Research Conducted Within This State

The South Carolina Research and Development tax credit is a five percent nonrefundable incentive based on qualified research expenditures physically performed and incurred within the state’s borders. To qualify, a taxpayer must simultaneously claim the federal research credit and ensure all state-level costs satisfy strict geographic nexus requirements.

The phrase "research conducted within this state" serves as a restrictive geographic clause that distinguishes the South Carolina Research and Development (R&D) credit from its federal counterpart under Internal Revenue Code (IRC) Section 41. While the federal credit encompasses all qualified research activities within the United States, South Carolina Code Section 12-6-3415 mandates a specific segmentation of expenditures to isolate only those occurring within the legal boundaries of South Carolina. This requirement creates a complex compliance environment where taxpayers must not only satisfy the scientific and technological rigor of the federal four-part test but also maintain meticulous records of the physical location where every hour of labor was logged, every supply was consumed, and every contract research activity was performed. The statutory framework effectively uses federal eligibility as a baseline for scientific validity while imposing state-specific limits to ensure the fiscal benefit of the credit remains tied to local economic investment and job performance.

Statutory Framework and the Legal Definition of In-State Research

The primary authority for the R&D credit is S.C. Code Section 12-6-3415, which provides that a taxpayer who claims a federal income tax credit for increasing research activities is allowed a credit against South Carolina income tax or corporate license fees. The credit is precisely valued at five percent of the taxpayer's qualified research expenses (QREs) "made in South Carolina". The term "made in South Carolina" is interpreted by the South Carolina Department of Revenue (SCDOR) as a physical nexus requirement, meaning the research activity itself must take place within the state.

Federal Conformity and the Adoption of IRC Section 41

South Carolina maintains a policy of substantial conformity with the Internal Revenue Code, as periodically updated by the General Assembly. For the purposes of the R&D credit, the state explicitly adopts the definitions of "qualified research" and "qualified research expenses" found in IRC Section 41(b). This adoption simplifies the initial eligibility phase, as a project that meets federal standards is generally considered "qualified research" for state purposes.

Statutory Element	Federal Definition (IRC § 41)	South Carolina Application (§ 12-6-3415)
Qualified Research	Must pass the four-part test: Permitted Purpose, Elimination of Uncertainty, Process of Experimentation, and Technological in Nature.	Adopts federal definition but requires the activity to be physically performed within the state.
Wages	Cash compensation paid to an employee for performing, supervising, or supporting qualified research.	Limited to wages paid for services performed physically in South Carolina.
Supplies	Tangible property used in research, excluding land and depreciable assets.	Limited to supplies used or consumed within South Carolina during the research process.
Contract Research	65% of amounts paid to third parties for qualified research.	Limited to 65% of payments where the research was performed in South Carolina.

The state’s reliance on federal definitions creates a "verification proxy" mechanism. By requiring the taxpayer to claim the federal credit first, South Carolina leverages the audit and documentation standards of the Internal Revenue Service (IRS) to validate the technical nature of the research. This ensures that the state’s five percent credit is only applied to high-value, scientifically valid innovation, while the SCDOR focuses its own enforcement efforts on the geographic "nexus" of those expenses.

Department of Revenue Guidance and Administrative Interpretation

The South Carolina Department of Revenue provides administrative guidance through various channels, including Revenue Rulings, Information Letters, and formal instructions for tax forms like the TC-18. While there is no single Revenue Ruling that exclusively defines "Research Conducted Within This State," the department's position is integrated into broader policy manuals and specific instructions that emphasize physical location.

The Requirement of Contemporaneous Documentation

Administrative guidance emphasizes that the taxpayer carries the burden of proof to demonstrate that expenses were "made in South Carolina". For in-house research, the SCDOR expects to see time-tracking data that identifies where employees were located when research services were performed. In the era of remote work, this has significant implications; an employee of a South Carolina company who performs qualified research from a home office in North Carolina would not generate QREs for the South Carolina credit, as the research was not conducted "within this state".

The department also provides clarity on "Qualified Research Expenses" through the instructions for Form TC-18. These instructions state that the credit is five percent of the QREs "as defined by IRC 41(b), made by the taxpayer in South Carolina during the tax year". This wording confirms that the geographic filter applies to the entire definition of QREs, including wages, supplies, and contract research.

Ordering Rules and the 50% Liability Limitation

A unique aspect of South Carolina’s administrative guidance is the strict ordering rule for applying the R&D credit. Unlike some credits that may be applied first, the Research Expenses Credit must be applied after all other nonrefundable credits have been used. Furthermore, the credit is limited to 50 percent of the taxpayer's remaining tax liability.

The SCDOR’s guidelines for calculating this limitation involve a multi-step process:

1. Determination of Pre-Credit Liability: Calculate the tax due under Chapter 6 (Income Tax) and Section 12-20-50 (License Fee).
2. Application of Prior Credits: Deduct all other nonrefundable credits, such as the Job Tax Credit or the Headquarters Credit.
3. Calculation of the 50% Cap: Multiply the remaining liability by 0.50.
4. Credit Utilization: The taxpayer uses the lesser of the earned R&D credit or the 50% cap.

Any unused credit may be carried forward for a period of 10 years. However, the carryforward period is not indefinite; the credit must be used within 10 years from the date of the qualified research expenses. This creates a "use-it-or-lose-it" window that incentivizes companies to reach profitability or maintain consistent tax liability to exhaust their credits.

Judicial Scrutiny and Constitutional Consistency

The R&D tax credit has been influenced by significant judicial review, most notably regarding the procedural validity of its enactment. In the case of South Carolina Public Interest Foundation v. Harrell (2008), the South Carolina Supreme Court reviewed Act 110 of 2007, the "Research and Development Tax Credit Reform Act".

The One-Subject Rule and Act 110

The litigation centered on Article III, Section 17 of the South Carolina Constitution, which mandates that an act should relate to only one subject. Petitioners argued that the General Assembly had bundled numerous unrelated tax and spending provisions into single acts. The Court, while striking down certain unrelated sections in other bills, upheld the core of the Research and Development Tax Credit Reform Act. The Court found that sections relating to revenue raising and economic incentives were sufficiently germane to the act's title to satisfy the constitutional requirement.

This judicial confirmation was vital because it preserved the 2007 transition from a more complex incremental credit to the current straightforward five percent credit on total South Carolina QREs. The Court’s decision reinforced the legislative intent to provide a stable, predictable incentive for R&D-intensive businesses.

Detailed Analysis of Qualifying Components

To fully understand "Research Conducted Within This State," one must dissect how each category of QRE is treated under South Carolina law and SCDOR interpretation.

Qualified Wages in a Multi-State Environment

Wages are typically the largest portion of a taxpayer's QREs. In South Carolina, these must be paid for "qualified services" performed within the state. Qualified services include:

• Direct Research: Conducting the scientific experimentation itself.
• Direct Supervision: First-line management of the research process.
• Direct Support: Technical support, such as lab technicians cleaning equipment or software developers maintaining a dedicated R&D server.

For a multi-state corporation, the SCDOR expects a clear allocation. If a lead researcher spends 60 percent of their time at a lab in Greenville, SC, and 40 percent at a headquarters in Charlotte, NC, only 60 percent of their qualified wages are eligible for the South Carolina R&D credit. This necessitates a robust internal accounting system to track employee movements and project assignments.

The Supply Consumption Test

The "within this state" requirement for supplies is based on usage, not purchase location. Supplies are defined as tangible personal property used in the conduct of qualified research.

Supply Origin	Consumption Location	Eligible for SC R&D Credit?
South Carolina Vendor	South Carolina Lab	Yes.
Out-of-State Vendor	South Carolina Lab	Yes.
South Carolina Vendor	Out-of-State Lab	No.
Out-of-State Vendor	Out-of-State Lab	No.

This distinction is crucial for manufacturing sectors like the aerospace and automotive industries in South Carolina. A company developing a new fuel injection system may purchase specialty alloys from a German supplier; as long as those alloys are physically fabricated and tested within a South Carolina facility, the cost qualifies for the state credit.

Contract Research and the Vendor Nexus

Under Section 12-6-3415, contract research is limited to 65 percent of the amount paid to an outside person for qualified research. The "made in South Carolina" requirement extends to the contractor's activities. If a South Carolina life sciences firm hires a university in Georgia to perform clinical trials, those expenses are generally excluded from the South Carolina credit calculation, even if the South Carolina firm manages the project. Conversely, if the same firm hires the Medical University of South Carolina (MUSC) or Clemson University to perform the research, the expense is eligible because the research is conducted "within this state".

Integrated Case Study: Palmetto Aerospace Components, LLC

To illustrate the application of these rules, consider a hypothetical manufacturer, Palmetto Aerospace Components, LLC (PAC), which designs custom propellers and aerospace parts. PAC is a C-Corporation based in Charleston, SC, and also has a small sales office in Virginia.

2024 Financial Data and Research Activities

In 2024, PAC conducts a major project to develop a new noise-reducing propeller blade. The project meets the federal four-part test, and PAC claims the federal R&D credit. Their total 2024 R&D expenditures are as follows:

Expense Category	Total Federal QREs	South Carolina Portion	Explanation of SC Eligibility
Wages	$1,000,000	$800,000	$200k paid to the VA sales team; $800k paid to the SC design and engineering team.
Supplies	$250,000	$200,000	$50k in materials used for testing in VA; $200k in carbon-fiber used in the SC lab.
Contract Research	$100,000	$50,000	$50k paid to a Florida lab; $50k paid to a Clemson University testing facility.
Total QREs	$1,350,000	$1,050,000	(Calculation of contract research follows below).

Calculation of the South Carolina R&D Credit

1. Identify SC In-House Expenses:
   • Wages: $800,000
   • Supplies: $200,000
   • Sub-total: $1,000,000
2. Identify SC Contract Research:
   • Total SC Contract Expense: $50,000 (only the Clemson portion)
   • Qualified Portion (65%): $50,000 × 0.65 = $32,500
3. Total SC QREs:
   • $1,000,000 + $32,500 = $1,032,500
4. Calculate Credit Earned:
   • $1,032,500 × 0.05 = $51,625

Applying the 50% Tax Liability Limitation

PAC has a South Carolina tax liability of $100,000 before any credits. They also claim a Job Tax Credit of $20,000.

1. Liability Before R&D Credit: $100,000
2. Less Job Tax Credit: $100,000 - $20,000 = $80,000
3. Calculate 50% Limit: $80,000 × 0.50 = $40,000
4. Credit Used in Current Year: The credit used is limited to $40,000.
5. Carryforward: $51,625 - $40,000 = $11,625. This amount can be carried forward for 10 years.

Interaction with Other South Carolina Incentives

The R&D credit does not exist in a vacuum; it is part of a broader suite of incentives that often overlap in the "innovation lifecycle".

Job Tax Credit (§ 12-6-3360)

The Job Tax Credit (JTC) is a significant incentive for "research and development facilities". While the R&D credit targets expenditures, the JTC targets employment headcount. A company that establishes a new R&D lab in a "Least Developed" county may earn up to $25,000 per job per year for five years.

The SCDOR provides guidance on how these two credits interact. Because both credits are generally limited to 50 percent of tax liability, a company with high employment and high R&D spending may find itself with substantial carryforwards if its tax liability is insufficient to absorb both.

Headquarters Credit (§ 12-6-3410)

The Headquarters Credit provides a 20 percent credit on the real and personal property costs of a new or expanded headquarters. For the personal property component, the taxpayer must create at least 75 new jobs, which can include "research and development related functions".

This creates a strategic opportunity:

• Infrastructure phase: Use the Headquarters Credit for property costs.
• Hiring phase: Use the Job Tax Credit for personnel growth.
• Operational phase: Use the R&D Tax Credit for ongoing innovation expenses.

Property Tax Exemptions for R&D Activities

South Carolina provides a five-year exemption from county property taxes for facilities engaged in research and development. Under S.C. Code § 12-37-220(B)(34), this applies to new enterprises and additions to existing facilities valued at $50,000 or more.

The definition of "research and development" for property tax purposes is consistent with the scientific and engineering focus of the income tax credit: "basic and applied research in the sciences and engineering and the design and development of prototypes and processes". This alignment ensures that a company’s physical laboratory and the activities conducted within it are both incentivized under different tax types.

Policy Critiques and Future Outlook

The South Carolina Taxation Realignment Commission (TRAC) and other economic development analysts have periodically reviewed the R&D credit’s effectiveness. A major point of discussion in the TRAC Final Report (2010) was the "incremental" vs. "flat" nature of the credit.

At the federal level, the credit is generally based on the increase in research spending over a base period. In South Carolina, while a taxpayer must claim the federal incremental credit to be eligible, the state credit is often viewed as a flat five percent on total state QREs, which can make it more generous for companies with steady, rather than increasing, R&D budgets. TRAC suggested that the state credit should perhaps be brought more in line with the federal incremental model to truly incentivize growth rather than just maintenance of research activities.

Another area of focus is the nonrefundable nature of the credit. Many high-growth startups incur the highest R&D costs when they have zero tax liability. While the 10-year carryforward is helpful, it does not provide the immediate cash flow that a refundable credit (as seen in some other states) would offer. Proponents of the current system argue that the nonrefundable nature protects the state's budget and ensures that the credit is only used by companies that are ultimately successful and contributing to the tax base.

Summary of Compliance and Filing Procedures

To successfully claim and maintain the R&D credit in South Carolina, a taxpayer must follow a rigorous set of procedures outlined by the SCDOR.

1. Federal Filing: Complete Federal Form 6765 and ensure the federal R&D credit is claimed for the same taxable year.
2. State Documentation: Segregate all QREs to isolate those "made in South Carolina".
3. Form TC-18: Complete South Carolina Schedule TC-18, "Research Expenses Credit".
4. Ordering Rule: Ensure the R&D credit is the last nonrefundable credit applied in the calculation of tax liability.
5. Pass-Through Allocation: For partnerships or S-Corps, allocate the credit to owners based on their ownership share and report on Schedule K-1.
6. Retention of Records: Maintain all time logs, supply invoices, and third-party contracts for at least the standard three-year statute of limitations (or longer if carryforwards are utilized).

The "Research Conducted Within This State" requirement is more than a simple geographical boundary; it is a fundamental pillar of South Carolina's economic strategy. By requiring that the scientific "process of experimentation" physically occur in South Carolina, the state ensures that its tax incentives translate directly into laboratories, technical personnel, and advanced manufacturing capabilities within its own borders. For professional tax practitioners and corporate planners, a nuanced understanding of this geographic nexus—combined with a strict adherence to SCDOR’s ordering rules and federal conformity—is essential for maximizing the value of this high-impact incentive.

Final Thoughts

The rigorous analysis of location and expense allocation remains the critical factor for ensuring compliance and maximizing the benefit of the South Carolina R&D Tax Credit.