Comprehensive Analysis of the Taxpayer (Claiming the Credit) for the Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

The Taxpayer (Claiming the Credit) is the entity or individual that incurs qualified research facility costs or receives a proportional share of the resultant credit from a pass-through entity.1 This taxpayer utilizes the nonrefundable 5% credit against Kentucky Income Tax or the Limited Liability Entity Tax (LLET), subject to statutory ordering rules and a mandatory 10-year carryforward period.1

The identity and compliance obligations of the claiming taxpayer are governed by KRS 141.395 and related Kentucky Department of Revenue (DOR) regulations. This incentive is a nonrefundable credit calculated at 5% of the qualified costs associated with capital investment in research infrastructure located within the Commonwealth.1 Unlike the federal R&D tax credit, which focuses broadly on operational expenses, the Kentucky credit strictly targets capital expenditures, specifically those related to the construction, remodeling, expansion, or equipping of facilities used for qualified research.2 This structural emphasis on long-term infrastructure investment necessitates the robust 10-year carryforward provision for unused credit balances, ensuring sustained value for substantial capital projects.2

II. Foundational Statutory and Administrative Framework

A. Legal Basis (KRS 141.395): Alignment and Scope

The Kentucky General Assembly established the statutory framework for this incentive by defining “Qualified Research” identically to the definition found in Section 41 of the Internal Revenue Code (IRC).1 This requires that the underlying research activity meet the four-part test of the federal code, focusing on technological uncertainty resolution.

However, the scope of “Construction of research facilities” is strictly limited to costs related to tangible, depreciable property.1 This limitation fundamentally shapes the taxpayer’s claim mechanism. For a taxpayer to substantiate a claim, the traditional federal focus on tracking qualified research expenses (QREs) like wages, supplies, and contractual research is replaced by a necessity to meticulously track capital expenditures. Furthermore, the statute explicitly excludes amounts paid or incurred for replacement property, reinforcing the incentive’s goal of fostering net new or expanded research capabilities within Kentucky.1

The timing of credit generation is linked to the asset’s use. The DOR mandates that the taxpayer’s supporting schedule must list not only the cost but also the date placed in service.1 This indicates that the credit is realized when the facility or equipment begins its qualified research function, a critical factor for financial planning regarding multi-year construction projects.

B. Applicable Tax Liabilities

The utility of the credit is realized through offsets against the three primary business tax liabilities imposed by the Commonwealth 1:

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

The ability of a taxpayer to apply the credit against these liabilities, particularly LLET, is determined by the specific classification of the entity claiming the benefit.

III. Classification of Eligible Taxpayers and Claiming Methods

The designation of the “Taxpayer Claiming the Credit” dictates the necessary compliance forms and the method of credit application.

A. Corporate Entities (C-Corporations)

C-Corporations are primary claimants, applying the credit directly against their corporate income tax (KRS 141.040) or LLET (KRS 141.0401) liability.1 The utilization of the credit is governed by the statutory ordering rules of KRS 141.0205. C-Corporations must file Schedule QR to document the generation of the credit and then use Schedule TCS (Tax Credits for Corporations and Pass-through Entities) to calculate and apply the credit against their tax obligations.1

B. Individual Taxpayers (Sole Proprietorships)

A natural person operating a business as a sole proprietorship, reporting business income on federal Schedule C (Form 1040), is eligible to claim the credit directly.1 This direct claimant applies the credit against their Individual Income Tax (KRS 141.020) liability generated by the business activity. These taxpayers utilize Schedule QR for the initial calculation and tracking, and then apply the credit using Schedule ITC (Individual Tax Credits).1

C. Pass-Through Entities (PTEs)

Pass-through entities, including partnerships, S-corporations, LLCs, and trusts, play a unique dual role. While the entity itself generates the credit via its capital investment, the primary benefit is realized by its owners.1

1. Entity-Level Utilization: PTEs are liable for LLET and must first apply the generated credit against this entity-level tax.2 The entity uses Schedule QR and Schedule TCS for this application, subject to the $175 LLET minimum constraint (detailed in Section V).
2. Credit Flow-Through: Any unused credit balance remaining after the LLET offset must be mandatorily passed through to the owners. This allocation is done pro rata based on the owner’s distributive share of income for the taxable year.1 DOR guidance specifies that the credit is passed through only to the individuals or entities who were owners at the time of the application and subsequent approval of the credit.1 This requires PTEs to strictly track ownership to the approval date, presenting a critical timing factor for compliance, especially in cases of ownership transfer or restructuring.

D. Claiming by Owners of Pass-Through Entities

Owners of PTEs receive their allocated share of the credit via the Kentucky Schedule K-1.

• Individual Owners: Must file Schedule ITC with their Kentucky Form 740 (or 740-NP) to apply the allocated credit against their individual income tax liability.1
• Corporate Owners: Must file Schedule TCS with their corporate tax return to apply the allocated credit against their corporate income tax or LLET liability.1

A vital compliance requirement for all K-1 recipients—both individuals and corporations—is the mandatory attachment of two documents to their annual tax return: the relevant Schedule ITC or TCS, and a copy of the original Schedule QR filed by the PTE that generated the credit.1

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

A. Generating the Credit: Schedule QR

Schedule QR is the foundational document for the R&D Facility Credit.1 It serves not only to calculate the initial 5% credit but also to record the credit claimed each year throughout the carryforward period.1 Taxpayers must file a separate Schedule QR for each new project that qualifies and is placed in service in a given year.1

To support the figures on Schedule QR, the taxpayer must include a supplemental schedule detailing the tangible, depreciable property. This schedule must include the date of purchase, the date the asset was placed in service, a description, and the corresponding cost.1 This meticulous documentation is crucial for demonstrating that the expenditures meet the strict definition of qualified facility costs and are not ineligible replacement property.1

B. Applying the Credit: Annual Claiming Requirements

The nonrefundable nature of the credit and the lengthy 10-year carryforward require stringent annual reporting requirements.2

The requirement to attach a copy of the original Schedule QR to the tax return each year the credit is claimed establishes the schedule as a mandatory 10-year credit ledger.1 This procedure allows the DOR to track the cumulative utilization of the credit against the initial approved amount over the entire decade-long carryforward period. Non-compliance with this attachment requirement for any claim year introduces substantial risk of credit disallowance. The specific application forms are then used to calculate the offset: Schedule ITC for individuals and Schedule TCS for corporations and PTEs.1

V. Statutory Ordering and LLET Interplay (KRS 141.0205)

The application of the research facilities credit is subject to strict prioritization under KRS 141.0205, which dictates the mandatory sequence of applying nonrefundable business incentive credits.8

A. Priority of Application

The Research Facilities Credit (KRS 141.395) holds position (1)(j) in the statutory ordering of nonrefundable business incentive credits.8 This placement means the R&D credit is applied relatively late in the sequence, after nine categories of higher-priority credits have been utilized. These preceding credits include the Limited Liability Entity Tax (LLET) credit (1)(a) and various other economic development and incentive credits (1)(b) through (i).8 The late statutory position increases the risk that a taxpayer claiming multiple incentives may find the R&D credit “crowded out” in the current year due to the prior depletion of the tax liability. This structural reality makes accurate tracking of the 10-year carryforward balance critically important for long-term recovery of the investment.2

B. The Absolute Constraint: LLET Minimum Threshold Rule

The most significant constraint on credit utilization occurs when the R&D credit is applied against the LLET. Kentucky law dictates that the credit cannot reduce the LLET liability below the statutory minimum of $175.2

This minimum payment rule has a direct financial consequence for PTEs that generate the credit. Although the PTE must first utilize the credit against its LLET liability, the mandatory $175 floor ensures the state receives a minimum payment. The equivalent value of the R&D credit that might have otherwise offset this $\$175$ is effectively lost, as that portion of the credit is neither carried forward nor passed through to the owners as usable credit.9

Furthermore, the LLET acts as a gatekeeper to the corporate income tax. The LLET credit (LLET paid minus $\$175$) is the very first credit applied against corporate income tax liability.8 This application occurs before the R&D credit is reached at position (1)(j), further reducing the taxable income base available for R&D credit utilization. The combined effect of LLET’s minimum floor and its high priority in the ordering sequence minimizes the entity-level usage of the R&D credit for PTEs, emphasizing that the incentive’s primary financial value is realized by the owners against their proportional income tax liability.

VI. Comprehensive Illustrative Example: Flow-Through Credit Mechanics

A detailed analysis of the flow-through process for the $\$50,000$ R&D credit generated by a limited liability entity.

A. Scenario: Quantum Research LLC Investment

Quantum Research LLC, structured as a Partnership, completes a qualified research facility investment of $\$1,000,000$ in Year 1. The total generated credit is $\$50,000$ (5% of qualified costs).2 The LLC has a pre-credit LLET liability of $\$15,000$. The entity is equally owned (50/50) by an individual, Ms. Johnson, and a corporation, BioCorp, Inc.

B. Entity-Level Credit Utilization (LLC)

The LLC first uses the generated $\$50,000$ credit to offset its $\$15,000$ LLET liability. Due to the $\$175$ minimum threshold, the LLC is required to pay $\$175$ in LLET.9

$$\text{Credit Used Against LLET} = \$15,000 \text{ (LLET Liability)} – \$175 \text{ (Minimum LLET)} = \$14,825$$

The LLC pays the minimum $\$175$ LLET and files Schedule TCS reporting the $\$14,825$ credit offset. The remaining credit balance available for flow-through is $\$50,000 – \$14,825 = \$35,175$.

C. Distribution to Owners

The remaining $\$35,175$ is allocated based on the 50/50 distributive share ratio 1:

Each owner receives a Kentucky Schedule K-1 detailing this credit allocation.

D. Owner-Level Claiming

1. Ms. Alice Johnson (Individual Taxpayer): Ms. Johnson has an $\$8,000$ individual income tax liability attributable to her partnership income. She files Schedule ITC and applies her allocated $\$17,587.50$ credit. She uses $\$8,000$ of the credit to reduce her tax liability to zero. The remaining $\$9,587.50$ is carried forward for up to 10 years.
2. BioCorp, Inc. (Corporate Taxpayer): BioCorp has a $\$10,000$ corporate income tax liability (after accounting for the LLET credit). It files Schedule TCS and applies its allocated $\$17,587.50$ credit. It uses $\$10,000$ of the credit to reduce its liability to zero. The remaining $\$7,587.50$ is carried forward for up to 10 years.

Both Ms. Johnson and BioCorp, Inc. must attach a copy of the LLC’s Schedule QR to their respective returns to validate the origin and amount of the claimed credit.1

VII. Key Compliance Tables for Reporting

Table 1: Eligibility and Filing Requirements by Taxpayer Type

Table 2: Kentucky Credit Ordering Priority (KRS 141.0205 Partial List)

Conclusions

The definition of the “Taxpayer (Claiming the Credit)” under KRS 141.395 extends far beyond the entity that initially incurs the qualified costs, incorporating a complex flow-through mechanism designed to benefit the ultimate owners of PTEs.

The analysis confirms that the primary constraint on current-year credit utilization is the statutory ordering defined in KRS 141.0205, which places the R&D credit in a secondary position relative to higher-priority economic development incentives and the LLET credit.8 This structural constraint necessitates the reliance on the 10-year carryforward period to realize the full benefit of capital investments.

Furthermore, the mandatory minimum $\$175$ LLET payment acts as a permanent forfeiture mechanism for PTEs, effectively limiting the entity-level utilization of the credit and transferring the primary tax planning opportunity to the individual and corporate owners.9 Taxpayers receiving allocated credit must recognize that their compliance burden includes maintaining the integrity of the credit generation record by attaching a copy of the originating Schedule QR to their own tax returns for every year the credit is claimed, validating the initial capital expenditure for the subsequent decade.1

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