Analysis of KRS 141.040 (Corporation Income Tax) and the Kentucky Qualified Research Facility Tax Credit

I. Executive Summary: The Nexus of Kentucky Corporate Tax and R&D Incentives

Kentucky Revised Statute (KRS) 141.040 establishes the mandatory annual income tax for corporations conducting business within the state. The statute determines which corporate entities are taxable, specifies key statutory exemptions, and defines the rate applied to a corporation’s taxable net income.1

This report provides a detailed analysis of KRS 141.040 in the context of the Kentucky Qualified Research Facility Tax Credit (KRS 141.395). This specialized incentive provides a five percent (5%) nonrefundable credit against qualified capital costs incurred for the construction, remodeling, expansion, or equipping of fixed research facilities within the Commonwealth.2 For corporate taxpayers, successful utilization of this credit requires meticulous navigation of two primary tax liabilities—the Corporation Income Tax (CIT) imposed by KRS 141.040 and the Limited Liability Entity Tax (LLET) imposed by KRS 141.0401—along with adherence to a strict statutory credit ordering mechanism prescribed by KRS 141.0205.3

Key operational constraints derived from state law and Department of Revenue (DOR) guidance dictate complex compliance procedures. A primary constraint is the mandate that the credit utilization and carryforward must be tracked separately for the CIT and the LLET liability.4 Furthermore, the credit cannot reduce the LLET liability below the mandated $175 minimum.5 Finally, the Research Facilities Credit is positioned relatively low in the statutory hierarchy of nonrefundable business credits (item (j) under KRS 141.0205), meaning its immediate use is often deferred by higher-priority credits, regardless of the corporation’s overall profitability.7

II. Foundational Statute: KRS 141.040 – Corporation Income Tax

A. Statutory Mandate and Scope of Applicability

KRS 141.040(1) serves as the foundation for taxing corporations in Kentucky, dictating that every corporation engaged in business activities within the state must remit an annual tax.1 This taxable nexus is essential: if a corporation does not meet the “doing business” standard, it is not subject to the CIT liability against which the R&D credit may be applied. The ultimate tax base is the corporation’s taxable net income, which for multi-state entities, is determined through state apportionment formulas designed to calculate the portion of income earned in Kentucky.6 Administrative regulations, such as those related to 103 KAR 16:270, further detail the computation of the receipts factor used in this apportionment.8

B. Current Corporate Income Tax Rate and Taxable Net Income Calculation

Historically, Kentucky utilized a graduated corporate income tax rate structure, with rates climbing up to six percent (6%) on taxable net income exceeding $100,001.6 However, in recent years, the rate structure has undergone significant reform. For tax years beginning on or after January 1, 2018, the Kentucky Department of Revenue (DOR) implemented a statutory change that replaced the previous tiered structure with a flat tax rate of 5.0% on corporate taxable net income.9 This flat rate, referenced generally in KRS 141.040(1), became effective on April 14, 2018.1

This change to a predictable, flat rate simplifies the valuation of tax credits, including the R&D facility credit. Under a tiered system, the effective value of a tax credit would depend on whether the corporation’s income was taxed at a lower or higher marginal rate. The current 5.0% flat rate ensures that the dollar-for-dollar value of a generated R&D facility credit is consistent across all levels of profitability, provided the corporation maintains a sufficient tax liability under KRS 141.040 to utilize the credit. This structural certainty is critical for long-term tax planning involving the 10-year credit carryforward provision.

The current tax schedule for the corporate income tax liability subject to KRS 141.040 is summarized below:

Kentucky Corporation Income Tax Rate Structure (Post-2018)

C. Analysis of Statutory Exemptions (KRS 141.040(1))

KRS 141.040 provides explicit carve-outs for specific entities, exempting them from the corporate income tax.1 These exemptions include insurance companies, financial institutions (with specific caveats), savings and loan associations making loans only to members, banks for cooperatives, production credit associations, and corporations or other entities exempt under Section 501 of the Internal Revenue Code (IRC), such as religious, educational, or charitable organizations.1

The existence of these exemptions has a direct implication for the utilization of the R&D credit. If a corporation is statutorily exempt from the CIT imposed by KRS 141.040, it will not have a gross CIT liability against which to apply the R&D credit. While such an entity may still be subject to the Limited Liability Entity Tax (LLET) under KRS 141.0401—and thus potentially able to use the R&D credit against LLET—the largest potential benefit of the R&D credit (offsetting the 5.0% income tax) is lost, severely limiting the economic incentive for capital investment in research facilities.

III. The Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

A. Legislative Intent and Distinction from Federal R&D Incentives

The Kentucky Qualified Research Facility Tax Credit, codified in KRS 141.395, is designed as a nonrefundable incentive to promote the establishment of physical research infrastructure within the state.2 The statute provides a structural divergence from the typical federal R&D tax credit (IRC § 41), which primarily targets operating expenditures (OPEX) such as qualified wages, supplies, and contract research.12

In contrast, the Kentucky credit exclusively rewards capital investment (CAPEX) in fixed assets supporting research. The legislative focus on tangible, depreciable property signals a policy objective: securing long-term, fixed economic footprints within the Commonwealth. By limiting the incentive to facilities, Kentucky aims to encourage high-barrier-to-entry investments, thereby maximizing the likelihood of retaining high-tech industries. This legislative choice structurally favors large corporations undertaking significant, non-routine expansions or new entrants establishing a major presence, while often excluding mature Kentucky firms that focus on incremental research progress through personnel (QREs) rather than new facility construction.

B. Defining “Qualified Research Facilities” and Eligible Costs

The calculation for the credit centers on the cost of the qualified research facility. The statute defines “Construction of research facilities” as the act of constructing, remodeling, equipping, or expanding existing facilities in Kentucky specifically for the purpose of qualified research.2

The eligible costs are strictly limited to tangible, depreciable property.3 This provision explicitly excludes all intangible assets, certain indirect overhead costs, and land costs (as land is generally not depreciable). Furthermore, the statute explicitly bars the inclusion of amounts paid or incurred for replacement property.2 This exclusion reinforces the policy goal of stimulating new economic activity, ensuring that the credit is not merely utilized for routine maintenance, modernization, or cyclical equipment upgrades, but rather for genuine, material expansion or new construction.

C. Adopting the Federal Standard: “Qualified Research” as defined in IRC § 41

Although the eligible expenditures are strictly capital in nature, the activity conducted within the facility must meet specific technical standards. KRS 141.395 mandates that “qualified research” means qualified research as defined in Section 41 of the Internal Revenue Code.2

This linkage requires the taxpayer to demonstrate that the activity conducted in the facility meets the four-part test under IRC § 41, which involves activities related to physical science, biological science, engineering, or computer science, and involves a process of experimentation intended to resolve technological uncertainty regarding the function, performance, reliability, or quality of a new or improved business component.5 Thus, compliance requires not only documentation of capital costs but also technical studies confirming that the facility is utilized for activities that qualify under the stringent federal definition.

D. Calculation and Carryforward Provisions

The Qualified Research Facility Tax Credit equals five percent (5%) of the qualified costs of construction of research facilities.2

A critical compliance point is the timing of the credit generation. The credit is generated and available for use only once the tangible, depreciable property is placed in service in Kentucky, not when the expenditure is incurred.13 This requirement necessitates that the facility or equipment be operational and ready for its intended use in qualified research activities before the credit can be claimed on Schedule QR.3 This date also triggers the beginning of the carryforward period.

As the credit is nonrefundable, it can only offset a tax liability, not generate a cash refund.3 Any amount of credit generated but unused due to insufficient tax liability may be carried forward for ten (10) years.2 The predictability offered by the flat 5.0% CIT rate (KRS 141.040) is advantageous here, as it simplifies the modeling of this 10-year carryforward projection, allowing for a straightforward assessment of the value of the nonrefundable tax asset over the next decade.

IV. Interoperability with Kentucky Tax Regimes

A. Limited Liability Entity Tax (LLET) – KRS 141.0401

Corporations subject to the CIT under KRS 141.040 are also subject to the Limited Liability Entity Tax (LLET), codified in KRS 141.0401. LLET is a gross receipts tax applied at the entity level to both C corporations and pass-through entities.4 The tax base is generally calculated based on the lesser of Kentucky gross receipts or Kentucky gross profits, applying apportionment factors defined in KRS 141.120.17

The LLET uses variable rates, such as $0.095$ per $100 of Kentucky gross receipts (0.095%) or $0.75$ per $100 of Kentucky gross profits (0.75%).6 Crucially, the statute mandates a $175 minimum tax liability, which must be paid regardless of the calculation method or whether the entity qualifies for the small-business exemption.5

B. Application Against Both CIT and LLET: The Bifurcated Ledger Requirement

KRS 141.395(2) explicitly permits the Research Facilities Credit to be applied against both the CIT imposed by KRS 141.040 and the LLET imposed by KRS 141.0401.2 This dual-application capability is governed by specialized Department of Revenue guidance.

The instructions for Schedule QR, Qualified Research Facility Tax Credit, clarify that the credit amounts applied against CIT and LLET must be tracked and calculated separately.4 This constitutes a mandatory bifurcated ledger requirement. The administrative guidance explicitly states that any balance of credit available for income tax (CIT) cannot be used as a credit against the LLET, and likewise, any balance available for the LLET cannot be used as a credit against the income tax liability.4

Furthermore, the utilization of the credit against the LLET is constrained by the statutory minimum tax. The R&D facility credit may not reduce the LLET liability below the mandatory $175 floor.4

This separation critically affects the strategic value of the credit against the LLET base. Due to the high capital costs required to generate the credit (5% of millions of dollars) and the relatively low ceiling on the LLET liability (compared to the CIT liability), the LLET credit balance will almost invariably result in a substantial, slowly amortizing carryforward balance. For example, if a corporation generates a $210,000 credit but only has a $10,000 LLET liability, only $9,825 of the credit can be used immediately (offsetting the liability down to $175). The remaining $200,175 must be carried forward, potentially taking decades to fully utilize if LLET liabilities remain stable. Consequently, the primary economic benefit of the KRS 141.395 credit for a C corporation is overwhelmingly realized through the offset of its CIT liability under KRS 141.040.

V. Compliance and Kentucky Department of Revenue (DOR) Guidance

A. Filing Requirements: Schedule QR

To claim the Qualified Research Facility Tax Credit, taxpayers—including corporations, pass-through entities, and sole proprietors—must complete and file Schedule QR, Qualified Research Facility Tax Credit.3 For C corporations, this schedule is attached to the Kentucky Corporation Income Tax and LLET Return (Form 720).19

Schedule QR is the mechanism used both to determine the initial credit amount and to record the annual utilization and remaining balance. A copy of the Schedule QR must be submitted with the tax return each year the credit is claimed until the full credit amount is utilized or the 10-year carryforward period expires, whichever occurs first.3 If a taxpayer initiates a new qualified research facility project in a subsequent year, a separate Schedule QR must be completed for that project.3

B. Mandatory Supporting Documentation and Timing

DOR guidance emphasizes the necessity of detailed record-keeping. The taxpayer must include a supporting schedule listing all tangible, depreciable property comprising the qualified costs. This documentation must clearly delineate the date purchased, the description, the cost, and most critically, the date the property was placed in service.3

The date placed in service is the legal trigger for the credit’s availability and the commencement of the 10-year carryforward period.13 This requirement creates a potential compliance challenge, as it necessitates precise project management to ensure the date of operational readiness is clearly documented. Claiming the credit prematurely based solely on expenditure rather than the date placed in service risks immediate disallowance and associated penalties upon audit. The ability to utilize the credit to offset the liability under KRS 141.040 is therefore directly dependent on timely and accurate documentation of the facility’s operational status.

C. Administrative Regulations and Guidance Framework

Tax administrative law in Kentucky is centralized in the Kentucky Administrative Regulations (KAR), with Title 103, Chapter 16 specifically governing Income Tax for Corporations.20 Regulations within this chapter, such as 103 KAR 16:270, govern the technical computation of the tax base, specifically addressing apportionment and the receipts factor used for both KRS 141.040 and KRS 141.0401.8

For the Research Facility Tax Credit, the primary administrative guidance is issued directly by the Department of Revenue through publications and the instructions for Schedule QR.3 These documents provide the definitive interpretation of statutory requirements, including the strict adherence to the LLET minimum tax constraint and the absolute prohibition against transferring credit balances between the CIT and LLET ledgers.4

VI. Credit Ordering and Priority Analysis (KRS 141.0205)

A. Statutory Hierarchy of Nonrefundable Business Incentive Credits

The order in which tax credits must be applied against the tax liabilities imposed by KRS 141.040 and KRS 141.0401 is mandated by KRS 141.0205, which establishes the “Priority of application and use of tax credits”.3 This statute ensures a uniform methodology for utilizing credits and dictates which tax assets are consumed first.

B. The LLET Credit Precedence

The gross LLET liability calculated under KRS 141.0401 is allowed as a nonrefundable credit against the gross CIT liability calculated under KRS 141.040. This LLET credit is granted the highest priority among all nonrefundable business incentive credits, listed as item (a) under KRS 141.0205(1).7

The immediate application of the LLET credit against the CIT liability has a compounding effect on all lower-priority credits. By reducing the gross CIT liability first, the LLET credit shrinks the available pool of liability against which the subsequently ranked credits may be utilized.

C. Placement of the Research Facilities Credit

The Research Facilities Credit (KRS 141.395) is situated significantly lower in the statutory hierarchy, specifically at item (j) within KRS 141.0205(1).7 This positioning means that nine higher-priority categories of credits must be applied and fully utilized or exhausted before any portion of the R&D facility credit can be applied to the remaining net CIT liability.

These higher-priority credits include economic development credits (KRS 141.400, etc., item (b)), the qualified farming operation credit (item (c)), the certified rehabilitation credit (item (d)), and others.7 The low placement of the R&D credit implies a legislative preference, or secondary priority, for rewarding fixed research infrastructure investment compared to tax incentives associated with direct job creation or community redevelopment, which are generally categorized earlier in the statutory list. Consequently, corporations participating in multiple Kentucky incentive programs may find that the R&D facility credit is entirely deferred to the 10-year carryforward period, even if the corporation is highly profitable, because the CIT liability was consumed by higher-priority incentives. Effective tax planning for multi-incentive taxpayers must factor in this high likelihood of deferral.

VII. Financial Modeling and Practical Example

To illustrate the complex interaction between KRS 141.040, KRS 141.0401, and KRS 141.395, the following case study models the application of the Qualified Research Facility Tax Credit, adhering strictly to the DOR’s bifurcated tracking requirements and the credit ordering under KRS 141.0205.

A. Case Study Setup: Corporation X (Tax Year 202X)

Corporation X is a multi-state manufacturing firm subject to Kentucky income tax and LLET.

• Taxable Net Income (CIT Base): $5,000,000
• CIT Rate (KRS 141.040): 5.0% 9
• Kentucky Gross Receipts (LLET Base): $10,000,000
• LLET Rate (KRS 141.0401): 0.095% on gross receipts 9
• LLET Minimum Tax: $175 6
• Qualified Research Facility Cost (Tangible, Depreciable Property placed in service): $4,200,000 22
• Other High-Priority Credits (KRS 141.0205 (b)-(i)): $10,000

B. Credit Generation and Gross Tax Liabilities

1. R&D Credit Generated (KRS 141.395):
   
   $$\$4,200,000 \times 0.05 = \$210,000$$
2. Gross CIT Liability (KRS 141.040):
   
   $$\$5,000,000 \times 0.05 = \$250,000$$
3. Gross LLET Liability (KRS 141.0401):
   
   $$\$10,000,000 \times 0.00095 = \$9,500$$

C. Application of Credit and Carryforward Determination

The sequential application of credits is mandatory under KRS 141.0205 and the DOR guidance for Schedule QR.4

Table: Financial Application of the Research Facility Credit (KRS 141.395)

The example clearly demonstrates that while the entire $210,000 Research Facility Tax Credit was successfully utilized in Year 1 against the large CIT liability, a significant theoretical balance of the credit ($200,675) is functionally stranded in the LLET ledger (F). Because DOR guidance prohibits the transfer or commingling of these separate balances 4, this remaining LLET balance must be tracked separately for up to 10 years, and can only offset future LLET liability in excess of $175. This means that if Corporation X’s LLET liability remains at $9,500 annually, it will take over 21 years to fully amortize the $200,675 balance, far exceeding the statutory 10-year carryforward limit. Therefore, the strategic planning for the KRS 141.395 credit should focus almost exclusively on ensuring sufficient future CIT liability under KRS 141.040, recognizing that the LLET offset offers negligible long-term tax value beyond the first year.

VIII. Conclusion and Expert Recommendations for Optimal Utilization

A. Synthesis of KRS 141.040 and KRS 141.395

The Kentucky corporate tax framework integrates the broad imposition of the Corporation Income Tax (KRS 141.040) with targeted capital incentives (KRS 141.395). While the 5.0% flat CIT rate provides a stable environment for valuing the nonrefundable 5% R&D facility credit, the application mechanics are complex due to the co-existence of the LLET (KRS 141.0401) and the mandated credit ordering (KRS 141.0205). The strategic utility of the R&D credit hinges on generating sufficient net CIT liability after all higher-priority credits, including the LLET credit, have been applied.

B. Expert Recommendations for Compliance and Strategy

Based on the statutory framework and administrative guidance from the Department of Revenue, the following recommendations are critical for achieving full compliance and maximizing the financial benefit of the Qualified Research Facility Tax Credit:

1. Prioritize Documentation of “Placed in Service”: The taxpayer must establish a robust internal control system to ensure that the date the tangible, depreciable property is placed in service is accurately documented and aligns with the date the credit is first claimed on Schedule QR.3 This date legally triggers the credit generation and commences the 10-year expiration clock.
2. Strict Adherence to Credit Ordering: Tax teams must meticulously follow the hierarchy stipulated in KRS 141.0205. The gross LLET liability must first be converted into a credit and applied against the gross CIT liability (priority (a)). Subsequently, all other higher-ranked economic development and statutory credits (priority (b)-(i)) must be applied before the Research Facilities Credit (priority (j)) is utilized.7 Failure to adhere to this order risks the disallowance of credits applied out of sequence.
3. Mandatory Dual Ledger Tracking: Due to the explicit DOR guidance in the Schedule QR instructions, the taxpayer is required to maintain two legally separate 10-year carryforward schedules for the R&D credit: one for the CIT liability and one for the LLET liability.4 This tracking must rigorously prevent the commingling of balances and ensure that the credit balance allocated to the LLET ledger does not reduce the LLET payment below the $175 minimum.4 The low utilization rate against LLET means this ledger must be recognized as a low-value, long-term asset susceptible to expiration.
4. Audit Readiness and Technical Substantiation: Although the Kentucky credit rewards capital expenditure, the taxpayer must be prepared to provide detailed project documentation proving that the constructed facilities are used for activities that meet the technical definition of “Qualified Research” as defined in IRC § 41.2 This evidence is crucial for supporting the initial qualification of the capital expenditure upon audit by the Kentucky DOR.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/