The Kentucky Qualified Research Facility Tax Credit: A Strategic Analysis of Capital Investment Incentives (KRS 141.395)

The Kentucky Qualified Research Facility Tax Credit is a nonrefundable incentive offering a 5% credit on qualified costs associated with constructing, remodeling, expanding, or equipping research facilities located within the Commonwealth. It specifically targets investments in tangible, depreciable property used for activities meeting the federal definition of “qualified research” under Internal Revenue Code (IRC) Section 41.1

I. Introduction: The Power of Infrastructure Investment in Kentucky

Strategic Overview and Value Proposition

This credit, codified under Kentucky Revised Statutes (KRS) 141.395, is designed to encourage significant capital expenditures in the state’s scientific and technological infrastructure. For businesses undertaking large construction or expansion projects, this incentive is a crucial financial tool used to offset state tax liability following substantial investment in research and development (R&D) facilities.2

The structure of the Kentucky credit distinguishes it sharply from its federal counterpart, the IRC Section 41 R&D tax credit. While the federal credit primarily targets operational expenditures, such as qualified wages and supplies used directly in R&D activity 3, the Kentucky credit is explicitly focused on encouraging long-term, permanent physical assets within the Commonwealth.2 This difference allows businesses to “stack” the federal operational credit with the state facility credit, significantly multiplying the total economic benefit derived from R&D investment.2 Furthermore, the nonrefundable nature of the credit is mitigated by a generous provision allowing any unused credit to be carried forward for up to 10 years, enhancing the incentive’s long-term utility and cash flow benefits for projects with high initial capital outlay.1

Statutory Framework (KRS 141.395)

The credit is computed at a rate of 5% of the qualified costs of construction of research facilities.1 It is permitted against three primary Kentucky business tax liabilities:

1. Individual Income Tax (KRS 141.020).1
2. Corporation Income Tax (KRS 141.040).1
3. The Limited Liability Entity Tax (LLET, KRS 141.0401).1

The utilization of the credit must follow the statutory ordering established in KRS 141.0205, which dictates how the research facilities credit is applied alongside other business incentive credits.1

Legislative Stability and Current Status

While tax legislation is often subject to change, the Qualified Research Facility Tax Credit has demonstrated significant resilience. A 2016 legislative measure (House Bill 142) proposed sunsetting the existing facility credit (KRS 141.395) to replace it with a new credit focused solely on university research funding.6 However, the current status, as evidenced by guidance from the Kentucky Department of Revenue (DOR) and recent fiscal reporting, confirms the continued viability and relevance of the facility credit. The DOR actively issues the necessary forms, such as Schedule QR, and recent Tax Expenditure Analysis reports (covering Fiscal Years 2024–2026) project that this incentive will result in approximately $1.1 million in forgone state revenues annually.1 This continuation of the program, despite past legislative proposals to replace it, assures tax professionals and corporate leaders that KRS 141.395 remains a stable and current incentive for planning long-term capital investments in Kentucky.

II. Establishing the Foundation: Definition and Federal Nexus

Successful utilization of the Kentucky facility credit requires a precise understanding of two key definitions: the scope of eligible costs under “Construction of research facilities” and the nature of the research activity under “Qualified research.”

A. The Defining Scope of “Construction of Research Facilities”

KRS 141.395(1)(a) strictly limits eligible expenditures to costs incurred for “constructing, remodeling, and equipping facilities in this state or expanding existing facilities in this state for qualified research”.1

Inclusions: Tangible, Depreciable Property (TDP)

The singular defining constraint on eligible costs is that they must constitute tangible, depreciable property (TDP).1 This includes:

• Costs related to the physical construction or structural remodeling of the research facility.2
• Costs incurred for equipping the facility, such as purchasing and installing depreciable equipment, machinery, and specialized lab components (e.g., testing gear).2
• The facility must be physically located within the state of Kentucky.1

The credit is generated and available for use once the tangible, depreciable property is physically placed in service—meaning it is ready and available for its intended research use.7

Exclusionary Rules

A crucial aspect of compliance involves understanding what costs are explicitly excluded from the 5% credit calculation:

• Replacement Property: Amounts paid or incurred for replacement property are specifically excluded. This rule ensures the credit incentivizes expansion and new infrastructure, rather than routine maintenance or like-for-like asset swaps.1
• Non-Depreciable Assets: Costs related to land or improvements to land are excluded because they are non-depreciable capital assets under federal rules.1
• Operational Expenses: The Kentucky credit strictly focuses on capital assets, excluding typical federal Qualified Research Expenses (QREs) such as wages, supplies, contract research expenses, and computer rentals.2

The restriction of eligibility solely to tangible, depreciable property is a crucial factor in compliance. The Kentucky statute aligns its capital expenditure criteria with federal depreciation principles. For instance, the federal R&D tax credit regulations, in defining “supplies,” explicitly exclude “land or improvements to land”.3 By mirroring this distinction, Kentucky enforces a clear delineation between eligible capital investments (TDP that depreciates) and ineligible real estate/operational costs. Consequently, taxpayers must maintain rigorous fixed asset records and often employ cost segregation studies to accurately separate depreciable R&D assets (e.g., specialized utility systems, cleanroom structures, lab machinery) from non-depreciable site improvements (e.g., land, general grading, sidewalks).

B. Adopting the Federal Standard: IRC Section 41

The Kentucky statute achieves its link to innovation by defining “Qualified research” through direct reference to Section 41 of the Internal Revenue Code (IRC).1 This reference establishes the technical gateway requirement: the activity undertaken within the newly constructed or expanded facility must meet federal R&D standards.

To satisfy IRC § 41, the activity performed in the facility must meet the four criteria of the federal activity-based test 13:

1. The expenditure must qualify as a domestic research or experimental expenditure.
2. The research purpose must be the discovery of information that is technological in nature.
3. The application of the information must be intended to be useful in the development of a new or improved business component.
4. Substantially all the activities must constitute a process of experimentation intended to resolve technological uncertainties.

Non-Incremental Calculation Advantage

The method by which the Kentucky facility credit is calculated provides an important advantage over the federal credit calculation. Federal R&D tax credit calculation is often complicated, requiring historical fixed-base percentages or an alternative simplified method that measures incremental increases in spending.2 In contrast, the Kentucky facility credit simplifies this process significantly. The credit is calculated as 5% applied directly to all qualified facility costs incurred during the period.2 This structure eliminates the need for complex historical modeling and guarantees a predictable, immediate value proposition for new capital projects.

Table 1 provides a summary of the key parameters governing this incentive.

Table 1: Key Parameters of the Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

III. Financial Mechanics and Credit Utilization

A. Calculating the Credit: The 5% Statutory Rate

The calculation methodology is direct and non-incremental. Taxpayers must first determine the sum of all eligible expenditures for constructing, remodeling, expanding, or equipping R&D facilities incurred during the tax year, ensuring they meet the TDP criteria.2

$$\text{Credit Amount} = \text{Qualified Costs of Construction} \times 5\%$$

The 5% rate is applied directly to the total qualified costs, providing an upfront and certain incentive.2

B. The Nonrefundable Nature and 10-Year Carryforward

The credit is classified as nonrefundable, meaning it serves as a dollar-for-dollar offset against the calculated tax liability and cannot generate a cash refund if the credit exceeds the tax due.2 This characteristic is managed effectively by the long carryforward period: any portion of the credit that remains unused in the current taxable year may be carried forward for ten (10) consecutive years.1 This extended carryforward period is essential for businesses that undertake large, multi-million dollar capital projects, allowing them to monetize the full value of the credit over time even if their immediate tax liability is modest.

C. Application Strategy: Income Tax vs. Limited Liability Entity Tax (LLET)

The credit is versatile, applying against the Corporation Income Tax (KRS 141.040), Individual Income Tax (KRS 141.020), and the LLET (KRS 141.0401).1 However, the utilization rules across these tax types are highly segmented.

The Kentucky Department of Revenue (DOR) specifies that the credit claimed against the Income Tax liability and the LLET liability must be calculated and tracked separately.7 The credit balances are non-fungible; a balance available for Income Tax cannot be used against the LLET, and vice versa.7

Furthermore, when applying the credit against the LLET, utilization is constrained by the statutory minimum LLET liability. The credit cannot reduce the LLET payable below the minimum threshold of $175.2

The non-fungibility requirement mandates the establishment of a rigorous internal tracking mechanism—effectively a “dual ledger” accounting requirement. Taxpayers must generate a single pool of credit from the capital investment but then manage that pool as two separate utilization streams over the 10-year carryforward period, one specifically for Income Tax and one for LLET. This meticulous tracking must also ensure compliance with the mandatory statutory ordering (KRS 141.0205) when applying this credit alongside other state business incentives.2

For pass-through entities (PTEs)—including partnerships, S-Corporations, and LLCs—the credit is calculated at the entity level but passed through to the owners (members, partners, or shareholders) via the Kentucky Schedule K-1.1 This mechanism allows the economic benefit of the facility investment to flow directly to the owners, offsetting their individual income tax liability.1 This structure often maximizes the ability to utilize the nonrefundable credit pool quickly, especially if the entity itself has a high individual tax base but minimal LLET liability.

Table 3 summarizes the critical application rules.

Table 3: Application of the Facility Credit Against Kentucky Tax Liabilities

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

Compliance with the DOR is mandatory for both generating the credit and managing the carryforward. The core mechanism is Schedule QR.

A. The Mandate of Schedule QR (Qualified Research Facility Tax Credit)

Schedule QR is the required form used to document the initial credit calculation and track its subsequent utilization.1

• Initial Filing: A separate Schedule QR must be filed with the income tax return (Form 740 for individuals, Form 720 for corporations/LLET) in the tax year that the tangible, depreciable property is placed in service. This filing establishes the initial credit amount.1
• Annual Tracking: A copy of Schedule QR must be attached to the tax return each year the credit is claimed until the entire balance is utilized or the 10-year carryforward period expires.1
• New Projects: If a taxpayer initiates a new, qualifying capital project in a subsequent year, a separate Schedule QR is required for that distinct project.1

B. Documentation Deep Dive: Required Supporting Schedules (TDP Detail)

The DOR requires highly detailed documentation to substantiate the qualified costs claimed. The Schedule QR instructions mandate the attachment of a supporting schedule listing the specific tangible, depreciable property (TDP) that generated the credit.1 This schedule must include four critical data points for each asset:

1. Date purchased.
2. Date placed in service.
3. Detailed description of the property.
4. Cost.1

This requirement for detailed asset lifecycle information—specifically the date the property was placed in service—links the credit claim not just to the cost incurred but precisely to the point when the asset is ready for its intended research use. This integration of capital project milestones with tax year-end dates is critical for tax planning. This documentation acts as the primary defense in the event of a state audit, confirming that the claimed costs are indeed TDP and not ineligible items, such as replacement property or land improvements.2

V. Strategic Case Study: Calculating and Utilizing the Facility Credit

This strategic analysis is exemplified by considering a fictional Kentucky corporation, Alpha Tech Corp (ATC), undertaking a major facility expansion.

A. Scenario Setup: R&D Expansion Project

ATC, a corporation subject to Kentucky income tax (KRS 141.040) and LLET (KRS 141.0401), completes a multi-million dollar expansion of its materials testing laboratory in Lexington, KY. The activity within the lab meets the IRC § 41 definition of qualified research. The costs incurred in Year 1 are analyzed below to determine the Qualified Costs of Construction.

Table 2: Eligible and Excluded Costs under KRS 141.395

B. Calculation Walkthrough

Based on the Total Qualified Costs (TQC) of $4,000,000, the credit generated in Year 1 is calculated:

$$\text{Total Credit Generated} = \$4,000,000 \times 5\% = \$200,000$$

2

C. Utilization Model (Year 1 – Year 4)

ATC generates a $200,000 nonrefundable credit. The utilization must be tracked separately for Income Tax (IT) and LLET.

*Note on Year 3 Utilization: The remaining $45,000 credit is entirely utilized against the Income Tax liability (reducing the $60,000 liability to $15,000). The non-fungibility rule means the LLET liability of $5,000 must be paid (less the $175 minimum due if a carryforward LLET balance existed, though in this case, the total credit pool is exhausted).

Strategic Implications of the Facility Credit

The Kentucky facility credit operates strategically to enhance the overall tax efficiency of capital investment.

The explicit focus on capital investment for the Kentucky credit allows for beneficial stacking with the federal R&D tax credit.2 While the $200,000 Kentucky credit offset the facility costs, ATC would simultaneously be eligible to claim a federal R&D credit based on its operational costs (wages, supplies). Federal R&D credits often range from 6% to 10% of qualified operational research expenses.4 Combining these credits significantly maximizes the total tax benefit derived from the single R&D project.12

Furthermore, the incentive remains active and highly valuable, particularly for large corporations. While facility-based credits require high barriers to entry (large capital expenditure), the state projects an annual utilization resulting in $1.1 million in forgone revenue for Fiscal Year 2024, demonstrating that the incentive is continually sought and maximized by Kentucky businesses.8

VI. Conclusion and Forward-Looking Strategy

The Kentucky Qualified Research Facility Tax Credit (KRS 141.395) is a powerful, stable, and specific incentive designed to drive capital investment in research infrastructure within the Commonwealth. It offers a clear, non-incremental 5% credit on qualified tangible, depreciable property and provides substantial flexibility through its 10-year carryforward provision.2

However, the specialized nature of the credit introduces critical compliance requirements that must be managed proactively:

1. Federal Nexus: The underlying research activity must satisfy the rigorous four-part test established by IRC Section 41, even though the expenses claimed are entirely capital.1
2. TDP Documentation: Compliance necessitates highly detailed asset tracking. Taxpayers must compile and retain supporting schedules listing the tangible, depreciable property with precise acquisition and placed-in-service dates for every asset claimed, which is the foundational defense documentation against state audit.15
3. LLET/Income Tax Separation: The non-fungibility of credit balances across Income Tax and LLET requires the maintenance of two separate credit utilization ledgers over the entire ten-year carryforward period, a crucial accounting distinction.7

Recommendations for Capital Planning

Businesses planning expansion or new research facility construction in Kentucky are strongly advised to integrate tax specialists early in the capital budgeting and construction phases. This allows for accurate cost segregation, ensuring eligible tangible, depreciable property is correctly identified and separated from ineligible costs such as land or labor. Furthermore, precise timing of asset acquisition and placement in service is necessary to generate the credit in the optimal tax year, maximizing the cash flow benefit associated with this robust state incentive.10

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/