Technological in Nature

The term “Technological in Nature” refers to research activities that fundamentally rely upon the principles of physical or biological sciences, engineering, or computer science. This standard distinguishes qualifying experimental research from routine commercial activities or social science inquiries that lack a hard-science foundation.

Statutory Foundations and the Adoption of Federal Standards

The Ohio Research and Development Investment Tax Credit represents a critical intersection between federal definitions and state-specific tax application. Codified primarily in Ohio Revised Code (R.C.) Section 5751.51 for the Commercial Activity Tax (CAT) and R.C. Section 5726.56 for the Financial Institutions Tax (FIT), the credit provides a nonrefundable offset for businesses that increase their research activities within the state. At the heart of these statutes is a direct reference to the Internal Revenue Code (IRC) Section 41, which defines “qualified research expenses” (QREs) for both federal and state purposes. This incorporation by reference means that to satisfy Ohio law, a taxpayer must first satisfy the federal “Four-Part Test,” of which the requirement that research be “technological in nature” is a fundamental pillar.

The transition from the historical Corporation Franchise Tax to the Commercial Activity Tax in 2005 through House Bill 66 significantly altered the administrative landscape for R&D incentives in Ohio. While the credit existed under the franchise tax, it became available against the CAT starting July 1, 2008. This shift necessitates a dual understanding of how the Ohio Department of Taxation (ODT) interprets federal law and how it applies state-specific jurisdictional limits, particularly the requirement that expenses be “incurred in this state”.

The following table outlines the primary statutory authorities governing research incentives in Ohio and their respective tax applications.

Ohio Revised Code Section	Tax Application	Primary Benefit and Method
R.C. 5751.51	Commercial Activity Tax (CAT)	7% of QREs exceeding the 3-year Ohio average.
R.C. 5726.56	Financial Institutions Tax (FIT)	7% of excess QREs for financial institution groups.
R.C. 5747.331	Personal Income Tax (PIT)	Credit for R&D loan payments by pass-through entity owners.
R.C. 166.21	Development Services Agency	Authorization for R&D Investment Loans and related credits.
R.C. 5751.52	Commercial Activity Tax (CAT)	Credit for borrower’s qualified R&D loan payments.

Detailed Analysis of the “Technological in Nature” Requirement

To satisfy the “technological in nature” requirement, often referred to as the Technological Information Test, the taxpayer must demonstrate that the process of experimentation used to discover new information fundamentally relies on the principles of the hard sciences. This requirement serves as a gatekeeper, ensuring that the tax credit supports innovation in fields that drive technical and industrial growth rather than aesthetic or purely organizational improvements.

The Hard Science Prerequisite

Administrative and judicial guidance consistently define the hard sciences as those rooted in the physical and natural world. Engineering is perhaps the most common field cited in R&D credit claims, encompassing the design of mechanical systems, structural components, and electronic circuitry. Physical sciences, such as physics and chemistry, are central to materials science and manufacturing process improvements, where the molecular or structural properties of a substance are altered or enhanced. Biological sciences are the bedrock of the bioscience and pharmaceutical sectors, involving the study of living organisms, molecular biology, and genetics. Computer science involves the development of new algorithms, software architectures, or the optimization of complex data processing systems.

The exclusion of “soft sciences” is a critical distinction in ODT guidance. Research that relies primarily on economics, management science, psychology, sociology, or market research does not meet the technological threshold. For instance, a company that conducts extensive surveys to determine the most appealing user interface for a software application may be performing valuable business research, but because the uncertainty is human-centric or aesthetic rather than rooted in computer science principles, it fails the technological in nature test.

The Concept of Discovery

The Technological Information Test requires that research be undertaken for the purpose of “discovering information”. It is a common misconception that this information must be “new to the world” or represent a revolutionary breakthrough. Rather, the standard focuses on whether the information is new to the taxpayer. If the taxpayer lacks knowledge regarding the capability, method, or optimal design of a business component, and must use scientific principles to find the answer, they are “discovering information” within the meaning of the law.

The “Patent Safe Harbor” is a powerful tool in this regard. Under Treasury Regulation §1.41-4(a)(3)(iii), which is applicable to Ohio through R.C. 5751.51, the issuance of a U.S. patent is considered conclusive evidence that a company has discovered information that is technological in nature and intended to eliminate uncertainty. While a patent does not automatically satisfy the “process of experimentation” test—which requires evidence of the actual work performed—it effectively settles the question of whether the project’s goal was technological.

Interaction with the Process of Experimentation

The “technological in nature” requirement is inextricably linked to the “process of experimentation” test. To qualify, substantially all of the activities must constitute elements of a process of experimentation, which involves identifying a technical uncertainty, proposing alternatives, and evaluating those alternatives through modeling, simulation, or systematic trial and error. Crucially, the evaluative process itself must rely on scientific principles. A trial-and-error process that is merely observational or based on routine engineering does not suffice. The taxpayer must demonstrate that they utilized the scientific method to resolve the uncertainty.

Ohio Department of Taxation (ODT) Guidance and Administrative Rules

The ODT provides clarity on the application of the R&D credit through the Ohio Administrative Code (OAC) and periodic Information Releases. These documents interpret how federal IRC Section 41 standards function within the specific mechanics of Ohio’s Commercial Activity Tax and Financial Institutions Tax.

OAC Rule 5703-29-22: The Primary Regulatory Framework

This administrative rule outlines the procedural requirements for claiming the R&D credit against the CAT. It establishes several key mandates that distinguish state compliance from federal filing:

1. Calendar Year Computation: Regardless of a taxpayer’s federal taxable year, the Ohio credit must be calculated based on expenses incurred during the calendar year. This often requires taxpayers to bifurcate their accounting data to match the state’s January-to-December reporting period.
2. Entity-Level Calculation: For taxpayers that are part of a consolidated elected or combined group, each member must separately calculate its own credit based on the qualified research expenses it personally incurred. A taxpayer may only claim the credit for persons included in the group as of December 31 of the year in which the expenses were incurred.
3. Prohibition of Double Benefits: A taxpayer is explicitly barred from claiming a credit against the CAT if they previously received the benefit of that same credit against another tax, such as the individual income tax or the insurance premiums tax.
4. Reporting Frequency and Deadlines: For quarterly CAT filers, the credit must first be claimed on the fourth-quarter return, which is generally due in February of the year following the calendar year in which the expenses were incurred.

Information Release CAT 2007-03

This release, titled “Commercial Activity Tax Credits, Explained,” remains a foundational piece of guidance. It emphasizes that the Ohio R&D credit is strictly a “within-state” incentive. While federal law (IRC §41) allows for credits on research performed anywhere in the United States or its possessions, R.C. 5751.51(B)(1) limits the Ohio credit to expenses “incurred in this state”. This jurisdictional limit is a frequent source of audit adjustments, as taxpayers often fail to exclude wages for out-of-state employees or payments to out-of-state contractors.

The Doctrine of Strict Construction

A recurring principle in ODT’s legal determinations is that tax reduction statutes must be “strictly construed” against the taxpayer. As held in Anderson/Maltbie Partnership v. Levin, any person seeking a tax credit must demonstrate a “clear entitlement” to it. In the context of the “technological in nature” test, this means the ODT will not accept broad assertions of innovation. Taxpayers must provide contemporaneous documentation—such as project plans, lab notes, and technical reports—that proves the research was rooted in the hard sciences and conducted through a systematic process of experimentation.

Legislative Evolution and the 2024-2025 CAT Reforms

The Ohio Commercial Activity Tax has undergone significant transformation recently, which directly impacts the utility and applicability of the R&D tax credit. House Bill 33, passed in 2023, introduced a tiered increase in the gross receipts exclusion, effectively exempting thousands of small businesses from the CAT altogether.

The following table details the changes to the CAT filing thresholds and their implications for R&D credit claims.

Tax Year	Annual Minimum Tax (AMT)	Gross Receipts Exclusion	Impact on R&D Credit Claims
2023	Tiered ($150 to $2,600)	$1,000,000	Baseline year for most existing R&D credit strategies.
2024	Eliminated	$3,000,000	Only businesses with >$3M in receipts will utilize the credit to offset liability.
2025+	Eliminated	$6,000,000	The credit becomes highly targeted toward mid-market and large enterprises.

These changes imply that for small high-tech startups with gross receipts below $3 million in 2024, the Ohio R&D credit may no longer be necessary, as they will have no CAT liability to offset. However, for companies exceeding these thresholds, the 7% credit remains a permanent and valuable incentive.

Identifying and Substantiating Qualified Research Expenses (QREs)

To calculate the credit, a taxpayer must first identify their Ohio-based QREs. These expenses fall into four primary categories, each with its own set of rules regarding its technological relevance and state-specific eligibility.

Wages for Qualified Services

Wages are typically the largest component of an R&D claim. These include all W-2 (Box 1) taxable wages paid to employees for “qualified services”. Qualified services are divided into three activities:

1. Engaging in Research: The actual conduct of experimentation, such as an engineer designing a part or a scientist conducting a lab test.
2. Direct Supervision: The immediate management of researchers, such as a project manager who oversees the daily progress of the technical team.
3. Direct Support: Activities that facilitate research, such as a technician preparing a prototype for testing or an assistant cleaning lab equipment used in the experiments.

Administrative guidance from the ODT and federal courts clarifies that “direct supervision” does not extend to upper-level management who only receive high-level reports. The “substantially all” rule (the 80% rule) allows that if an employee spends at least 80% of their time on qualified services, 100% of their wages can be included in the QRE calculation.

Supplies and Materials

Supplies include any tangible property—other than land or depreciable property—that is consumed or used in the conduct of qualified research. This commonly includes materials used to create prototypes or experimental models. Utility costs are generally excluded unless the taxpayer can demonstrate that the research required “additional extraordinary expenditures” for utilities beyond routine business operations.

Contract Research Expenses

Taxpayers may include 65% of the amount paid to third parties for research performed on their behalf. For Ohio purposes, the work must be performed in the state. If the contract research is performed by a “qualified research consortium”—such as a non-profit scientific research organization or a university—the inclusion rate increases to 75%.

Computer Rental and Cloud Hosting Costs

As technology has evolved, the “rental or lease of computers” category has increasingly come to include cloud computing and hosting costs. These expenses are eligible if they are directly associated with the research activities, such as cloud-based simulations or the development of AI algorithms.

Case Law Analysis and Administrative Final Determinations

The meaning of “technological in nature” is often clarified through the ODT’s Final Determinations and court cases that challenge the denial of credits.

The Cristal USA Determination (2020)

In Cristal USA v. McClain, the petitioner claimed QRE credits on amended CAT returns for plant trial activities. The ODT denied the credits, and the Tax Commissioner upheld the denial, primarily because the petitioner could not demonstrate that the activities were “incurred in this state”. This case underscores that even if a taxpayer has received a federal R&D credit, the ODT will perform its own audit to ensure the Ohio-specific jurisdictional requirements are met. The petitioner’s reliance on a federal credit study was insufficient to prove that the work was performed at its Ohio facilities.

Phoenix Design Group and the Routine Engineering Barrier

In Phoenix Design Group, Inc. v. Commissioner (2024), although a federal case, the court provided a clear distinction that is frequently cited in Ohio audits: the “routine engineering” barrier. The court found that an engineering firm’s work did not qualify because its process did not constitute a true “process of experimentation”. The firm was using existing knowledge and basic calculations to solve design issues. For an activity to be “technological in nature” and qualify for the credit, it must go beyond the standard application of known engineering principles; it must involve an evaluative process of testing multiple alternatives to resolve an unknown.

EMB-Airpouch and the Failure of Documentation

In a January 2022 Final Determination, the ODT denied credits for a project called “EMB-Airpouch”. The petitioner failed to demonstrate that its activities met the Section 174 and Process of Experimentation tests. The Commissioner noted that simply presenting an eventual solution to an issue does not prove that investigative activities were undertaken. This determination highlights the “discovery” element of the technological nature requirement: the taxpayer must document the path taken to the solution, not just the final product.

Specialized Application: Software Development and Internal Use

Software development is perhaps the most nuanced area of the R&D tax credit, particularly with the 2016 final regulations regarding Internal Use Software (IUS). Under R.C. 5751.51, Ohio follows these federal definitions.

Internal Use Software (IUS) Guidance

Software is considered IUS if it is developed for use in general and administrative functions, such as human resources, payroll, or accounting. Because these functions are not seen as the core “high-tech” drivers of the economy, IUS must meet a higher bar for qualification. To be “technological in nature” and eligible for the credit, IUS must satisfy a three-part “high threshold of innovation” test:

1. Innovation: The software must be intended to result in a reduction in cost or improvement in speed that is substantial and economically significant.
2. Significant Economic Risk: The taxpayer must commit substantial resources, and there must be a technical risk that the project will not be completed.
3. Not Commercially Available: The software cannot be purchased or leased in the open market.

Commercial software—developed to be sold, leased, or licensed—is not subject to this higher threshold. However, it must still rely on computer science principles. Simply creating a mobile app that uses existing web-service logic is often viewed as routine development. Qualifying software research usually involves optimizing algorithms, developing new data security protocols, or integrating disparate systems in a way that has not been done before.

Integrated Programs: R&D Investment Loans and JobsOhio

Ohio uniquely couples its R&D tax credit with financing programs to maximize the impact on the state’s manufacturing and tech sectors. The Research and Development Investment Loan Fund is a primary example of this integration.

Eligibility for R&D Loans

Administered by the Development Services Agency, these loans finance project costs for activities that are “technological in nature” and intended for the commercialization of new products or processes. The program requires a commitment to create high-wage jobs in Ohio.

Recipients of an R&D Investment Loan may claim a nonrefundable credit against their CAT or FIT liability for their qualified loan payments. This credit, codified in R.C. 5751.52, is separate from the QRE-based credit under R.C. 5751.51. However, the same underlying requirement remains: the project must be rooted in the hard sciences.

The following table lists the industry sectors targeted by the Ohio Innovation Fund (IOF) and related R&D incentives, all of which are presumed to meet the “technological in nature” standard.

Target Industry Sector	Focus of Qualifying Research
Advanced Materials	Polymers, alloys, and composite material development.
Biosciences	Medical devices, pharmaceuticals, and genetic research.
Information Technology	Cybersecurity, AI, and complex software architectures.
Instruments & Electronics	Sensors, control systems, and propulsion technologies.
Manufacturing	Automation, additive processes, and refining techniques.

Quantitative Mechanics: Calculating and Claiming the Credit

The Ohio R&D credit is an “incremental” credit, meaning it rewards businesses for increasing their research spending compared to their historical average.

The Three-Year Average Calculation

The credit is equal to 7% of the amount by which the current year’s Ohio QREs exceed the average of the prior three years.

Example Calculation:

• 2024 Ohio QREs: $1,000,000
• 2023 Ohio QREs: $800,000
• 2022 Ohio QREs: $700,000
• 2021 Ohio QREs: $600,000

Base Amount: ($800,000 + $700,000 + $600,000) / 3 = $700,000

Excess QREs: $1,000,000 – $700,000 = $300,000

Ohio R&D Credit: $300,000 * 7% = $21,000

If a business has no prior R&D history in Ohio, the base amount is zero, allowing for a 7% credit on the entire first-year investment.

Claiming the Credit on the CAT Return

The credit must be claimed on the CAT return (typically the fourth-quarter return due in February). Taxpayers must complete a specific schedule promulgated by the Tax Commissioner, which includes the amount of the credit and any carryforwards from prior years. While prior approval is not required to claim the credit, it is subject to audit. If the credit is based on an R.C. 166.21 loan, a certificate from the Director of Development must be attached.

Comprehensive Example: The “Technological in Nature” Standard in Practice

To demonstrate the application of ODT guidance and the technological information test, consider the following detailed scenario involving an Ohio-based manufacturer.

The Project: High-Efficiency Polymer Extrusion

“Buckeye Polymers LLC,” located in Columbus, Ohio, specializes in manufacturing specialized industrial coatings. In 2024, the company initiates a project to develop a new extrusion process that reduces the thermal degradation of its proprietary polymer blend.

Satisfying the Four-Part Test

1. Section 174 Test (Permitted Purpose): Buckeye Polymers faces uncertainty regarding the “appropriate design” of the extrusion screw and the “methodology” of the cooling sequence. They do not know if a faster cooling cycle will cause the polymer to become brittle. The goal is to improve the performance and quality of the extrusion process.
2. Technological in Nature: The project relies on chemistry (analyzing the polymer’s thermal properties) and mechanical engineering (designing the extrusion machinery). The solution cannot be found through aesthetic changes or simple price adjustments; it requires hard-science investigation.
3. Business Component Test: The component is a “process”—specifically, the high-efficiency extrusion process—used in Buckeye’s trade or business.
4. Process of Experimentation: Buckeye’s engineering team develops four different screw designs and three different cooling sequences. They use thermal imaging and structural stress tests (modeling and experimentation) to evaluate each combination. They document 15 failed test runs before finding the optimal configuration.

Expense Identification (Ohio-Specific)

Buckeye Polymers spends $800,000 on the project in 2024:

• Wages: $400,000 for Columbus-based engineers. (100% included as Ohio QREs).
• Supplies: $150,000 in polymer resins and machine parts consumed during the 15 failed test runs. (100% included).
• Contract Research: $250,000 paid to a materials lab in Cincinnati to perform the structural stress tests. (65% included = $162,500).

Total 2024 Ohio QREs: $400,000 + $150,000 + $162,500 = $712,500

Final Credit Determination

Assuming Buckeye Polymers had an average of $400,000 in Ohio QREs over the 2021-2023 period:

Excess QREs: $712,500 – $400,000 = $312,500

Ohio R&D Tax Credit: 7% of $312,500 = $21,875

This $21,875 credit is claimed on their February 2025 CAT return. Because Buckeye’s gross receipts in 2024 were $10 million (well above the $3 million exclusion), they can use the full amount to reduce their CAT liability.

Final Thoughts and Practical Recommendations

The “technological in nature” requirement serves as the vital gateway for the Ohio Research and Development Investment Tax Credit, ensuring that state fiscal incentives are directed toward activities that advance scientific and engineering knowledge. For Ohio businesses and tax professionals, the administrative and legal landscape necessitates a proactive and rigorous approach to compliance.

The ODT’s “strict construction” of the law means that the burden of proof is high. Taxpayers cannot simply rely on the presence of engineers or a general culture of innovation; they must document a specific process of experimentation rooted in the hard sciences. As the 2024 and 2025 CAT reforms remove smaller businesses from the filing requirements, the credit will increasingly become a focused tool for mid-market and large-scale enterprises.

To maximize the benefit and survive an audit, businesses should:

1. Segregate Ohio Expenses: Clearly identify wages and contractor payments for work performed within state lines to satisfy the “incurred in this state” requirement.
2. Maintain Contemporaneous Records: Link employee time logs and supply invoices directly to technical project descriptions that identify the uncertainty and the scientific principles used to resolve it.
3. Evaluate Internal Software Carefully: For IUS projects, document the “high threshold of innovation” and the significant technical risks involved.
4. Leverage Integrated Programs: Consider coupling the R&D tax credit with JobsOhio R&D Investment Loans to provide a comprehensive funding and incentive package for high-tech expansion.

In a competitive economic environment, the 7% Ohio R&D credit remains a permanent and substantial reward for businesses that choose to innovate within the state, provided they can demonstrate the necessary scientific rigor and adherence to ODT administrative standards.