Technological in Nature Test

The "Technological in Nature" test requires that a taxpayer’s research activities fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. Under South Carolina law, this criterion ensures that tax incentives are reserved for scientific innovation rather than aesthetic, market-based, or routine business improvements.

The "Technological in Nature" requirement serves as the second pillar of the comprehensive "Four-Part Test" used to define qualified research under both federal and South Carolina law. For an activity to be considered technological in nature, it must go beyond the mere application of existing knowledge; it must be undertaken to discover information that is currently unknown to the taxpayer and must do so through the methodology of the "hard sciences". In the specific context of South Carolina, where the economy is driven by heavy manufacturing, aerospace, and automotive clusters, this test distinguishes between the routine work of a skilled mechanic or craftsman and the experimental work of a research engineer or scientist. The South Carolina Department of Revenue (SCDOR) mirrors the federal definition provided in Section 41 of the Internal Revenue Code (IRC), yet the application of this test is subject to unique state-level administrative guidance, local property tax implications, and specific filing requirements through the SC Schedule TC-18.

The Statutory Foundation of Research Incentives in South Carolina

The South Carolina Research and Development (R&D) tax credit is established by S.C. Code Section 12-6-3415, which provides a credit against corporate income tax, individual income tax, and corporate license fees. The state’s legislative intent is to reward innovative industries and companies that conduct qualifying research activities within the state's borders. To achieve this, the statute explicitly adopts the federal definition of qualified research expenses (QREs) while imposing its own limitations on the credit’s use.

Alignment with Internal Revenue Code Section 41

South Carolina is a "conformity state," meaning its income tax laws generally align with the federal Internal Revenue Code as amended through a specific date—most recently December 31, 2024. For the R&D credit, the state specifically adopts the meaning of "qualified research expenses" as provided in IRC Section 41. This creates a mandatory nexus: a taxpayer is only eligible for the South Carolina state credit if they also claim a federal income tax credit under IRC Section 41 for the same taxable year.

The "Technological in Nature" test is not explicitly defined in the South Carolina Code but is incorporated by reference through the adoption of Section 41 and its accompanying Treasury Regulations, specifically Treas. Reg. § 1.41-4. This regulatory framework mandates that research is technological in nature only if it depends on the principles of:

• Physical sciences (physics and chemistry).
• Biological sciences (biology, biochemistry, and medicine).
• Engineering (mechanical, electrical, chemical, and industrial).
• Computer science (software architecture and algorithmic development).

Statutory Authority	Description
S.C. Code § 12-6-3415	Primary statute governing the R&D tax credit.
IRC Section 41(d)	Federal definition of qualified research, including the Four-Part Test.
S.C. Code § 12-6-40	Conformity statute adopting federal tax treatment.
SC Schedule TC-18	Mandatory filing form to claim the state-level credit.

The Mechanics of the Technological in Nature Test

To satisfy the "Technological in Nature" standard, a taxpayer must demonstrate that the process used to eliminate technical uncertainty was rooted in scientific principles rather than aesthetic design or business logic. This distinction is paramount in the South Carolina Administrative Law Court, where the nature of the work often determines the availability of millions of dollars in credits.

The Distinction Between Hard and Soft Sciences

The test rigorously excludes "soft sciences," which include psychology, sociology, and economics. In a business context, this means that if a South Carolina manufacturer conducts market research to determine whether customers prefer a specific color for a new vehicle, the activity fails the "Technological in Nature" test because it relies on consumer psychology. If, however, the manufacturer researches the chemical composition of a new paint to ensure it does not peel under extreme thermal conditions, the activity is technological because it relies on the physical sciences.

The fundamental requirement is that the process of experimentation used to discover information must rely on the scientific method. This involves formulating a hypothesis, testing that hypothesis through observation or experimentation, and iteratively refining the design based on the results.

The "Discovery" Rule and the Taxpayer’s Knowledge

Historically, there was significant debate over whether the "Technological in Nature" test required the discovery of information that was "new to the world" or merely "new to the taxpayer". Modern interpretations, which are followed by South Carolina, utilize the "Discovery Rule." Under this rule, research can be qualified if it discovers information that is technological in nature and is intended to be useful in the development of a new or improved business component of the taxpayer, even if that information is already known to other companies in the industry.

This is particularly relevant for South Carolina’s aerospace sector. A company developing a new carbon-fiber wing component may not be discovering the general principles of aerodynamics, which are well-known. However, they are discovering the specific application of those principles to a new, proprietary design. If the internal engineering team must resolve uncertainties about how that specific material behaves under localized stress through scientific testing, they have satisfied the "Technological in Nature" requirement.

South Carolina Department of Revenue Guidance

The SCDOR provides guidance through policy manuals, revenue rulings, and form instructions that clarify how the "Technological in Nature" test and other federal standards are applied within the state.

The South Carolina Tax Incentives for Economic Development (SCTIED) Manual

The SCTIED manual serves as the primary resource for interpreting tax law applications. In the 2025 Edition, the manual emphasizes that "research and development" facilities must be used for the purpose of discovering information that is technological in nature. Furthermore, Chapter 4 of the manual discusses the interaction between R&D and property taxes. S.C. Code Section 12-37-220(B)(34) provides a five-year exemption from county property taxes for the facilities of new enterprises engaged in research and development activities.

The SCDOR defines the phrase "research and development" for property tax purposes as "basic and applied research in the sciences and engineering and the design and development of prototypes and processes". This definition reinforces the "Technological in Nature" standard by excluding activities that do not rise to the level of science or engineering.

Revenue Rulings and Advisory Opinions

SCDOR Revenue Rulings, such as #99-5, #05-5, and #07-2, primarily address the Job Tax Credit but provide definitions for qualifying facilities that are often the same facilities claiming the R&D credit. A "research and development facility" is defined as an establishment where "tangible personal property is produced or assembled" for the purpose of testing or prototyping, or where the "design and development of prototypes and processes" occurs.

One key insight from SCDOR guidance is the "strict construction" of tax exemptions. As noted in the manual, tax exemption statutes are strictly construed against the taxpayer and in favor of the taxing authority. This means that if a taxpayer’s activity only "vaguely" involves engineering, the SCDOR is likely to deny the credit unless the taxpayer can provide comprehensive documentation proving that the work fundamentally relied on scientific principles.

SCDOR Resource	Key Guidance
SCTIED-2025 Chapter 2	Details on credit calculation and carryforward rules.
SCTIED-2025 Chapter 4	Definitions of R&D for property tax exemptions.
Revenue Ruling #19-11	Updates for job creation in Tier III and IV counties.
Form TC-18 Instructions	Filing requirements and social security privacy disclosures.

The Four-Part Test: A Synergistic Analysis

The "Technological in Nature" test cannot be analyzed in isolation. It is the second step in a four-part inquiry that every research activity must pass.

The Section 174 Test (Elimination of Uncertainty)

The activity must qualify as a research and experimental expenditure under IRC Section 174. This requires that the expenditures are made in connection with the taxpayer's trade or business and represent research and development costs in the experimental or laboratory sense. The taxpayer must intend to discover information that would eliminate uncertainty concerning the capability of development, the method of development, or the appropriateness of the design.

The Technological in Nature Test

The process of eliminating that uncertainty must fundamentally rely on principles of physical or biological sciences, engineering, or computer science.

The Business Component Test (Permitted Purpose)

The research must be intended to develop a new or improved business component, which is defined as a product, process, software, technique, formula, or invention. The work must be aimed at improving functionality, performance, reliability, or quality.

The Process of Experimentation Test

Substantially all of the activities (generally interpreted as 80% or more) must constitute elements of a process of experimentation. This involves a systematic evaluation of alternatives, such as through modeling, simulation, or trial and error.

Test Pillar	Requirement
Pillar 1	Uncertainty regarding capability, method, or design.
Pillar 2	Reliance on "hard sciences" (Physics, Biology, Engineering, CS).
Pillar 3	Development of a new or improved business component.
Pillar 4	Substantial activities involve evaluation of alternatives.

Judicial Precedents and Challenges in South Carolina

The interpretation of the "Technological in Nature" standard is often shaped by how courts view the "Process of Experimentation." In many cases, if a court finds that no scientific process was used, the activity is deemed "not technological" even if it was performed by scientists.

Phoenix Design Group and the Engineering Fallacy

In Phoenix Design Group, Inc. v. Commissioner, the court evaluated whether a firm employing professional engineers could claim R&D credits for designing building systems. The court ruled against the taxpayer, despite the use of engineers. The court’s reasoning was that the firm was merely "performing calculations and communicating the results," which did not constitute an "evaluative process that mirrors a scientific method".

For South Carolina taxpayers, this serves as a warning: simply having an engineering degree or using CAD software is not enough to satisfy the "Technological in Nature" test. The engineers must be engaged in an iterative process to solve a specific technical problem where the solution is not already known.

The Kyocera AVX Case and Documentation Nexus

A critical development in South Carolina involves Kyocera AVX Components Corp., which faced a multi-million-dollar challenge regarding its R&D credit claims. The government’s central argument was the lack of adequate documentation to substantiate that the activities met the "Four-Part Test". This case highlights that "Technological in Nature" is not just a theoretical standard but an evidentiary one. Taxpayers must provide a "nexus" between the scientific activity and the specific wages claimed.

The Kyocera case also settled a jurisdictional issue, confirming that disputes regarding the federal Section 41 credit—even when they impact state tax liability—fall under the exclusive jurisdiction of the Tax Court. This ensures that South Carolina taxpayers are bound by the same rigorous federal standards as taxpayers in other states.

Administrative Compliance: Filing the SC Schedule TC-18

To claim the South Carolina Research Expenses Credit, taxpayers must use Form TC-18. The form and its instructions provide several critical administrative rules that apply to the "Technological in Nature" context.

Identifying the Qualified Research Expenses

The form requires the taxpayer to list their "Qualified Research Expenses made in South Carolina". These expenses typically include:

• Wages: Payments to employees for the time they spend performing, supervising, or supporting qualified research.
• Supplies: Costs of tangible personal property used in the research, excluding land or depreciable property.
• Contract Research: 65% of amounts paid to third-party vendors (conducted within the U.S.) for qualified research activities.

Pass-Through Entity Rules

If a credit is generated by a partnership, S corporation, or LLC, it must be passed through to the owners on a Schedule K-1. The individual or corporate owner then reports their share of the credit on Form TC-18. The SCDOR mandates that individual taxpayers provide their Social Security Numbers on these forms, and business entities must provide their Federal Employer Identification Numbers (FEINs).

Credit Limitations and Carryforward

The South Carolina credit is non-refundable. Under S.C. Code Section 12-6-3415(B), the credit taken in any one taxable year cannot exceed 50% of the taxpayer’s remaining tax liability after all other credits have been applied. Any unused portion of the credit may be carried forward for a period of ten years.

Limitation Parameter	Rule
Annual Limit	50% of remaining tax liability.
Carryforward	10 years from the date of the expense.
Refundability	No (Non-refundable).
Ordering	Applied after all other credits.

Industrial Example: Advanced Aerospace Composites

To clarify how the "Technological in Nature" test is applied in a practical scenario, consider "Palmetto Aerospace Systems," a hypothetical manufacturer located in Charleston, South Carolina.

Scenario: Developing a High-Temperature Turbine Blade

The company seeks to develop a new turbine blade for a jet engine that can withstand temperatures 200 degrees Celsius higher than current industry standards.

Step 1: Identification of Technical Uncertainty

The company faces uncertainty regarding the appropriate alloy composition and the structural design of internal cooling channels. They do not know if a specific nickel-based superalloy will maintain structural integrity at these new temperatures.

Step 2: Application of Scientific Principles (Technological in Nature)

To resolve this, the company’s engineering team uses thermodynamics (physics), metallurgy (chemistry), and computational fluid dynamics (computer science). They are not simply "designing" a blade; they are applying the principles of the hard sciences to discover how materials behave under extreme thermal stress.

Step 3: Process of Experimentation

The team designs three different prototype blades. They perform thermal stress tests in a specialized laboratory in Charleston. After the first prototype fails, they analyze the fracture points using electron microscopy and modify the cooling channel design. This iterative cycle of testing and analysis constitutes a systematic process of experimentation.

Step 4: Expense Calculation and State Credit Claim

The company identifies the following South Carolina QREs for the tax year:

Expense Item	Calculation	Eligible SC QRE
Salaries of R&D Engineers	100% of time spent on testing	$800,000
Lab Technician Wages	Supporting the experimentation	$200,000
Nickel Superalloy Supplies	Consumed during prototyping	$150,000
3rd Party Material Testing	$100,000 x 65%	$65,000
Total SC QREs		$1,215,000

Calculation of State Credit:

• Tentative Credit: $1,215,000 \times 5\% = \$60,750$.
• Assume Tax Liability: $100,000.
• Remaining Liability after other credits: $100,000.
• Allowable Credit for Current Year: 50% of $100,000 = $50,000.
• Carryforward Amount: $\$60,750 - \$50,000 = \$10,750$ (available for 10 years).

The Impact of Federal Legislative Shifts (OBBBA and TCJA)

The "Technological in Nature" test has taken on heightened significance due to shifts in federal capitalization rules, which South Carolina follows through its conformity provisions.

The Section 174 Amortization Requirement

Starting with the 2022 tax year, the Tax Cuts and Jobs Act (TCJA) required businesses to capitalize and amortize R&D expenses over five years (fifteen years for foreign research), rather than deducting them in the year they were incurred. This created a major cash-flow challenge for South Carolina firms.

The One Big Beautiful Bill Act (OBBBA)

In July 2025, the OBBBA was signed into law, restoring the option for businesses to immediately deduct domestic R&D expenses for tax years beginning after December 31, 2024. Because South Carolina adopts the federal tax treatment for the allowance of expenses, state taxpayers will once again be able to fully deduct their South Carolina R&D expenditures in the year they are made, provided they meet the "Technological in Nature" test.

Form 6765 and Increased Documentation

The IRS has proposed revisions to Form 6765, which is used to claim the federal credit. The new version will require detailed project-by-project information, including a description of the information sought to be discovered and the alternatives evaluated. Since the South Carolina credit is dependent on a valid federal claim, these increased documentation standards will effectively become the "gold standard" for SCDOR audit compliance as well.

Strategic Implications for South Carolina Taxpayers

The interplay between the "Technological in Nature" standard and the SCDOR’s administrative requirements necessitates a strategic approach to documentation and filing.

The Importance of "Nexus"

The Kyocera case illustrates that the most common reason for credit denial is the failure to link specific wages to specific "Technological in Nature" activities. South Carolina businesses should implement project-tracking software (such as Jira or Asana) to log the time spent by engineers on R&D versus routine maintenance. Without this granular data, the SCDOR may argue that the "substantially all" requirement has not been met.

Interaction with Other State Credits

South Carolina offers several other incentives that may overlap with R&D operations, such as the "Headquarters Credit" and the "Job Tax Credit".

• Headquarters Credit: A 20% credit for real property and personal property costs associated with establishing a corporate headquarters. To qualify, the facility must handle functions like "information technology" or "planning" on a regional or national basis.
• Job Tax Credit: Provides a per-job credit for companies creating at least 10 new full-time jobs in a "research and development facility".

Taxpayers must be careful not to "double-dip" by using the same expenses for multiple credits unless explicitly allowed. For example, the R&D credit is applied after other credits, and if a company’s tax liability is already reduced to zero by the Jobs Credit, the R&D credit must be carried forward.

Audit Readiness and the SCDOR Policy

The SCDOR’s "Tax Policy Services" division is responsible for providing guidance, and they allow taxpayers to request a formal private letter ruling if the application of the law to their specific facts is unclear. For large-scale South Carolina projects, seeking a ruling on whether a new process is "Technological in Nature" can provide certainty and mitigate the risk of a future audit.

Final Thoughts

The "Technological in Nature" test is the gatekeeper of the South Carolina R&D tax credit. It ensures that the state’s tax expenditures are used to support the hard sciences and engineering efforts that drive long-term economic growth. For South Carolina businesses, the path to a successful credit claim is built on three pillars: a deep understanding of the scientific principles governing their research, a rigorous systematic process of experimentation to resolve technical uncertainties, and the maintenance of contemporaneous, project-level documentation that creates a clear nexus between scientific activities and financial expenditures.

As federal and state authorities align their documentation requirements and the OBBBA provides new cash-flow relief for domestic R&D, the credit will remain a critical tool for South Carolina’s aerospace, automotive, and technology sectors. Taxpayers who can demonstrate that their innovation is fundamentally "Technological in Nature" will be best positioned to maximize their state tax benefits while insulating their claims from the increasing scrutiny of federal and state audits.