The Kentucky Qualified Research Facility Tax Credit: A Capital Investment Incentive Under KRS 141.395

The Qualified Research Facility Tax Credit (QRFC) provides a 5% nonrefundable credit for businesses investing in new, expanded, remodeled, or equipped research infrastructure located in Kentucky.1 Codified under Kentucky Revised Statute (KRS) 141.395, the credit focuses purely on capital expenditures related to tangible, depreciable property used for qualified research activities, offering a guaranteed five percent return against state income and Limited Liability Entity Tax (LLET) liabilities.2

A detailed analysis of the Kentucky QRFC reveals that it fundamentally targets infrastructure development, strategically separating itself from traditional operational R&D tax credits, such as the federal incentive. This capital-focused approach, combined with a generous ten-year carryforward provision for unused credits, provides significant financial certainty and incentive for companies undertaking major, long-term investments in research infrastructure within the Commonwealth.1

Statutory and Contextual Framework of the QRFC

Legislative Intent and Enabling Statute: KRS 141.395

The QRFC was enacted by the Kentucky General Assembly to foster a climate conducive to technological advancement by reducing the cost of establishing or improving research facilities within the state. The legal authority resides primarily in KRS 141.395, which made the credit effective for tax years beginning on or after July 15, 2002.3

The mechanism of the credit is straightforward: it is nonrefundable and calculated as five percent (5%) of the qualified costs of constructing research facilities.5 This incentive is a versatile mechanism that can be applied to offset a taxpayer’s liability against the corporation income tax (KRS 141.040), the individual income tax (KRS 141.020), and the Limited Liability Entity Tax (LLET, KRS 141.0401).2 If the credit generated in a given year exceeds the tax liability, the unutilized portion does not result in a cash refund but must be carried forward. Taxpayers are afforded a substantial window, ten (10) subsequent taxable years, to utilize any unused credit amounts.1 This long carryforward period is essential for companies whose capital investments precede high taxable income years, ensuring the benefit is eventually realized.

The Critical Nexus to IRC Section 41: Defining “Qualified Research”

A mandatory requirement for claiming the Kentucky QRFC is that the activities conducted within the constructed or equipped facility must qualify as “qualified research” as defined in Internal Revenue Code (IRC) Section 41.4 Kentucky’s statutory adoption of this federal standard provides a crucial compliance benchmark. The state is effectively relying on the federal tax definition, which is supported by extensive regulatory guidance and case law, to determine the technical eligibility of the facility use.

This reliance means that the research activities must satisfy the rigorous four-part test established under IRC § 41.7 These requirements mandate that the activity be Technological in Nature (relying on principles of physical or biological science, engineering, or computer science), performed for a Permitted Purpose (seeking to improve a business component’s performance or quality), intended to Eliminate Uncertainty (seeking information to resolve technical unknowns), and involve a Process of Experimentation.7 The facility’s eligibility is therefore contingent on the tax quality of the research occurring within its walls, benefiting taxpayers who already adhere to stringent federal R&D documentation standards.

Core Mechanics of the Credit: Calculation Simplicity and Durability

The mechanism employed for the QRFC significantly enhances its value, particularly for large projects. The credit is calculated simply as 5% of the total qualified facility costs incurred in the taxable year.1

A distinguishing feature is the absence of a base amount requirement.1 Unlike many federal and state R&D credits that require complex calculations based on prior-year spending or fixed-base percentages, Kentucky allows 100% of the eligible capital costs incurred in the current year to qualify for the 5% credit.1 This structural simplicity significantly increases the immediate value and predictability of the incentive. For businesses planning multi-million dollar capital expansions, the assurance of a guaranteed 5% credit on the entirety of their qualified investment minimizes financial projection uncertainties and heavily favors large, capital-intensive infrastructure projects by accelerating the return on investment.

Defining and Documenting Qualified Facility Costs

The Scope of “Construction of Research Facilities”

The definition of “construction of research facilities” provided in Kentucky statute is comprehensive, covering major capital actions taken solely within the state. Qualified costs include constructing, remodeling, expanding, or equipping facilities for qualified research.1 To be eligible, all costs must be associated with facilities physically located in Kentucky; the credit is strictly Kentucky-sourced.1

The Capital Expenditure Requirement: Tangible and Depreciable Property

Eligibility is restricted to costs related to tangible, depreciable property.1 This requirement dictates that claimed expenditures must be capital investments subject to depreciation under federal tax rules.

Specific eligible examples of costs include site preparation and construction expenses for new research laboratories or centers.1 Remodeling costs qualify if they structurally adapt existing spaces specifically for technological research. Furthermore, the purchase and installation of fixed, depreciable equipment, such as laboratory machinery, specialized testing gear, or equipment used for pilot manufacturing and experimentation, are eligible expenditures under the “equipping” criterion.1 Linking the credit to capital assets provides a clear documentation path through the taxpayer’s fixed asset ledger.

Explicit Statutory Exclusions and Non-Qualified Expenditures

While promoting capital investment, the QRFC explicitly excludes certain types of expenditures, maintaining a clear line between facility investment and operational spending:

1. Replacement Property: The statute explicitly excludes amounts paid or incurred for “replacement property”.4 This limitation ensures that the credit is directed toward capacity expansion or new construction, not routine capital maintenance or asset turnover.
2. Operational Costs: The credit is not an operational incentive. Consequently, expenses that form the basis of the federal R&D credit are ineligible for the Kentucky facility credit. These non-qualified expenditures include employee wages, costs for supplies and raw materials, contract research, and general computer rentals.1

The structural divergence of the Kentucky QRFC from the federal QRE definition mandates that taxpayers pursuing both incentives maintain separate and distinct documentation streams. Taxpayers must carefully segregate expenditures into federal QREs (wages, supplies) and Kentucky QRF costs (depreciable capital assets) to minimize audit risk and maximize compliance efficiency.

Kentucky Department of Revenue (DOR) Guidance and Compliance Procedures

Eligibility of Taxpaying Entities

The DOR extends eligibility to a wide range of entities operating in the state.4

• Corporate Filers: Corporations may apply the credit against both their Corporation Income Tax and their LLET liabilities.1
• Pass-Through Entities (PTEs): This includes S-Corporations, Partnerships, LLCs, and Trusts. The credit is calculated at the entity level but flows through to the owners (partners, members, shareholders) proportionally via a Kentucky Schedule K-1.1
• Individual Filers: Sole proprietors reporting business income on federal Schedule C can claim the credit directly. Individuals who constructed a qualified facility and filed the necessary application are also eligible. For married couples, special rules govern the claim: if both spouses are listed on the application, they may claim the credit wholly if filing jointly, but must split it if filing separately. If only one spouse is listed, that individual is entitled to the full credit.4

The flexibility to offset LLET is a significant strategic consideration. Since LLET exposure is determined by metrics like gross receipts or gross profits, entities can face substantial LLET liability even during periods of low taxable income, such as the early years of a major expansion.9 Applying the QRFC against the LLET (down to the mandatory $\$175$ minimum) allows these companies to realize the benefit of their investment faster, significantly improving early-stage cash flow recovery.10

Mechanisms for Claiming the Credit: Required DOR Schedules

Taxpayers must comply with specific filing requirements established by the DOR:

1. Schedule QR (Qualified Research Facility Tax Credit): This form is used to calculate and record the credit amount. It must be attached to the income tax return each year the credit is claimed, and must continue to be filed annually until the credit is fully utilized or the 10-year carryforward period expires.3 The DOR requires a separate Schedule QR for each new project that qualifies.4
2. Schedule TCS (Tax Credit Summary for Entities): Corporations and pass-through entities use this schedule to summarize and apply the credit against their tax liability.4
3. Schedule ITC (Individual Tax Credit Summary): Individuals claim the credit using this schedule.4

In addition to these forms, the DOR mandates that taxpayers attach a detailed supporting schedule listing all tangible, depreciable property. This schedule must include the purchase date, date placed in service, a description, and the cost of the assets claimed.4

Utilizing the Credit and Statutory Ordering (KRS 141.0205)

Effective management of the QRFC requires awareness of the statutory prioritization rules for applying multiple tax credits. When a taxpayer is entitled to more than one nonrefundable tax credit, the priority of application against income tax and LLET is governed by KRS 141.0205.2 The research facilities credit (KRS 141.395) is enumerated among the nonrefundable business incentive credits subject to this ordering.11 Tax professionals must consult the specific statutory clause to ensure the QRFC is utilized optimally relative to other credits that may take priority, thereby avoiding premature loss or inefficient application of the benefit.

Strategic Tax Planning and Stacked Incentives

Differentiation: Kentucky’s Capital Focus vs. Federal Operational QREs

Kentucky’s QRFC provides a powerful leverage point for R&D investment because of its structural independence from the federal credit. The state incentive focuses strictly on capital infrastructure, whereas the federal credit is calculated primarily based on operational Qualified Research Expenses (QREs), such as wages and supplies.1

This separation means the Kentucky and federal incentives are fully stackable. The capital costs used to generate the 5% Kentucky credit do not reduce the basis for calculating the federal R&D tax credit (which is based on operational expenses). This non-overlap allows businesses to maximize the combined financial benefit, substantially reducing the true economic cost of both R&D operations and the necessary infrastructure simultaneously.1

Maximizing the Benefit: Synergy and Case Data

The synergy between the state facility credit and the federal operational credit is a critical economic differentiator for Kentucky. For manufacturing, high-tech, and biotechnology firms where laboratory, plant, or specialized equipment costs represent a major investment, the 5% state credit offers a reliable and meaningful capital cost recovery.1

In one reported case, a company incurred $\$4.2$ million in qualified facility costs in 2014, resulting in a $\$210,000$ state QRFC. This state benefit was secured alongside $\$327,833$ in federal R&D tax credits earned over a multi-year period, demonstrating the significant combined financial impact these stacking incentives can provide.7 The predictable nature of the 5% rate on capital investment, without base period complexity, is particularly appealing for strategic financial planning.

Table 3: Key Features of the Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

Illustrative Case Study: Utilizing the Qualified Research Facility Tax Credit

Scenario: Commonwealth Biomedical Corporation (CBC)

Commonwealth Biomedical Corporation (CBC), a C-Corporation, initiates a $\$6.85$ million capital project in 2024 to build and equip a specialized testing laboratory in Lexington, Kentucky. The laboratory will perform R&D activities designed to eliminate technical uncertainty related to the performance and reliability of new prosthetic materials, thereby meeting the IRC § 41 definition of qualified research.7

Calculation of Qualified Facility Costs (QRF Costs)

CBC analyzes its 2024 expenditures, ensuring only costs related to tangible, depreciable property are included.4

Table 4: Commonwealth Biomedical Corporation QRF Cost Analysis (2024)

Determining the Current Year Credit and Application

Based on the total qualified facility costs of $\$6,000,000$, CBC calculates its QRFC:

• QRFC Calculation: $\$6,000,000 \times 5\% = \$300,000$ (Total Credit Earned in 2024).

The company’s projected 2024 Kentucky tax liabilities are: Corporation Income Tax Liability of $\$120,000$, and LLET Liability of $\$40,000$.

• 2024 Credit Utilization: CBC uses the credit to fully offset its total tax liability of $\$160,000$.
• Remaining Unused Credit: $\$300,000$ (Earned) – $\$160,000$ (Used) = $\$140,000$.

The balance of $\$140,000$ must be carried forward. This amount remains available to offset future Kentucky tax liabilities for the next ten years, through the 2034 tax year.4

Filing and Administrative Requirements

CBC must fulfill the mandated reporting requirements:

1. In the 2024 tax return, CBC must file Schedule QR, documenting the $\$6,000,000$ in qualified costs and the $\$300,000$ credit earned, supported by a separate schedule itemizing the depreciable assets.3
2. CBC must also file Schedule TCS to claim the utilized credit amount of $\$160,000$ against its corporate income and LLET tax.4
3. For subsequent years, from 2025 until the credit balance is exhausted or expires, CBC is required to refile Schedule QR annually. This tracks the utilization of the $\$140,000$ carryforward, maintaining compliance with DOR requirements for monitoring the 10-year period.4

Conclusion and Key Takeaways for Kentucky Taxpayers

The Kentucky Qualified Research Facility Tax Credit (KRS 141.395) serves as a potent fiscal tool, explicitly targeting sustained capital investment in R&D infrastructure. Its strategic value lies in its direct, predictable calculation (5% of qualified costs with no base requirement) and its ability to be fully integrated with the federal R&D tax credit, offering a comprehensive incentive package that significantly lowers the financial barrier to entry for establishing major research facilities.1

Taxpayers utilizing this incentive must maintain rigorous compliance protocols. Documentation must clearly delineate capital expenditures (QRF costs) from operational expenditures (federal QREs), ensuring all claimed facility investments meet the technical standards of “qualified research” defined in IRC Section 41.1 Due to the nonrefundable nature and the 10-year carryforward, companies must integrate the QRFC into a long-term tax optimization strategy, necessitating accurate annual filing of Schedule QR to prevent the statutory expiration of valuable accrued credit balances.4 Companies engaged in R&D should therefore view the QRFC as a vital and dependable component for reducing the economic impact of capital expansion in Kentucky.

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