Efficiency Surveys (Exclusion)

Efficiency survey exclusions under the South Carolina Research and Development (R&D) tax credit represent a statutory boundary that disqualifies activities aimed purely at operational optimization, management workflow, or administrative throughput. Instead, the law prioritizes research that fundamentally resolves technological uncertainties through principles of hard science and rigorous experimentation.

The South Carolina tax landscape, particularly regarding the Research Expenses Credit governed by S.C. Code Section 12-6-3415, is deeply intertwined with federal standards. To understand the “Efficiency Survey” exclusion, one must navigate the nexus between the South Carolina Department of Revenue (SCDOR) guidance and the Internal Revenue Code (IRC) Section 41. The exclusion serves as a gatekeeper, ensuring that the five percent state credit is reserved for genuine technological innovation rather than routine business improvements or administrative studies. While a company might significantly improve its bottom line or throughput by analyzing the movements of its employees or the layout of its warehouse, such activities fail to cross the threshold of “qualified research” because they do not rely on the physical or biological sciences, engineering, or computer science to solve a technical uncertainty. This report provides an exhaustive exploration of these exclusions, the administrative guidance provided by the SCDOR, and the practical application of these legal principles in a corporate environment.

The Statutory Architecture of South Carolina R&D Incentives

The South Carolina Research and Development Tax Credit is established under S.C. Code Section 12-6-3415 and is administered by the South Carolina Department of Revenue. This nonrefundable credit provides a 5% incentive on qualified research expenditures (QREs) conducted within the state. The primary purpose of this credit is to foster an environment of innovation, particularly within the manufacturing, aerospace, and technology sectors that have become the backbone of the state’s economic development strategy.

A critical feature of the South Carolina credit is its mandatory alignment with federal law. To qualify for the state incentive, a taxpayer must elect and claim the federal R&D credit under IRC Section 41 for the same taxable year. This “federal claim requirement” means that the definitions of what constitutes “qualified research” and what is “excluded” are primarily dictated by federal statutes and Treasury Regulations, which are then adopted by South Carolina.

Feature	South Carolina R&D Credit Details	Statutory Reference
Credit Rate	5% of Qualified Research Expenses (QREs)	S.C. Code § 12-6-3415
Base Amount	No state-specific base amount required	S.C. Code § 12-6-3415
Federal Link	Must claim federal credit under IRC § 41	S.C. Code § 12-6-3415(A)
Liability Limit	Cannot exceed 50% of remaining tax liability	S.C. Code § 12-6-3415
Carryforward	Unused credits can be carried forward 10 years	S.C. Code § 12-6-3415
Tax Types	Corporate Income Tax, Individual Income Tax, License Fees	S.C. Code § 12-6-3415

The South Carolina credit is notably straightforward compared to the federal version. While the federal credit often requires complex calculations involving a “base amount” or “fixed-base percentage,” South Carolina applies a flat 5% rate directly to the QREs incurred within the state. However, the 50% liability limit acts as a significant guardrail. The credit is applied after all other credits have been utilized, meaning it is often the last incentive to reduce the taxpayer’s final liability.

Understanding the Efficiency Survey Exclusion

The exclusion for “efficiency surveys” is found in IRC Section 41(d)(4)(D), which specifies activities that do not constitute qualified research. Because South Carolina leverages the federal definition of QREs under IRC Section 41(b), these exclusions are fully operative at the state level.

Defining the Scope of the Exclusion

In the context of the R&D tax credit, an “efficiency survey” is broadly defined as any study or activity intended to measure, evaluate, or improve the efficiency of existing business operations, personnel, or management techniques. This is distinct from “process research,” which might improve the efficiency of a machine through mechanical engineering. The exclusion focuses on the nature of the study rather than the result. If the primary tool of improvement is a management technique or a social science observation (such as timing a worker’s movements), it is excluded.

Treasury Regulation Section 1.41-4(c)(5) provides the regulatory teeth for this exclusion. It clarifies that qualified research does not include any:

1. Efficiency survey.
2. Activity relating to management function or technique.
3. Market research, testing, or development (including advertising or promotions).
4. Routine data collection.
5. Routine or ordinary testing or inspection for quality control.

The underlying rationale is that the tax credit is designed to incentivize technological risk and scientific discovery. Efficiency surveys, while valuable to a business, generally do not involve the level of technical uncertainty or the “hard science” methodology required by the four-part test.

The Four-Part Test and Efficiency Surveys

To be considered qualified research in South Carolina, an activity must satisfy all four requirements of the federal test. Efficiency surveys almost invariably fail one or more of these prongs.

1. The Section 174 Test

The expenditures must be eligible for treatment as expenses under IRC Section 174. Section 174 covers costs in the “experimental or laboratory sense”. Efficiency surveys are typically categorized as general administrative or operational expenses rather than experimental costs.

2. The Technological in Nature Test

The research must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. Efficiency surveys often rely on the social sciences, economics, or general management theory, which are explicitly disqualified under IRC Section 41(d)(4)(G).

3. The Business Component Test

The research must be intended to be useful in the development of a new or improved business component (product, process, software, technique, formula, or invention). While an efficiency survey might “improve” a business component, it usually does so through non-technological means.

4. The Process of Experimentation Test

Substantially all (80% or more) of the activities must constitute elements of a process of experimentation. This requires identifying a technical uncertainty, identifying alternatives, and conducting a systematic evaluation of those alternatives. Efficiency surveys often identify “uncertainty” in the business sense (e.g., “how can we work faster?”) but not in the technical sense (e.g., “what is the optimal aerodynamic design?”).

South Carolina Revenue Office Guidance

The South Carolina Department of Revenue (SCDOR) has issued various forms of guidance that clarify the application of these exclusions. While much of the guidance is found in the “South Carolina Tax Incentives for Economic Development” manual, specific interpretations can be gleaned from Revenue Rulings and Private Letter Rulings.

Revenue Ruling and Private Letter Rulings on R&D Exclusions

The SCDOR has historically taken a strict view of the R&D definition, particularly in the context of sales and property taxes, which often share definitions with the income tax credit. For instance, in Private Letter Ruling (PLR) #93-6, the department addressed “Research and Development Machinery”. The department determined that for an item to qualify as R&D machinery, it must be used directly and exclusively in research in the experimental or laboratory sense.

The department specifically listed activities that do not qualify as R&D, mirroring the federal exclusions:

• Efficiency surveys
• Management studies
• Consumer surveys
• Economic surveys
• Advertising and promotion.

This distinction is crucial for South Carolina manufacturers. If a company invests in a sophisticated computer system to track employee efficiency or to perform management studies, that computer system—and the wages of the employees operating it—will likely be excluded from both the R&D income tax credit and the R&D sales tax exemption.

Consistency Across Tax Credits

The “efficiency survey” exclusion is not limited to the R&D credit. It appears in the definition of a “research and development facility” for the purposes of the Jobs Tax Credit (S.C. Code § 12-6-3360). Under this section, a research and development facility is defined as an establishment engaged in laboratory, scientific, or experimental testing and development. The statute explicitly states: “The term does not include an establishment engaged in efficiency surveys, management studies, consumer surveys, economic surveys, advertising, promotion, banking, or research in connection with literary, historical, or similar projects”.

This provides a clear legislative intent across the South Carolina Code: the state seeks to incentivize the “hard sciences” and technical innovation, not the optimization of business administration or market analysis.

SCDOR Guidance Type	Key Takeaway for R&D Exclusions	Reference
Tax Incentive Manual	Confirms state adoption of IRC § 41 QRE definitions and federal credit requirement.	19
Private Letter Ruling #93-6	Distinguishes technical computer software development from efficiency studies.	7
Revenue Ruling #22-4	Discusses wage disallowance modifications (IRC § 280C) in SC.	23
Form TC-18 Instructions	Directs taxpayers to claim 5% of SC QREs after all other credits.	1
SC Code § 12-6-3360	Excludes efficiency surveys from the definition of R&D facilities.	20

Practical Application and the “Process” Exception

The most frequent area of confusion for taxpayers is distinguishing between an “efficiency survey” and “qualified research into a new manufacturing process.” While the former is excluded, the latter is a primary driver of R&D claims in South Carolina’s manufacturing-heavy economy.

Process Research vs. Operational Efficiency

The difference lies in the source of the improvement and the nature of the uncertainty. If a textile manufacturer in Greenville wants to increase the speed of its looms, it might approach the problem in two ways:

1. The Efficiency Survey Approach: A manager observes the operators, realizes they are taking too long to load the bobbins, and conducts a time study to reorganize the workspace. This is an efficiency survey and is excluded.
2. The Qualified Research Approach: An engineer realizes the current loom design creates too much friction at high speeds. They test different ceramic coatings for the shuttles (principles of materials science) and use trial and error to find a design that doesn’t melt at high RPMs. This is qualified research because it solves a technical uncertainty using engineering principles.

The goal in both cases is “efficiency” (higher speed), but the method to achieve it determines the tax treatment. South Carolina law rewards the technical solution, not the managerial one.

The Role of Management Techniques

The exclusion of “activities relating to management function or technique” is often cited alongside efficiency surveys. This includes Lean Manufacturing, Six Sigma, and Total Quality Management (TQM) studies. While these methodologies are standard in South Carolina’s automotive and aerospace plants, the time spent by employees in these “Black Belt” training sessions or “Kaizen” events is generally non-qualifying. The IRS and SCDOR view these as management improvements rather than technological breakthroughs.

Detailed Example: The Advanced Aerospace Composite Project

To illustrate the application of these rules, consider “Palmetto AeroTech,” a hypothetical aerospace supplier located in Charleston, South Carolina. In the 2024 tax year, Palmetto AeroTech undertakes a multi-faceted project to improve the production of carbon-fiber wing flaps.

Phase 1: Material Science and Engineering

The engineers are uncertain if a new resin can cure properly in half the time of the current resin. They conduct thermal analysis, cure-cycle modeling, and destructive testing on fifty prototypes.

• Tax Treatment: This satisfies the four-part test. It is technological in nature (chemical engineering), addresses technical uncertainty (cure rate and structural integrity), and involves experimentation (trial and error with different cure cycles). These are Qualified Research Expenses (QREs).

Phase 2: Assembly Line Reconfiguration

The production manager wants to reduce the time it takes to move the cured flaps from the autoclave to the finishing station. They conduct a study using sensors to track the path of every flap and discover that moving the finishing station 20 feet closer to the autoclave saves four minutes per flap.

• Tax Treatment: This is an Efficiency Survey. It is a study of the logistics and workflow of a business operation. It does not rely on hard science to solve a technical uncertainty regarding the flap itself. These costs are Excluded.

Phase 3: Quality Control and Routine Testing

Once the new process is established, the company implements a “zero-defect” policy where every flap is visually inspected for cosmetic blemishes.

• Tax Treatment: This is “routine or ordinary testing or inspection for quality control.” Because it is not part of a process of experimentation to resolve a technical uncertainty, it is Excluded.

Calculation of the South Carolina Credit

Palmetto AeroTech incurs $1,000,000 in wages and supplies.

• $600,000 is attributed to Phase 1 (Qualified).
• $250,000 is attributed to Phase 2 (Excluded Efficiency Survey).
• $150,000 is attributed to Phase 3 (Excluded Quality Control).

Total South Carolina QREs: $600,000

South Carolina Research Credit: $600,000 x 5% = $30,000.

Project Phase	Activity Type	Status	Reason for Exclusion
Phase 1	Material Engineering	Qualified	Solves technical design uncertainty using hard science.
Phase 2	Workflow Study	Excluded	Classified as an Efficiency Survey under IRC § 41(d)(4)(D).
Phase 3	Post-Production Inspection	Excluded	Classified as Routine Quality Control under IRC § 41(d)(4)(D).

Administrative Compliance and Documentation

To claim the credit in South Carolina, taxpayers must file Schedule TC-18, “Research Expenses Credit,” with their income tax return. This form requires the taxpayer to calculate 5% of their South Carolina QREs and apply the 50% liability limitation.

The Importance of Contemporaneous Documentation

Because the “efficiency survey” exclusion is a common point of contention during audits, taxpayers must maintain robust documentation. The SCDOR, following IRS audit techniques, often looks for “contemporaneous records” that prove the activities were technical and not administrative.

Key documentation includes:

• Project Lists: Differentiating between technical engineering projects and operational improvement projects.
• Time Tracking: Detailed logs showing that employees were performing “qualified services” (actual research, direct supervision, or direct support) rather than management or administrative tasks.
• Technical Reports: Documents that outline the specific technological uncertainty and the alternatives evaluated during the process of experimentation.
• Federal Form 6765: A copy of the federal R&D claim, which serves as the foundation for the state credit.

Audit Risk and the “Dirty Dozen”

The R&D credit is frequently scrutinized and has appeared on the IRS’s “Dirty Dozen” list of tax scams due to over-claiming of non-qualifying activities. In South Carolina, an audit of the state credit often mirrors the federal audit. If an auditor determines that 25% of the claimed activities were actually efficiency surveys or management studies, the total QREs will be reduced accordingly, leading to a clawback of the credit plus interest and penalties.

Interaction with Other South Carolina Tax Provisions

The meaning of “qualified research” and the exclusion of “efficiency surveys” ripples through multiple layers of South Carolina’s tax code, affecting not just income tax, but property and sales tax as well.

Property Tax Exemptions for R&D Facilities

South Carolina Code Section 12-37-220(B)(34) provides a five-year exemption from county property taxes for facilities of enterprises engaged in research and development. To be eligible, the facility must be devoted directly and exclusively to R&D in the experimental or laboratory sense.

The SCDOR’s application of this exemption is notoriously strict. If a facility is used even partially for efficiency surveys or management studies, the “exclusive use” requirement may be violated, leading to the loss of the property tax exemption. Taxpayers often have to “seclude” or “set apart” the R&D function from the general manufacturing or administrative areas to satisfy the department that no excluded activities are occurring in the exempt facility.

Sales and Use Tax Exemption for R&D Machines

Similarly, S.C. Code Section 12-36-2120(56) exempts the sale of machines used in research and development from sales and use tax. The SCDOR defines these as machines used “directly and primarily” in R&D. In Revenue Ruling #26-1, the department clarified that “primarily” means more than 50% of the machine’s use must be for direct R&D.

If a machine is used 40% for designing a new product (Qualified) and 20% for conducting an efficiency survey of the production line (Excluded), the qualified use is only 40%. Since this is less than 50%, the machine would not qualify for the sales tax exemption. This demonstrates how the “efficiency survey” exclusion can have significant financial consequences beyond the income tax credit.

Tax Type	Incentive	Impact of Efficiency Survey Exclusion	Reference
Income Tax	R&D Credit (TC-18)	Excludes wages and supplies from the 5% calculation.	1
Property Tax	5-Year Exemption	May disqualify the entire facility if use is not “exclusive.”	7
Sales Tax	Machinery Exemption	Counts as “non-qualifying use” in the 50% primary use test.	17
Jobs Tax Credit	Credit per Job	Facility must not be primarily engaged in efficiency surveys.	20

Deep Insight: The “Shrink-Back” Rule in Efficiency Contexts

One of the most powerful tools for a South Carolina taxpayer to navigate the efficiency survey exclusion is the “Shrink-Back” rule found in Treasury Regulation Section 1.41-4(b)(2). If a large-scale project fails to qualify because it is deemed an efficiency survey at the macro level, the taxpayer can “shrink back” the analysis to a smaller subset of the project.

Applying the Rule to Complex Systems

Imagine a South Carolina chemical plant that undertakes a $5,000,000 project to automate its entire facility. At the project level, the IRS or SCDOR might argue this is a “management technique” or an “efficiency survey” aimed at reducing labor costs.

However, by applying the shrink-back rule, the plant can identify a specific sub-component, such as a “new proprietary sensor system” that had to be designed from scratch because no commercial alternative existed. While the entire project might be an efficiency improvement, the design of the sensor involved technical uncertainty and a process of experimentation. By “shrinking back” to the sensor, the taxpayer can salvage the QREs associated with that specific technical breakthrough, even if the rest of the project is excluded as an efficiency survey.

Recent Legislative and Administrative Context

The South Carolina tax code is not static, and the treatment of R&D has seen subtle shifts in administrative priority. As of 2024 and 2025, the state remains committed to the federal alignment, but with an increased focus on documentation.

Revenue Ruling #22-4 and Wage Deductions

A significant development for South Carolina taxpayers claiming R&D credits is Revenue Ruling #22-4, which addresses the disallowance of federal wage deductions when a credit is claimed. Under federal IRC Section 280C, a taxpayer must reduce their wage deduction by the amount of the R&D credit taken.

However, South Carolina generally allows a modification to federal taxable income, permitting the deduction of these “disallowed” wages for state purposes. This means that while a South Carolina manufacturer might lose a federal deduction for the wages of an engineer (because they took the credit), they can often still deduct those wages on their South Carolina return. This nuanced interaction makes the R&D credit even more attractive for South Carolina businesses compared to those in states that do not allow such a modification.

Legislative Trends in Economic Incentives

Legislative updates, such as those summarized in SCDOR Information Letter #24-16, indicate that while the R&D credit remains stable, other credits like the Jobs Tax Credit have seen adjustments in “Tier” designations for various counties. Because the R&D credit is applied after all other credits, these changes in the Jobs Tax Credit can affect the “50% liability cap” for the R&D credit. If a company in a Tier IV county (like Marlboro or Allendale) wipes out most of its tax liability with a large Jobs Tax Credit, its ability to use the R&D credit in the current year may be limited, requiring it to carry the credit forward for up to ten years.

Strategic Considerations for South Carolina Taxpayers

For professional peers advising clients in South Carolina, the efficiency survey exclusion requires a proactive strategy. It is not enough to simply identify “projects that improved things”; one must identify “projects that solved technical problems”.

Distinguishing Between “Method” and “Technique”

A key semantic battle in audits involves the word “technique.” IRC Section 41(d)(2) lists “technique” as a valid business component, yet IRC Section 41(d)(4)(D) excludes “management techniques”.

• A Technical Technique might be a new way to weld titanium using a specific pulse-arc method. This is qualified.
• A Management Technique might be a new way to schedule the welding shifts using a software dashboard. This is excluded.

Professional advisors must ensure that the “technique” being claimed is rooted in the hard sciences. If the documentation for a South Carolina R&D claim uses words like “workflow,” “throughput,” “man-hours,” or “personnel optimization,” it is a red flag that the activity may be classified as an efficiency survey.

Leveraging the State-Specific Benefits

Despite the exclusions, the South Carolina R&D credit remains one of the most generous in the country due to its lack of a “base amount” hurdle. In many states, a company that has consistent R&D spending year-over-year may get little to no credit because they never “increase” their research over their historical base. In South Carolina, every dollar of in-state QRE earns a 5% credit, regardless of historical spending. This makes the “qualified” vs. “excluded” distinction the single most important factor in determining the value of the credit for a South Carolina taxpayer.

Summary of SCDOR Compliance Hierarchy

To ensure a successful claim and withstand an audit concerning efficiency survey exclusions, taxpayers should follow the SCDOR’s implicit hierarchy of compliance:

1. Federal Qualification: Confirm the activity meets the federal four-part test and is claimed on Form 6765.
2. Exclusion Screening: Explicitly screen for efficiency surveys, management studies, and routine quality control per IRC § 41(d)(4).
3. Sourcing to South Carolina: Ensure 100% of the claimed wages, supplies, and contract research are for activities performed within South Carolina.
4. Priority of Credits: Apply the R&D credit only after all other non-refundable credits to stay within the 50% liability cap.
5. Modification for 280C: Check if a state-level modification is needed for disallowed federal wage deductions.
6. Administrative Filing: Complete Form TC-18 and attach it to the SC1120 or SC1040.

Final Thoughts

The “Efficiency Survey” exclusion within the South Carolina R&D tax credit framework is a vital distinction that protects the integrity of the state’s innovation incentives. By mirroring federal standards, South Carolina provides a predictable but rigorous environment for taxpayers. While the exclusion of operational and management studies may seem restrictive, it encourages businesses to invest in the deeper, technological challenges that drive long-term economic growth. For South Carolina’s professional tax community, the challenge lies in meticulously documenting the scientific and engineering nature of client activities, effectively distinguishing true technological experimentation from the routine pursuit of operational efficiency. Through careful adherence to SCDOR guidance and federal regulations, taxpayers can successfully navigate these exclusions and fully realize the benefits of the state’s Research Expenses Credit.