1 This dictates that it can only offset an existing tax liability imposed by KRS 141.020, 141.040, or 141.0401; it cannot generate a cash refund.1 The credit’s sustained value is derived from its provision allowing any unused portion to be carried forward for ten years.1

Navigating Statutory Credit Ordering (KRS 141.0205)

The ultimate realization of the 5% credit’s value in the current tax year is strictly governed by the mandatory application sequence outlined in KRS 141.0205.8 This statute dictates the order in which all nonrefundable business incentive credits must be applied against the tax liability.

The Research Facilities Credit (KRS 141.395) is listed relatively late in the sequence, specifically as item (j).8 This ranking has significant implications for cash flow planning. Credits with higher statutory priority, such as the Limited Liability Entity Tax (LLET) credit (a), which offsets income tax 8, and numerous economic development credits (b), which often account for substantial amounts 8, must be applied first.

For taxpayers benefiting substantially from higher-ranked incentives, the tax base may be significantly depleted before the 5% research facility credit is reached. This mandatory deferral means that for capital-intensive projects, a large fraction of the generated 5% credit will be carried forward for future utilization, often relying heavily on the 10-year carryforward period.1

Furthermore, when the credit is applied against the LLET, there is a hard floor: the liability cannot be reduced below the statutory minimum tax of $175.1 Because the utilization of the 5% credit is often deferred due to its low priority ranking, financial modeling should account for the delay in cash realization, which necessitates applying a suitable discount rate when evaluating the Net Present Value (NPV) of the long-term tax benefit stream.

Table 2: Priority Ranking of Key Kentucky Nonrefundable Business Incentive Credits (KRS 141.0205 Excerpt)

Case Study and Calculation Example

To illustrate the fixed rate and the application constraints, consider a corporation undertaking a substantial capital project.

A. Scenario Setup and Credit Generation

Assume a corporation, Advanced Manufacturing KY Inc. (AMKY Inc.), places a new research expansion facility, consisting of building improvements and equipment, in service in 2025.

• Qualified Facility Costs (QFC, Tangible Depreciable Property): $4,000,000
• Calculation of Total Qualified Credit (5%):
  
  $$\text{Total Credit} = \$4,000,000 \times 0.05 = \$200,000$$
• Total Qualified Credit Generated: $200,000.1

AMKY Inc.’s projected Kentucky tax liabilities and existing higher-priority credits for FY 2025 (before applying the Rank (j) credit) are:

• Gross LLET Liability: $40,000
• Corporate Income Tax Liability: $100,000
• Higher Priority Credits Utilized (Rank (a) through (i)): $5,000

B. Step-by-Step Application and Carryforward Determination

The $200,000 credit is applied in the statutory order against the tax liabilities.

1. LLET Liability Application:
   The $5,000 in higher-priority credits is applied first, reducing LLET to $35,000.
   The maximum application of the 5% credit against the LLET is the remaining liability minus the mandatory $175 minimum tax.1
   $$\text{LLET Offset} = \$35,000 – \$175 = \$34,825$$

• 5% Credit Utilized Against LLET: $34,825.

1. Credit Remaining for Income Tax Offset:
   The remaining credit balance is calculated by subtracting the LLET utilization.
   
   $$\text{Remaining Credit} = \$200,000 – \$34,825 = \$165,175$$
2. Income Tax Liability Application:
   The remaining credit ($165,175) is applied against the Corporate Income Tax Liability ($100,000).

• 5% Credit Utilized Against Income Tax: $100,000.

1. Unused Credit and Carryforward:
   The final unused portion is determined:
   
   $$\text{Unused Credit} = \$165,175 – \$100,000 = \$65,175$$

• Unused Credit Carried Forward: $65,175. This amount is available for up to 10 subsequent years.1

Table 3: Summary of Credit Calculation and Year 1 Application for Advanced Manufacturing KY Inc.

Conclusion and Strategic Recommendations

The Kentucky Qualified Research Facility Tax Credit (KRS 141.395) offers a strong, predictable financial incentive for capital expenditures in research infrastructure. The 5% rate is applied directly to the qualified capital base, providing a straightforward calculation for companies planning major investments.

For strategic planning, key compliance and utilization factors must be managed:

1. Restrict the Base: Strict adherence to the statutory definition of “Construction of research facilities” is non-negotiable. Only tangible, depreciable property physically placed in service in Kentucky qualifies for the 5% rate. Operational costs and replacement property must be rigorously excluded from the calculation base.1
2. Meticulous Documentation: Given the simplicity of the 5% rate, the rigor of DOR audit scrutiny will concentrate on the supporting documentation. Taxpayers must ensure internal accounting systems track and justify every asset included in the 5% base by maintaining the required schedules detailing purchase date, in-service date, description, and cost.4
3. Mandatory Credit Deferral: The application of the 5% credit is subjected to the statutory ordering sequence (KRS 141.0205), ranking it late (item (j)). Businesses must anticipate that large credits generated by significant capital investment will likely be deferred due to the precedence of higher-ranked economic development incentives, necessitating planning for the long-term realization of the benefit over the available 10-year carryforward period.8
4. Filing Requirements: Ongoing compliance requires filing Schedule QR upon completion of the project and attaching a copy of that schedule annually to the appropriate claiming form (Schedule TCS for businesses or Schedule ITC for individuals) for every year the credit is utilized.4

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