Expert Report: Navigating the Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

I. Executive Summary: The Kentucky Qualified Research Facility Credit

The Kentucky Research Facilities Credit (KRS 141.395) is a nonrefundable tax incentive allowing businesses to claim a five percent (5%) credit on costs associated with constructing, remodeling, or equipping facilities in Kentucky used for qualified research. This credit is applicable against both state income taxes and the Limited Liability Entity Tax (LLET), with any unused portion eligible for a ten-year carryforward period.

This facility-specific credit is a capital expenditure incentive designed to foster new and expanded R&D infrastructure within the Commonwealth, explicitly distinguishing itself from state tax relief on operational research expenses like wages and supplies. Successful utilization requires rigorous compliance with the Kentucky Department of Revenue (DOR) regarding tangible, depreciable property and adherence to state-mandated credit ordering rules. The tax benefit is generated once the tangible, depreciable property is placed in service in Kentucky.1

II. Foundational Statute: KRS 141.395 in Context

A. Legislative History and Core Statutory Parameters

The Qualified Research Facility Credit was originally established in 2002 (Ky. Acts ch. 230).3 Subsequent amendments in 2006 (1st Extra. Sess.) clarified its effective date, ensuring the credit applies to taxable years beginning on or after January 1, 2007.3 This statutory provision represents a targeted economic development effort by the Commonwealth to incentivize long-term, fixed infrastructure investment rather than short-term operational activities.

1. Credit Rate and Nonrefundable Status

KRS 141.395 explicitly establishes the credit amount: it shall equal five percent (5%) of the qualified costs of construction of research facilities.3 This rate applies uniformly to all qualified projects, regardless of project size.

A crucial aspect of this credit is its status as nonrefundable.2 A nonrefundable credit is restricted to offsetting a taxpayer’s existing state tax liability. It cannot, under any circumstance, result in a cash refund to the taxpayer. This mandates that businesses engaging in substantial facility construction must project their future state tax liability to determine the real economic value and timing of the credit realization.

2. Generous Carryforward Provision

Recognizing that large capital expenditures can generate significant credits that exceed a single year’s tax liability, the statute includes a generous provision allowing any unused credit to be carried forward for ten (10) years.3 This extended carryforward period is a critical component of strategic tax planning, particularly for start-ups or companies with fluctuating taxable income, ensuring they have ample time to utilize the incentive before the expiration date.

B. The Critical Distinction: Capital Investment vs. Operational R&D QREs

Kentucky’s research incentive legislation, codified in KRS 141.395, is deliberately distinct from the federal R&D tax credit regime (IRC § 41).5 While the federal credit focuses primarily on qualified research expenses (QREs) related to operations—such as wages, supplies, and contract research 7—the Kentucky facility credit focuses exclusively on capital expenditures.2

The credit is fundamentally a facility-related investment incentive. It is restricted to costs associated with constructing, remodeling, expanding, or equipping research facilities.2 This specific focus means that typical operational R&D costs—such as employee salaries, raw materials, supplies, and contract research fees—are explicitly excluded from the KRS 141.395 credit base, even though the definition of “qualified research” within the facility must conform to IRC § 41.2

The timing of the credit generation is also linked to capital processes. The credit becomes available once the tangible, depreciable property is placed in service in Kentucky.1 This necessitates that corporate tax specialists engage early in the capital budgeting and construction timelines to accurately time the credit generation for optimal use in the corresponding tax year. Furthermore, the mandatory requirement to file a separate Schedule QR for each new qualifying project emphasizes the necessity of meticulously tracking construction milestones and placed-in-service dates across various phases of facility development.4

III. Definitional Requirements for Qualified Costs and Activities

Claiming the KRS 141.395 credit requires strict adherence to statutory definitions regarding both the type of property expense and the nature of the research activity conducted.

A. Statutory Definition of “Construction of Research Facilities”

KRS 141.395 places rigid boundaries around what constitutes a qualified cost.3

1. Mandatory Inclusions and Property Type

The definition of “Construction of research facilities” covers constructing, remodeling, and equipping facilities in Kentucky, or expanding existing facilities, provided these are used for qualified research.3 This includes expenditures for building new laboratory spaces or significant, structural renovations aimed at adapting spaces for R&D activities.2

Crucially, the qualified cost base includes only tangible, depreciable property.3 This limitation means that investments in land, non-depreciable improvements, or intangible assets are not eligible for the 5% credit. Eligible examples include specialized lab machinery, testing gear, and the cost of installing such equipment.2

2. Mandatory Exclusion: Replacement Property

The statute unequivocally dictates that qualified costs do not include any amounts paid or incurred for replacement property.3

The distinction between excluded replacement and included remodeling or equipping is a significant source of compliance complexity and potential audit exposure. Simple, routine asset swaps—such as replacing an old chiller unit with a new, equivalent one—are deemed non-qualifying replacements. To qualify, remodeling or equipping costs must demonstrate a clear intent to expand capacity or fundamentally alter the facility to support new or improved research activities, thus proving a net new or expansive investment rather than merely maintenance.2 Taxpayers must possess documentation illustrating that the capital outlay resulted in a demonstrable enhancement of the facility’s ability to conduct advanced technological research, thereby justifying the inclusion of the cost in the credit calculation.

B. Defining “Qualified Research” via Federal Standards

Kentucky minimizes the creation of unique state R&D definitions by explicitly linking its criteria to federal law.

1. Reference to IRC Section 41

For the purpose of KRS 141.395, “Qualified research” is defined as qualified research under Section 41 of the Internal Revenue Code.3

This conformity ensures that facility investments must support activities that meet the rigorous federal four-part test for qualified research: the activity must be technological in nature, involve technical uncertainty, be part of a process of experimentation, and be intended to develop a new or improved business component.5

2. The Hybrid Documentation Requirement

The reliance on IRC § 41 for the activity definition, while restricting the cost base to capital expenditures, creates a specialized compliance burden. To claim the state credit, taxpayers must produce robust documentation that satisfies two distinct legal requirements: first, the technical documentation proving the activities conducted within the facility meet the federal standards of “qualified research” (resolving technical uncertainty); and second, the detailed financial and asset documentation proving the costs are solely related to the construction of tangible, depreciable property within Kentucky.2 A failure to satisfy the underlying IRC § 41 technical requirement for the activities planned for the facility will invalidate the claim on the capital investment.

IV. Kentucky Department of Revenue (DOR) Compliance and Reporting

The administrative framework established by the Kentucky DOR is designed to track the nonrefundable credit over its long lifespan, imposing annual reporting obligations.

A. The Core Reporting Instrument: Schedule QR (Form 41A720QR)

The foundational document for both calculating the credit and reporting its ongoing utilization is the Schedule QR, Qualified Research Facility Tax Credit.4

1. Purpose and Attachment

This schedule is mandatory for determining the initial credit amount and recording the credit claimed each tax year against the income tax liability and the Limited Liability Entity Tax (LLET) liability.1 It must be attached to the relevant Kentucky income tax return, which may include Form 720 (Corporate), Form 740 (Individual), or Form 725 (LLET).8

2. Annual Requirement and Segmentation

The compliance burden extends across the life of the credit. A copy of the Schedule QR must be submitted each year the credit is claimed until the full credit amount is exhausted or the 10-year carryforward period expires.1

Furthermore, the DOR requires administrative segmentation: a separate Schedule QR must be filed each year that a new construction or expansion project qualifies. This protocol ensures that the utilization and carryforward timeline (the 10-year clock) are correctly tracked for credits generated in different years.4

B. Required Supporting Documentation and Utilization Schedules

To substantiate the credit calculation, taxpayers must include a supporting schedule with the initial filing that lists all eligible tangible, depreciable property. This list must specify the date purchased, the date placed in service, a clear description of the asset, and the corresponding cost.4

For the annual claim of the credit balance, utilization is claimed on ancillary schedules, requiring different forms based on the filing entity:

• Individuals claiming the credit must utilize Schedule ITC (Individual Income Tax Credits).4
• Corporations and Pass-Through Entities (PTEs) must utilize Schedule TCS (Tax Credit Summary).4

In all instances, the Schedule QR must accompany the appropriate tax return and Schedule ITC or TCS.4

C. Treatment of Pass-Through Entities and Spousal Claims

The credit can flow through organizational structures. A pass-through entity must report the partner’s, member’s, or shareholder’s pro rata share of the credit on a Kentucky Schedule K-1.10 The ultimate recipient then uses Schedule ITC or Schedule TCS, along with a copy of Schedule QR, to apply the credit to their individual return.4

For individual taxpayers who constructed a qualified facility, rules govern spousal claims. If both names are listed on the application, the credit can be claimed wholly if filing jointly, but must be split if filing separately. If only one spouse’s name is listed on the application, that listed spouse is entitled to claim the full credit.4

V. Strategic Application: Credit Ordering and Tax Liability Constraints

The mechanical application of the KRS 141.395 credit is governed by explicit statutory rules regarding credit priority and the distinct limitations of the LLET regime.

A. The Hierarchy of Credits (KRS 141.0205)

Kentucky law, specifically KRS 141.0205, dictates the mandatory sequence of application for multiple nonrefundable tax credits.3 This sequence is highly consequential for utilization planning.

1. Placement in the Order

The research facilities credit permitted by KRS 141.395 is applied relatively late in the statutory sequence of nonrefundable business incentive credits. It is listed as item (j) within the ordering statute.11 This means that numerous other economic development incentives, such as the LLET credit, various economic development credits (KRS 141.347, 141.400, etc.), and the recycling equipment credit (KRS 141.390), must be utilized first.11

2. Implication for Utilization Strategy

The late application priority means that taxpayers who hold significant amounts of other business incentive credits may find their Corporate Income Tax (CIT) or Individual Income Tax liability substantially reduced or fully absorbed before they even reach the facility credit. This frequently pushes the utilization of the KRS 141.395 credit into the carryforward period. Consequently, businesses investing heavily in R&D facilities must rely heavily on the generous 10-year carryforward provision, necessitating long-term tax liability forecasting to ensure the credit is not lost upon expiration.

B. Application Constraints Against Income Tax and LLET

The credit can be applied against the tax assessed by both the Income Tax (KRS 141.020/141.040) and the Limited Liability Entity Tax (LLET, KRS 141.0401).4 However, the Kentucky DOR imposes two strict constraints on this dual application.

1. Separate Tracking Mandate

The most critical constraint is that the credit must be calculated and tracked separately against each liability. The DOR explicitly warns that “any balance available for income tax cannot be used as a credit against the LLET nor can any balance available for the LLET be used as a credit against the income tax liability”.9

This mandate requires the taxpayer to allocate the total credit generated by the facility expenditure into two distinct pools: an Income Tax pool and an LLET pool. If the available credit against one tax (e.g., LLET) is exhausted, the remaining balance in that pool cannot be transferred to offset the other liability (Income Tax).

2. LLET Minimum Floor Constraint

The utilization of the credit against the LLET liability is severely limited. The LLET cannot be reduced below the statutory minimum threshold of $175.2

Since LLET is typically based on the greater of a calculated net income or gross receipts amount, and the liability is often significantly lower than the income tax liability, the LLET pool derived from the 5% facility credit will be quickly depleted. Due to the $175 minimum floor and the smaller LLET base, the vast majority of the facility credit must be designated for offsetting Corporate or Individual Income Tax liability.

VI. Case Study: Calculating and Utilizing the Research Facility Credit

This hypothetical example demonstrates the calculation, the required segmentation of the credit pools, and the impact of the nonrefundable constraint and the LLET floor.

A. Scenario Setup: Bluegrass BioTech Corp (Year 1)

Taxpayer: Bluegrass BioTech Corp (A standard C Corporation)

Project: Construction and equipping of a new, qualifying R&D facility in Kentucky. Placed in service on January 1, Year 1.

Total Qualified Facility Costs (Tangible, Depreciable): $10,000,000 (QRC Base)

Year 1 Financial Snapshot (Prior to KRS 141.395 Credit Application):

• Corporate Income Tax Liability (KRS 141.040): $120,000
• Limited Liability Entity Tax (LLET) Liability (KRS 141.0401): $60,000
• Higher Priority Credits Utilized (KRS 141.0205(a)-(i)): $25,000

B. Calculation of Initial Qualified Credit and Allocation

The initial credit is calculated at 5% of the qualified costs:

$$\text{Initial Credit} = \$10,000,000 \times 0.05 = \$500,000$$

This $500,000 must be allocated to two separate, non-transferable pools: the CIT Pool and the LLET Pool. For maximization purposes, the allocation should prioritize the liability constraints.

Available CIT Liability after Higher Priority Credits:

$$\$120,000 (\text{Gross CIT}) – \$25,000 (\text{Other Credits}) = \$95,000$$

Available LLET Liability (Before Minimum Floor):

$$\$60,000 (\text{Gross LLET}) – \$175 (\text{Minimum LLET}) = \$59,825$$

C. Strategic Application and Carryforward Tracking (Year 1)

The taxpayer opts to assign the minimum required credit to the LLET pool and the remainder to the CIT pool, anticipating better utilization against the higher CIT liability over the carryforward period.

1. LLET Pool Utilization

• The maximum LLET reduction allowed is $59,825.
• The credit claimed against LLET is limited to the available reduction: $59,825.
• Remaining LLET Liability: $175 (statutory minimum).
• $500,000 Total Credit – $59,825 Utilized = $440,175 Remaining Credit Pool.

2. Corporate Income Tax (CIT) Pool Utilization (KRS 141.395)

• The CIT liability available for this credit is $95,000.
• The credit claimed against CIT is limited to the available liability: $95,000.
• Remaining CIT Liability: $0.
• $440,175 Remaining Credit Pool – $95,000 Utilized = $345,175 Unused Credit Carryforward.

The utilization results for Year 1 are summarized below:

Qualified Research Facility Tax Credit Utilization (Year 1)

The balance of the unused credit, $345,175, begins its 10-year carryforward period. The taxpayer must submit a copy of Schedule QR annually for up to 10 subsequent years to document the ongoing utilization of this remaining balance against future income and LLET liabilities.1

VII. Broader Economic and Administrative Context

A. Economic Utilization and Policy Niche

Analysis of Kentucky’s tax expenditure data provides context for the scale and impact of KRS 141.395. The credit’s utilization is relatively small, indicating its highly specialized nature.

State taxpayer data projects that the total utilization of the Construction of Research Facilities Credit (KRS 141.395) will be approximately $1.1 million annually across fiscal years 2024, 2025, and 2026.13 This is broken down into $0.7 million applied against Corporate Income Tax and $0.4 million against LLET annually.13

This low utilization figure confirms that the facility credit is claimed by a limited number of enterprises that undertake extremely large, capital-intensive infrastructure projects within the Commonwealth, such as advanced manufacturing, biotech, or defense companies.6

B. Strategic Focus on Infrastructure

The restricted scope of KRS 141.395—focusing exclusively on depreciable infrastructure and facility investment, excluding operational costs like wages, supplies, or contract research—reinforces a policy goal centered on increasing Kentucky’s physical research capacity. For businesses primarily focused on intangible R&D (e.g., software development) or those incurring high personnel costs but low capital costs, this specific state incentive offers little to no benefit. These companies must seek their R&D relief through federal provisions.2

Recent legislative reviews of Kentucky’s tax policies, such as the effort to improve overall state tax competitiveness, highlight the Commonwealth’s progress in areas like reducing individual income taxes and broadening the sales tax base.14 However, the modest utilization of the research facility credit suggests that while the incentive exists to attract major capital projects, it does not broadly incentivize general R&D activity across the state economy.

VIII. Conclusion: Maximizing the Value of Kentucky’s Research Infrastructure Incentive

KRS 141.395 is an essential, though constrained, tax tool for businesses making significant capital investments in Kentucky-based research infrastructure. The 5% nonrefundable credit, coupled with the 10-year carryforward, represents a substantial deferred tax asset. Strategic realization of this credit, however, requires intricate compliance and disciplined financial modeling due to its structural limitations.

A. Key Compliance Constraints

1. Strict Capitalization Requirement: Only costs related to constructing, remodeling, equipping, or expanding facilities that qualify as tangible, depreciable property are eligible. Costs for routine replacements, wages, supplies, or land are excluded.2
2. Federal Alignment: All investment must support research that rigorously adheres to the definition of “qualified research” found in IRC Section 41. Comprehensive technical documentation is necessary to substantiate this requirement.3
3. Mandatory Credit Segregation: The total credit amount must be separately calculated and tracked against Income Tax and LLET liabilities, and balances cannot be transferred between the two pools.9

B. Recommendations for Strategic Planning

1. Integrated Project and Tax Timeline Management: Given that the credit is generated only when the tangible asset is placed in service, capital investment decisions and fixed asset management must be closely integrated with tax planning to optimize the timing of credit generation and filing of the corresponding, separate Schedule QR for each qualifying project.4
2. Long-Term Liability Modeling: The late priority of the credit within the KRS 141.0205 ordering structure means utilization against current income tax may be minimal, increasing reliance on the 10-year carryforward.11 Taxpayers must develop detailed 10-year projections of state tax liability and utilization of higher-priority credits to ensure the facility credit is fully applied before its expiration.
3. Sustained Administrative Compliance: The requirement to attach Schedule QR annually for up to a decade places a significant administrative burden on taxpayers. Robust, centralized record-keeping of the original qualified costs, placed-in-service dates, and annual utilization history is mandatory for compliance and successful audit defense.4

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