Consumer Surveys (Exclusion)

In the context of the South Carolina Research and Development tax credit, the “Consumer Survey Exclusion” represents a statutory bar against including expenses incurred for gathering market data, preference studies, or aesthetic feedback in the calculation of qualified research expenditures. This provision ensures the credit is strictly limited to activities aimed at resolving technical uncertainties through scientific experimentation rather than commercial or social science-based investigations.

The Legislative Genesis and Policy Framework of the South Carolina Research and Development Credit

The South Carolina Research and Development (R&D) tax credit, codified under Section 12-6-3415 of the South Carolina Code of Laws, functions as a critical economic lever designed to foster a high-technology industrial base within the state. Unlike many other state credits that utilize a complex incremental calculation based on a historical base period, South Carolina has adopted a more streamlined approach by offering a credit equal to 5% of a taxpayer’s qualified research expenses (QREs) incurred specifically within the state’s borders. This legislative design reflects a policy preference for direct, predictable incentives that reward current-year investments in innovation. However, the simplicity of the 5% rate is counterbalanced by the state’s rigorous adoption of the federal definitions of “qualified research” and “qualified research expenses” as established under Section 41 of the Internal Revenue Code (IRC).

The South Carolina General Assembly’s intent in enacting Section 12-6-3415 was to create a symbiotic relationship between state tax policy and federal standards. By leveraging IRC Section 41, South Carolina effectively delegates the complex technical definitions of innovation to the federal government while maintaining sovereign control over the credit rate and the geographical nexus requirements. This conformity is not merely a matter of administrative convenience but is a foundational principle of South Carolina tax law. Section 12-6-40 of the state code ensures that South Carolina’s income tax laws remain in substantial alignment with the federal code through annual conformity updates, typically adopting the IRC as it stands at the end of the preceding calendar year. Consequently, any activity excluded from the federal R&D credit—such as consumer surveys—is automatically excluded from the South Carolina credit unless the state legislature explicitly provides otherwise.

Key Statutory Component	South Carolina Provision	Federal Reference (IRC)
Governing Law	S.C. Code § 12-6-3415	IRC § 41
Credit Percentage	5% of QREs	20% (Regular) / 14% (ASC)
Expenditure Basis	South Carolina only	National (U.S.)
Carryforward Period	10 Years	20 Years
Liability Limitation	50% of remaining tax liability	Section 38 limitations
Consumer Survey Treatment	Explicit Exclusion	Explicit Exclusion § 41(d)(4)(D)

The economic rationale for the exclusion of consumer surveys lies in the distinction between “technological innovation” and “market adaptation.” South Carolina’s industrial policy, particularly within its burgeoning manufacturing and aerospace sectors, seeks to subsidize the high-risk, high-reward phase of scientific discovery where engineers and scientists struggle with the laws of physics or chemistry. Conversely, market research and consumer surveys represent a “commercial risk” rather than a “technical risk.” While understanding whether a customer prefers a specific product shape or color is essential for business success, it does not advance the state’s knowledge base in the physical or biological sciences. Thus, the South Carolina Department of Revenue (SCDOR) maintains a strict boundary around the R&D credit, ensuring that state revenue is not used to subsidize the routine business functions of marketing and advertising.

The Technical Anatomy of the Consumer Survey Exclusion

The specific exclusion for consumer surveys is rooted in the “Four-Part Test” that all activities must satisfy to qualify for the R&D credit. To understand why consumer surveys are excluded, one must analyze how they fundamentally fail to meet the cumulative requirements of Section 41(d) of the Internal Revenue Code, which South Carolina adopts in full.

The Section 174 Test and the Laboratory Sense Requirement

The first hurdle for any research activity is the “Section 174 Test,” which requires that expenditures be eligible for treatment as research or experimental costs in the “experimental or laboratory sense”. Treasury Regulation Section 1.174-2(a)(1) defines these as costs aimed at discovering information that would eliminate uncertainty concerning the development or improvement of a product. Crucially, Treasury Regulation Section 1.174-2(a)(3) explicitly identifies “consumer surveys” as an activity that does not constitute research or experimental expenditures.

This regulatory disqualification at the Section 174 level is the primary mechanism through which consumer surveys are barred from the South Carolina R&D credit. Because an expense must first qualify under Section 174 to be eligible for the Section 41 credit, and because the state code specifically incorporates these definitions, the exclusion is absolute. The “laboratory sense” requirement implies a focus on the mechanical, chemical, or digital properties of a business component. Consumer surveys, which focus on human preferences, do not seek to resolve a technical uncertainty regarding the product’s capability or design in a scientific sense.

The Technological in Nature Mandate

Even if a survey were somehow deemed to satisfy the Section 174 requirement, it would encounter the “Technological in Nature” test. This prong requires that the process of experimentation used to discover information fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science. South Carolina law and federal regulations distinguish between these “hard sciences” and “soft sciences” like economics, psychology, and management.

Consumer surveys are inherently social science-based. They utilize statistical sampling and behavioral analysis to gauge market demand or aesthetic satisfaction. While these methodologies may be rigorous, they do not rely on the physical properties of matter or the laws of biological systems. Therefore, the information discovered through a consumer survey is not “technological in nature” as defined for tax purposes. This distinction is vital in the South Carolina context, where much of the R&D activity is conducted by manufacturing firms that are frequently audited on the scientific basis of their claims.

The Process of Experimentation and Market Feedback

The third major barrier is the “Process of Experimentation” test, which requires that substantially all of the activities constitute elements of a process designed to evaluate one or more alternatives through a systematic trial-and-error methodology. Federal and state guidance clarify that “routine data collection” is not a process of experimentation. A consumer survey is, by definition, a form of data collection. While it may involve testing different product versions (e.g., “A/B testing” of a user interface), if the goal is to determine which version the user likes more, rather than which version works more effectively under technical stress, the activity remains an excluded survey.

Qualification Prong	Requirement for R&D Credit	Status of Consumer Surveys
Section 174 Test	Elimination of technical uncertainty	Excluded by Reg. § 1.174-2(a)(3)
Technological Test	Reliance on hard sciences (STEM)	Fails; based on social science
Purpose Test	Function, performance, or reliability	Fails; often related to style/taste
Experimentation Test	Systematic trial and error	Fails; considered routine data collection

South Carolina Department of Revenue (SCDOR) Guidance and Local Interpretations

The South Carolina Department of Revenue provides several critical layers of local guidance that reinforce the exclusion of consumer surveys. This guidance is disseminated through Revenue Rulings, Revenue Procedures, Information Letters, and tax form instructions.

Revenue Ruling #87-8 and Historical Precedent

One of the most enduring pieces of guidance is SC Revenue Ruling #87-8, which initially addressed the sales and use tax limitations for machinery used in research and development. Although this ruling was issued in the context of sales tax, it established a definition of “research and development” that has permeated throughout the state’s tax code. The ruling explicitly states that the R&D tax limitation “does not extend to machinery used in connection with efficiency surveys, management studies, consumer surveys, economic surveys, advertising, promotion, or research in connection with literary, historical, or similar projects”.

The significance of Revenue Ruling #87-8 lies in its focus on the usage of the machinery. It establishes that if a piece of equipment—such as a high-powered server or a laboratory computer—is used primarily for conducting consumer surveys, it loses its status as R&D equipment. This historical precedent informs the SCDOR’s current approach to the R&D income tax credit: if the activity is excluded for sales tax purposes because it lacks an “experimental or laboratory sense,” it is almost certainly excluded for the income tax credit under Section 12-6-3415.

Revenue Ruling #08-3 and the “Primary Use” Standard

In 2008, the SCDOR issued Revenue Ruling #08-3 to clarify the percentage of use required for a machine to qualify for R&D exemptions. The ruling concluded that more than 50% of a machine’s total use must be for direct research and development as defined by the statute. Crucially, the ruling reiterates that “indirect” uses, such as administrative functions, and excluded activities like “consumer surveys,” must be categorized as “non-qualifying uses”.

This ruling provides a vital operational rule for South Carolina businesses: if their technical staff uses laboratory equipment to perform both engineering tests (qualifying) and consumer preference surveys (non-qualifying), the company must track the time and usage of that equipment. If the excluded survey activities exceed 50% of the equipment’s total use, the company may lose the ability to claim exemptions or credits associated with that machinery. This demonstrates how the consumer survey exclusion applies not just to labor costs (wages), but also to the qualification of property and infrastructure used in the research process.

Form TC-18 and Reporting Compliance

The administrative vehicle for claiming the credit is Form TC-18, “Research Expenses Credit”. The instructions for TC-18 reiterate that “qualified research expenses” have the same meaning as provided in IRC Section 41. Taxpayers are required to list their South Carolina QREs and maintain detailed documentation to substantiate these expenses upon audit. The SCDOR’s policy manuals, such as the “Tax Incentives for Economic Development” guide, explicitly group consumer surveys with other management functions that are prohibited from being included in the credit base.

The Impact of the Exclusion Across Different Industry Sectors

The exclusion of consumer surveys has varying implications depending on the industry sector. In South Carolina, the impact is most pronounced in manufacturing, software development, and the burgeoning life sciences sector.

Manufacturing and Product Refinement

South Carolina’s manufacturing base, including automotive and aerospace giants, frequently engages in research to improve product reliability and performance. In these environments, the line between a consumer survey and a functional test can be thin. For example, if an automotive company conducts a survey to see if drivers find a new seat design comfortable, the costs are excluded as a consumer survey. However, if the company uses sensors to measure the physical pressure exerted on the driver’s spine and adjusts the seat’s mechanical structure to reduce fatigue, the activity qualifies as R&D.

The SCDOR scrutinizes these activities during audits to ensure that the “permitted purpose” of the research relates to function, performance, reliability, or quality, rather than style or taste. If the documentation for a project focuses heavily on “customer satisfaction scores” rather than “engineering tolerance levels,” the SCDOR is likely to reclassify the entire project as an excluded management study or consumer survey.

Software Development and User Experience (UX)

In the software industry, “User Experience” (UX) research often involves observing how users interact with a product. Under federal and South Carolina law, research relating to the “adaptation of an existing business component to a particular customer’s requirement” is also excluded. When software developers conduct surveys to determine which interface layout is more intuitive, they are often performing an excluded consumer survey.

For the activity to qualify, the developer must prove that the research was intended to solve a technical problem, such as reducing the computational load of the interface or improving its responsiveness over low-bandwidth connections. If the survey simply gathers feedback on whether the icons are “pretty” or “easy to find,” it falls under the cosmetic and consumer survey exclusions.

Industry Sector	Qualifying Activity Example	Excluded Consumer Survey Example
Automotive	Testing impact resistance of a new bumper material.	Surveying buyers on preferred paint colors for a new model.
Software	Developing a new algorithm for real-time data encryption.	Surveying users on whether they like a “dark mode” interface.
Pharmaceuticals	Clinical trials to determine drug efficacy and safety.	Market research on the optimal brand name for a new medication.
Aerospace	Wind tunnel testing of a new wing configuration.	Focus groups on passenger seat comfort for a commercial jet.

Administrative Procedures and Audit Defense Strategies

Given the strict nature of the consumer survey exclusion, South Carolina taxpayers must adopt proactive strategies to document their R&D activities and protect their credits from SCDOR disallowance.

The “Substantially All” Rule as a Protective Shield

The “substantially all” rule, found in IRC Section 41(d)(1)(C), states that an activity constitutes qualified research only if 80% or more of the activities involve a process of experimentation. This rule is a double-edged sword regarding the consumer survey exclusion. On one hand, if a project is primarily composed of engineering work (say 85%) and contains a minor component of consumer feedback (15%), the entire project might still qualify.

However, the SCDOR often uses the “shrink-back” rule to isolate non-qualifying components. If the consumer survey is a distinct phase of a project, the Department can “shrink back” the business component to the level where the exclusion applies, thereby disqualifying all costs associated with that specific phase. Consequently, taxpayers should avoid bundling survey costs with engineering costs in their internal accounting.

Documentation and Narratives

The key to a successful R&D tax credit claim in South Carolina is the “narrative” provided during an audit. A well-structured narrative must:

• Identify the Technical Uncertainty: Clearly state the engineering or scientific challenge that the taxpayer was trying to solve.
• Describe the Process of Experimentation: Detail the trials, prototypes, and models used.
• Distinguish from Excluded Activities: Explicitly state that the data collected was functional and technical, rather than social or aesthetic.

If a taxpayer’s internal project titles include words like “Market Research,” “Focus Group,” or “User Sentiment Analysis,” they are essentially handing the SCDOR a reason to disallow the credit. Professional tax analysts in South Carolina recommend using technical terminology that reflects the “hard science” nature of the work, such as “Ergonomic Stress Analysis” instead of “Comfort Survey”.

The Role of IRC Section 174A and Conformity

The landscape of R&D tax law shifted significantly with the federal Tax Cuts and Jobs Act (TCJA), which required the amortization of Section 174 expenses starting in 2022. South Carolina, through its conformity rules, initially adopted this requirement, creating a temporary disconnect where companies had to capitalize their R&D costs for state purposes. However, the 2025 “One Big Beautiful Bill Act” (OBBBA) restored immediate expensing for domestic R&D.

This restoration reinforces the state’s desire to keep R&D cash-flow positive for businesses. However, it also means that the SCDOR has a renewed interest in ensuring that the costs being immediately deducted—and credited at 5%—are truly scientific and not excluded market studies. The restoration of Section 174 expensing makes the consumer survey exclusion a higher-stakes issue, as the immediate tax impact of a disallowance is greater for the taxpayer.

Comparison with Regional Peer States

To understand the nuance of South Carolina’s approach, it is helpful to look at how neighboring states handle the same exclusion. States like Virginia and Texas also conform to the federal Section 41 definitions but have different administrative emphasizes.

Virginia, for instance, provides a sales and use tax exemption for property used in research and development that is almost identical in language to South Carolina’s. The Virginia regulations specify that “research” does not include “consumer surveys, economic surveys, or advertising”. This regional consistency suggests that the consumer survey exclusion is a standard boundary for state economic incentive programs, designed to prevent the erosion of the tax base by routine business expenses that do not contribute to long-term technological progress.

Texas, which offers a franchise tax credit and a sales tax exemption, also utilizes the Section 41 four-part test. The Texas Administrative Code and subsequent rulings have echoed the SCDOR’s stance: that while market research is a valid business expense, it is not “qualified research” for the purpose of specialized tax incentives.

State	R&D Credit Rate	Federal Conformity	Consumer Survey Treatment
South Carolina	5% (Flat)	Rolling Conformity	Explicitly Excluded
Virginia	15% (Capped)	Static Conformity	Explicitly Excluded
Texas	6.25% (Incremental)	Rolling Conformity	Explicitly Excluded
Michigan	Variable (Capped)	Partial Conformity	Explicitly Excluded

Detailed Case Study: The “SolarPalmetto” Innovation Project

To bring these legal and regulatory concepts together, consider the hypothetical case of “SolarPalmetto,” a renewable energy startup based in Greenville, South Carolina.

The Innovation: High-Efficiency Thin-Film Solar Panels

SolarPalmetto is developing a new type of thin-film solar cell using a perovskite structure that is significantly more efficient than standard silicon panels in low-light conditions. The project involves three distinct phases:

1. Phase I: Material Science and Prototyping. The company’s chemists experiment with different chemical vapor deposition techniques to apply the perovskite layer without creating defects. They build 50 small-scale prototypes and test their electrical output under varying light intensities.
2. Phase II: Durability and Stress Testing. The company exposes the prototypes to extreme South Carolina humidity and heat in a specialized environmental chamber to see how long the perovskite layer lasts before degrading.
3. Phase III: Market Launch and Consumer Feedback. Before the full-scale launch, the company sends 20 functional units to local homeowners. They conduct a survey asking the homeowners if they like the “darker aesthetic” of the new panels and whether they would prefer the panels to be sold through a subscription model or a direct purchase.

The Tax Analysis

Applying S.C. Code Section 12-6-3415 and the associated guidance:

• Phase I & II: These activities qualify as R&D. They are technological in nature (material science), aim to eliminate technical uncertainty (defect reduction and durability), and involve a process of experimentation. The wages of the chemists and the cost of the chemicals are QREs. If these costs total $500,000, SolarPalmetto earns a $25,000 state credit.
• Phase III: The costs associated with the homeowner survey—including the staff time to create the questionnaire and analyze the results—are excluded as a consumer survey. These are market studies and management functions relating to the “aesthetic” and “commercial” aspects of the product. Even though the panels being tested are functional prototypes, the activity of surveying the users for their opinions is what triggers the exclusion.

The Financial Impact of Misclassification

If SolarPalmetto incorrectly included the $50,000 cost of the Phase III survey in its R&D claim, it would overstate its credit by $2,500 ($50,000 x 5%). Upon audit, the SCDOR would disallow this amount. If the company had already used the credit to reduce its corporate license fee or income tax, it would be liable for the back taxes, plus interest and potential penalties for the understatement of tax.

Interplay with Other South Carolina Credits

The consumer survey exclusion is also relevant when a taxpayer is navigating the “ordering rules” of South Carolina credits. Section 12-6-3415 provides that the R&D credit can only be applied after all other credits have been used, and it is limited to 50% of the remaining liability.

If a company is also claiming the “Jobs Tax Credit” under Section 12-6-3360, it must be aware that the definition of a “Research and Development Facility” for the job credit also excludes establishments engaged in consumer surveys. This creates a high level of risk for a company that misidentifies its core function. If a facility is primarily engaged in market analytics and consumer surveys, it may not only lose the R&D expenditure credit but also the $1,500 to $8,000 per-job tax credit, as it would no longer meet the definition of a qualifying “facility”.

Future Outlook: Technology-Intensive Facilities and Beyond

As South Carolina continues to attract sophisticated tech firms, the definition of “Consumer Survey” may face new challenges, particularly in the realm of Big Data and Artificial Intelligence (AI).

Many modern AI companies use “Reinforcement Learning from Human Feedback” (RLHF) to improve their models. The SCDOR has not yet issued a specific Revenue Ruling on whether human feedback used to train a neural network is an “excluded consumer survey” or a “qualified support activity” for a technological experimentation process. However, based on the current regulatory framework, the Department is likely to maintain that if the feedback is used to align the AI with “human preference” (e.g., making the AI’s tone more polite), it remains an excluded survey of taste and sentiment. If the feedback is used to identify and correct technical errors in the model’s logic, a stronger case for qualification could be made.

Final Thoughts and Recommendations for Professional Practice

The Consumer Survey Exclusion is a cornerstone of the South Carolina R&D tax credit, serving as the primary guardrail that keeps the incentive focused on hard scientific progress. By adhering to the federal standards of IRC Section 41 and supplementing them with local Revenue Rulings like 87-8 and 08-3, the state has created a clear, albeit strict, environment for innovation.

For tax professionals and business leaders in South Carolina, the path forward involves a rigorous internal audit of all R&D projects to ensure that:

• Any activity aimed at measuring customer satisfaction, aesthetic preference, or market demand is systematically removed from the QRE base.
• Documentation for qualifying projects focuses on technical challenges and engineering datasets rather than marketing outcomes.
• Usage of machinery and equipment is tracked to ensure it remains “primarily” devoted to qualifying research as per Revenue Ruling 08-3.

As South Carolina’s economy becomes increasingly data-driven, the distinction between “gathering data” and “conducting an experiment” will remain the defining boundary of the R&D tax credit. Companies that respect this boundary can leverage the 5% credit to significantly reduce their state tax burden, while those that attempt to include excluded surveys risk costly audits and the loss of their most valuable economic incentives.