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The Foreign Research Exclusion represents a statutory prohibition within the South Carolina tax code that prevents taxpayers from claiming research credits for any activities conducted outside the state’s borders, effectively narrowing the federal domestic research definition to an in-state requirement[cite: 3]. [cite_start]While federal law excludes research conducted outside the United States, South Carolina further restricts the incentive to qualified expenses physically incurred and performed within the state of South Carolina[cite: 3].
Statutory Genesis and Federal Conformity
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The South Carolina Research Expenses Credit is structurally anchored in the South Carolina Income Tax Act, specifically under Section 12-6-3415, which serves as the enabling legislation for the incentive[cite: 3]. [cite_start]The state’s approach to research and development (R&D) incentives is one of selective conformity; it adopts the rigorous definitions and the four-part test established by the Internal Revenue Code (IRC) Section 41 while simultaneously imposing geographic and administrative filters that reflect local economic development priorities[cite: 3]. [cite_start]The mechanism by which the state grants this credit is contingent upon the taxpayer’s eligibility for the federal research credit for increasing research activities, creating a dependency that necessitates a dual understanding of both federal exclusions and state-specific limitations[cite: 3].
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South Carolina’s tax policy is designed to attract high-value industries such as advanced manufacturing, aerospace, and life sciences, where technical innovation is a core business component[cite: 3]. [cite_start]However, the state legislature has long maintained that the subsidy should only apply to activities that provide direct economic benefit to the local workforce and infrastructure[cite: 3]. [cite_start]Consequently, the term “Foreign Research” in the context of the South Carolina R&D tax credit takes on a dual meaning: it encompasses the federal definition of research conducted outside the United States and its possessions, but it also practically includes any research conducted in other U.S. states[cite: 3]. [cite_start]This “Foreign Research Exclusion” at the state level ensures that the five percent credit is reserved exclusively for the “made in South Carolina” innovation ecosystem[cite: 3].
Comparative Framework of Geographic Eligibility
The following table delineates the geographic boundaries that determine whether research activities are categorized as “qualified” or “foreign/excluded” under federal and South Carolina tax jurisdictions.
| Research Location | Federal Qualification (IRC § 41) | South Carolina Qualification (SC Code § 12-6-3415) |
|---|---|---|
| South Carolina (Directly performed) | Qualified [cite: 3] | Qualified [cite: 3] |
| North Carolina / Georgia (Directly performed) | Qualified [cite: 3] | Excluded (State Foreign Research) [cite: 3] |
| Puerto Rico / U.S. Possessions | Qualified [cite: 3] | Excluded (State Foreign Research) [cite: 3] |
| Europe, Asia, Americas (Non-U.S.) | Excluded (Federal Foreign Research) [cite: 3] | Excluded (Total Foreign Research) [cite: 3] |
| International Waters | Excluded [cite: 3] | Excluded [cite: 3] |
The Federal Foundation: IRC Section 41(d)(4)(F)
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The specific exclusion of foreign research is codified at the federal level under IRC Section 41(d)(4)(F), which states that the term “qualified research” shall not include any research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States[cite: 3]. [cite_start]This federal provision serves as the baseline for the South Carolina credit[cite: 3]. [cite_start]The rationale behind this exclusion is fundamentally protectionist, aiming to incentivize the domestic retention of high-skilled engineering and scientific labor while preventing the export of tax-subsidized technology[cite: 3].
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For the purposes of this exclusion, the physical location of the activity is the sole determining factor[cite: 3]. [cite_start]The IRS and subsequently the South Carolina Department of Revenue (SCDOR) focus on where the individual performing the services is physically standing when the work is executed[cite: 3]. [cite_start]This means that if a scientist employed by a South Carolina corporation travels to a research facility in Germany to conduct experimentation, the wages paid for the duration of that trip are categorized as foreign research expenses and must be backed out of the credit calculation[cite: 3]. [cite_start]Similarly, if a South Carolina firm contracts with a foreign university to perform a portion of the research, those contract research expenses are ineligible, regardless of where the contract was signed or where the results are utilized[cite: 3].
The Four-Part Test Integration
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The SCDOR relies on the federal four-part test to determine if the activity itself qualifies as research, after which the geographic filter is applied[cite: 3]. [cite_start]The research must be technological in nature, relate to a new or improved business component, be intended to resolve technical uncertainty, and involve a process of experimentation[cite: 3]. [cite_start]The foreign research exclusion acts as an overriding negative filter; even if an activity perfectly satisfies all four parts of the test—such as a complex trial-and-error process using physics to develop a revolutionary automotive sensor—it is immediately disqualified if the physical lab is located outside the qualifying jurisdiction[cite: 3].
| Test Component | Compliance Focus | Geographic Influence |
|---|---|---|
| Section 174 Test | Must qualify as an experimental expenditure [cite: 3] | Subject to 5 vs 15-year amortization based on location [cite: 3] |
| Technological Information | Based on physical/biological sciences, engineering, or computer science [cite: 3] | Irrelevant if conducted outside SC borders [cite: 3] |
| Business Component | Useful in developing/improving a specific product, process, or software [cite: 3] | Component must be the subject of in-state research [cite: 3] |
| Process of Experimentation | Evaluation of alternatives through testing or trial and error [cite: 3] | The “substantially all” (80%) threshold applies to in-state activities [cite: 3] |
Administrative Guidance from the South Carolina Department of Revenue
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The SCDOR provides guidance through various channels, including the South Carolina Tax Incentives for Economic Development (SCTIED) manual, form instructions, and specific policy documents[cite: 3]. [cite_start]The department’s position is unambiguous: the Research Expenses Credit is designed to reward companies for increasing research activities within the state[cite: 3].
TC-18 Form and Compliance Instructions
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The primary administrative tool for claiming the credit is South Carolina Schedule TC-18[cite: 3]. [cite_start]The instructions for TC-18 reiterate that the taxpayer must claim a federal income tax credit under IRC Section 41 to be eligible for the state version[cite: 3]. [cite_start]Line 1 of the form requires the taxpayer to enter “Qualified research expenses made in South Carolina”[cite: 3]. [cite_start]This phrasing is a deliberate implementation of the state-level foreign research exclusion[cite: 3].
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The SCDOR also emphasizes that the credit taken in any single year cannot exceed 50% of the taxpayer’s remaining tax liability after all other credits have been applied[cite: 3]. [cite_start]This “ordering rule” means that the R&D credit is often one of the final deductions taken against corporate income tax or license fees[cite: 3]. [cite_start]If the credit is reduced or denied due to a foreign research exclusion during an audit, the impact can be significant because it cascades through the liability calculation[cite: 3].
Revenue Rulings and Policy Interpretations
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The department has issued various rulings that illustrate the state’s rigorous approach to geographic presence and economic substance[cite: 3]. [cite_start]Applying logic to the R&D credit, the SCDOR looks for the “economic process” of research to be located within South Carolina[cite: 3]. [cite_start]In recent advisory opinions and the SCTIED 2025 manual, the department clarifies that the carryforward period for the credit is 10 years[cite: 3]. [cite_start]While the R&D credit itself does not have a job-creation floor, its interaction with other incentives means that a taxpayer’s overall geographic footprint is under constant administrative review[cite: 3].
The Impact of Federal Tax Reform: TCJA and OBBBA
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The landscape of the Foreign Research Exclusion has been fundamentally altered by federal legislative changes that South Carolina follows through its general conformity statutes[cite: 3]. [cite_start]The Tax Cuts and Jobs Act (TCJA) of 2017 introduced mandatory capitalization of research expenses under IRC Section 174[cite: 3].
The Section 174 Amortization Disparity
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Under the current regime, research expenses are no longer immediately deductible and must be amortized[cite: 3]. The law treats domestic and foreign research differently:
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- Domestic (U.S.-based) Research: Amortized over 5 years[cite: 3].
- Foreign (International) Research: Amortized over 15 years[cite: 3].
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South Carolina adopts these amortization schedules by reference[cite: 3]. [cite_start]For a South Carolina taxpayer, the 15-year period for foreign research acts as a significant deterrent to offshoring R&D[cite: 3].
The One Big Beautiful Bill Act (OBBBA) of 2025
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The OBBBA has introduced further refinements, restoring same-year deductions for U.S.-based research costs for tax years beginning after December 31, 2024, but explicitly retaining the 15-year amortization for foreign research[cite: 3]. [cite_start]This creates an even wider gulf between domestic and foreign activities[cite: 3].
| Provision | Domestic (SC) Research | Foreign (Intl) Research |
|---|---|---|
| Federal Expensing (OBBBA) | Full expensing permitted (post-2024) [cite: 3] | 15-year amortization required [cite: 3] |
| South Carolina Credit | 5% of QREs allowed [cite: 3] | Excluded [cite: 3] |
| Federal Credit | Allowed (IRC § 41) [cite: 3] | Excluded [cite: 3] |
| Recovery Period (TCJA) | 5 years (pre-2025) [cite: 3] | 15 years [cite: 3] |
Legislative Changes: House Bill 4087 and R&D Restrictions
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In the spring of 2024, the South Carolina General Assembly enacted House Bill 4087, which revamped several tax incentives[cite: 3]. [cite_start]While this bill did not change the 5% rate for the R&D credit, it introduced critical exclusions affecting broader corporate tax strategies[cite: 3].
Separation of R&D Jobs from the Headquarters Credit
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The 2024 amendment explicitly changed the law so that jobs for research and development-related functions no longer count toward the job creation requirement for the headquarters credit[cite: 3]. [cite_start]This highlights a strategic move to treat R&D as a distinct activity governed by its own credit[cite: 3].
Remote Work and Geographic Complexity
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The new law modernized the definition of “employee” to include remote and hybrid workers[cite: 3]. [cite_start]For a researcher working from home in Rock Hill, SC, for a company based in Charlotte, NC, their wages may be eligible for the South Carolina R&D credit because the research is conducted within the state[cite: 3]. [cite_start]Conversely, if a South Carolina company employs a researcher working remotely from Georgia, those wages are “foreign” to the South Carolina credit[cite: 3].
Multi-State and International Corporate Complexities
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For multinational corporations, the foreign research exclusion involves complex accounting for intercompany transfers and the “funded research” doctrine[cite: 3].
The Funded Research Exclusion
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IRC Section 41(d)(4)(H) excludes any research funded by any grant or contract by another person[cite: 3]. [cite_start]To avoid the foreign research/funded exclusion, the South Carolina entity must demonstrate it has “substantial rights” and bears the “economic risk”[cite: 3].
Aggregation Rules for Controlled Groups
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Under IRC Section 41(f), all members of a controlled group are treated as a single taxpayer[cite: 3]. [cite_start]When the South Carolina return is filed, only QREs physically located in South Carolina are brought into the state calculation[cite: 3].
Practical Example: The Geographic Filter in Action
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Consider “AeroState Solutions,” an aerospace engineering firm with a presence in South Carolina, Georgia, and France[cite: 3].
Scenario Background
Expenditures for a new carbon-fiber wing stabilizer:
- Greenville, SC Lab: $1,500,000 in wages.
- Savannah, GA Facility: $500,000 in wages.
- Toulouse, France Office: $1,000,000 in wages.
- Supplies: $200,000 in materials (Greenville).
Step 1: Federal Qualified Research Expenses (IRC § 41)
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Total Federal QREs: $2,200,000 (Greenville and Savannah included; Toulouse excluded)[cite: 3].
Step 2: South Carolina Qualified Research Expenses (SC § 12-6-3415)
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Total South Carolina QREs: $1,700,000 (Greenville and Supplies included; Savannah and Toulouse excluded)[cite: 3].
Step 3: Credit Calculation and Limitation
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Credit Earned: $1,700,000 x 0.05 = $85,000[cite: 3]. [cite_start]Limitation checks apply based on state tax liability[cite: 3].
Strategic Implications of the Example
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This illustrates the “intermediate” status of other-state domestic research, which qualifies for federal but not South Carolina state credits[cite: 3].
Documentation and Audit Preparedness
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The SCDOR has increased focus on the substantiation of tax credits[cite: 3]. [cite_start]The Foreign Research exclusion is a high-risk area during an audit because it is a binary test of physical location[cite: 3].
Contemporaneous Record-Keeping
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Taxpayers must maintain meticulous records[cite: 3]:
-
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- Time-Tracking Systems: Capture the “work location” of employees[cite: 3].
- Laboratory Logs: Document where the process of experimentation occurred[cite: 3].
- Supply Invoices: Show where materials were consumed[cite: 3].
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Audit Trends and Penalties
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The SCDOR uses data analytics to identify companies with spikes in R&D spending[cite: 3]. [cite_start]If a company claimed the state credit for “foreign” research, it faces disallowed credits, interest, and penalties[cite: 3].
Future Outlook: Quantum Computing and Emerging Technologies
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South Carolina is recruiting emerging sectors like quantum computing[cite: 3]. [cite_start]The state’s “Foreign Research Exclusion” creates a challenge for distributed research teams, requiring firms to strategically localize technical resolution within South Carolina[cite: 3].
Final Thoughts
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The Foreign Research Exclusion is a critical gatekeeper in the South Carolina tax landscape[cite: 3]. [cite_start]It prioritizes local innovation over global activity[cite: 3]. [cite_start]Success for practitioners lies in the proactive isolation of state-specific research expenses and maintaining ironclad documentation[cite: 3].
