Physical or Biological Science

Physical and biological sciences in the South Carolina research and development tax credit context represent the hard-science disciplines—such as chemistry, physics, and biology—required to satisfy the federal technological-in-nature test. These principles must be fundamentally relied upon during a process of experimentation to resolve technical uncertainties regarding the design, capability, or methodology of a specific business component.

The South Carolina Research Expenses Credit, as codified in S.C. Code § 12-6-3415, serves as a primary fiscal mechanism for incentivizing high-technology investment within the state. Unlike several other state-level tax incentives that create a distinct set of qualifying criteria, South Carolina’s legislature chose a path of federal conformity, tethering the state’s definitions and eligibility requirements directly to Section 41 of the Internal Revenue Code (IRC). This alignment ensures that the multi-decade evolution of federal case law and Department of the Treasury regulations regarding what constitutes "qualified research" provides the foundational bedrock for South Carolina’s tax policy. For a taxpayer to access the nonrefundable 5% credit against corporate or individual income taxes and corporate license fees, the underlying activities must transcend routine engineering and enter the realm of "experimental or laboratory" research. This detailed analysis explores the nuances of these scientific disciplines, the specific guidance issued by the South Carolina Department of Revenue (SCDOR), and the procedural requirements for substantiating a claim.

The Statutory Foundation of the South Carolina Credit

The South Carolina Research Expenses Credit is governed by S.C. Code § 12-6-3415, which was enacted to foster an environment conducive to innovation in sectors such as aerospace, life sciences, and advanced manufacturing. The statute’s primary function is to allow a credit for a taxpayer that claims a federal income tax credit pursuant to Section 41 of the IRC for increasing research activities for the taxable year. The state credit is specifically equal to 5% of the taxpayer's qualified research expenses (QREs) made within the state of South Carolina.

A critical component of this legislation is its explicit adoption of federal definitions. S.C. Code § 12-6-3415(A) mandates that "qualified research expenses" have the same meaning as provided for in Section 41 of the IRC. This means that the three categories of expenses eligible for the federal credit—wages for qualified services, supplies used in research, and a percentage of contract research expenses—are the same categories utilized for the South Carolina credit, provided those expenses are attributable to activities conducted within the state’s borders.

Expense Category	Federal Treatment (IRC § 41)	South Carolina Treatment (§ 12-6-3415)
In-House Wages	100% of wages for qualified services	100% of SC-based wages for qualified services
Supplies	100% of non-depreciable tangible property	100% of SC-used supplies
Contract Research	Generally 65% of payments to third parties	65% of SC-based contract research payments
Computer Lease/Rent	Eligible if used for qualified research	Eligible if used for SC-based R&D

The state’s credit is nonrefundable, but it offers a generous 10-year carryforward period for any unused portion of the credit. However, the utilization of the credit in any single tax year is limited by S.C. Code § 12-6-3415(B), which stipulates that the credit cannot exceed 50% of the taxpayer’s remaining tax liability after all other credits have been applied. This "ordering rule" is significant because it requires the Research Expenses Credit to be applied last, which may increase the likelihood of generating a carryforward if other credits already reduce the tax liability substantially.

Defining Physical and Biological Sciences in the R&D Context

To be eligible for the credit, research activities must satisfy the "Four-Part Test" found in IRC § 41(d). The third limb of this test—the "Technological in Nature" requirement—is where the definitions of physical and biological sciences become paramount. According to Treasury Regulation § 1.41-4(a)(4), information is technological in nature if the process of experimentation used to discover such information fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.

Principles of Physical Science

The physical sciences encompass disciplines that study non-living systems, primarily physics and chemistry. In the context of South Carolina's manufacturing-heavy economy, the application of physical sciences is often seen in the development of new materials, chemical formulations, or mechanical systems.

• Chemistry: This includes research into the composition, structure, properties, and reactions of matter. In South Carolina, a chemical manufacturer developing a new polymer with specific thermal resistance properties is engaging in research that relies on chemical principles. The process of discovering a new synthetic pathway to optimize yield or purity is a hallmark of physical science R&D.
• Physics: This discipline involves the study of matter and its motion through space and time, along with related concepts such as energy and force. Examples in the South Carolina context include aerospace firms testing the aerodynamics of new wing designs or automotive companies utilizing the principles of thermodynamics to improve engine cooling systems.
• Material Science: Often a hybrid of physics and chemistry, material science involves investigating the relationships between the structures and properties of materials. Developing a high-strength, low-weight alloy for use in industrial turbines relies heavily on metallurgical principles, which are subset of the physical sciences.

Principles of Biological Science

Biological sciences focus on living organisms and life processes. This is the cornerstone of the life sciences industry, which has seen significant growth in South Carolina’s Upstate and Lowcountry regions.

• Pharmacology and Biochemistry: Research in these fields often involves the development of new drugs or therapeutic compounds. For instance, a pharmaceutical company in South Carolina researching the interactions between different chemical compounds and biological receptors to treat oncology is fundamentally relying on biological and chemical principles.
• Microbiology and Genetics: These sciences are applied in the development of new diagnostic tools or agricultural improvements. An example includes engineering yeast strains for more efficient fermentation or developing new assays for early-stage cancer detection via liquid biopsy.
• Medical Device Development: While often involving engineering, the development of medical devices frequently relies on biological science to ensure biocompatibility or to measure physiological responses to the device.

The Exclusion of Non-Hard Sciences

It is critical to note that Treasury Regulation § 1.41-4(a)(4) explicitly excludes certain types of research from being considered "technological in nature." Research that relies on the "soft" sciences—such as economics, psychology, sociology, or management studies—does not qualify for the credit. If a company conducts a survey to determine consumer preferences for a new product’s aesthetic design, this activity is considered non-technological because it relies on market research and subjective psychology rather than the physical or biological sciences.

Local South Carolina Revenue Office Guidance

The South Carolina Department of Revenue (SCDOR) provides essential guidance on how the state laws apply to research and development activities through Revenue Rulings, Information Letters, and procedural manuals. This guidance often bridges the gap between the broad federal definitions and the specific administrative requirements of the state.

SC Revenue Ruling #08-3: R&D Machines and the "Laboratory Sense"

One of the most significant pieces of state-level guidance is SC Revenue Ruling #08-3, which addresses the sales and use tax exemption for machines used in research and development. While this ruling specifically concerns sales tax under S.C. Code Ann. § 12-36-2120(56), it provides a window into how the SCDOR defines "research and development" in a practical, physical sense.

The ruling defines "machines used in research and development" as those used "directly and primarily in research and development, in the experimental or laboratory sense, of new products, new uses for existing products, or improvement of existing products." The SCDOR clarifies that for a machine to be exempt, more than 50% of its total use must be devoted to these direct R&D activities. Activities that do not meet this "experimental or laboratory sense" include:

• Administrative uses.
• Teaching or instructional uses.
• Management studies or efficiency surveys.
• Market research.

This "experimental or laboratory sense" requirement directly parallels the federal Section 174 definition of research and development costs, which is a prerequisite for the R&D tax credit. Consequently, if a taxpayer’s activities are not conducted in an experimental or laboratory sense—meaning they do not aim to eliminate technical uncertainty through a scientific process—they will likely fail both the sales tax exemption criteria and the income tax credit criteria.

The SCDOR Tax Incentives for Economic Development Manual

The SCDOR publishes a comprehensive manual, "South Carolina Tax Incentives for Economic Development," which is updated periodically. The 2025 edition provides detailed summaries of the Research Expenses Credit and its interaction with other facility-based credits.

A recurring theme in the manual and associated statutes is the definition of a "research and development facility." For the purposes of the Job Tax Credit (§ 12-6-3360) and certain property tax exemptions, an R&D facility is defined as an establishment engaged in "laboratory, scientific, or experimental testing and development related to new products, new uses for existing products, or improving existing products." This mirrors the language found in SC Revenue Ruling #08-3 and reinforces the state's focus on the hard sciences.

Property Tax Exemptions for R&D Activities

Under S.C. Code § 12-37-220(B)(34), South Carolina provides a five-year exemption from county property taxes for the facilities of new enterprises (and additions of $50,000 or more) engaged in R&D activities. The manual notes that for property classification purposes, real property used primarily for R&D is not considered "manufacturing" property. Instead, R&D is defined as "basic and applied research in the sciences and engineering and the design and development of prototypes and processes." This distinction is vital for taxpayers when reporting property to the SCDOR on Form PT-300, as the assessment ratios and exemptions may differ.

Application of the Law: The Four-Part Test in Detail

The application of the South Carolina R&D credit hinges on the taxpayer's ability to prove that their activities satisfy each of the four federal tests. For businesses in the physical and biological sciences, this requires a rigorous internal documentation process.

Limb 1: The Permitted Purpose Test

The research must be conducted to develop a new or improved "business component," which can be a product, process, software, technique, formula, or invention. The purpose must be to improve the functionality, performance, reliability, or quality of that component.

In biological sciences, the permitted purpose might be to increase the shelf-life of a vaccine or to reduce the toxicity of a chemotherapy agent. In physical sciences, it might be to increase the tensile strength of a structural beam or the fuel efficiency of an aircraft engine.

Limb 2: The Elimination of Uncertainty Test

The taxpayer must demonstrate that they encountered technological uncertainty at the outset of the project. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the business component, or the appropriate design of the component.

This is a technical threshold. It is not enough to say that the project was "difficult." The taxpayer must show that the scientific or engineering path to the solution was not known. For example, a chemical firm may know it is possible to create a certain compound, but it may be uncertain which catalyst will produce the highest yield at a specific temperature.

Limb 3: The Technological in Nature Test

As established, the process of experimentation used to resolve the uncertainty must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science. This limb filters out activities that rely on non-scientific methods, such as trial and error based on aesthetic preference.

Limb 4: The Process of Experimentation Test

The taxpayer must show that "substantially all" of the activities involved in the project constituted a process of experimentation. This is generally interpreted as the "80% Rule"—if 80% or more of the activities for a specific business component involve a process of experimentation, then 100% of the costs for that component qualify.

A process of experimentation involves:

1. Identifying the uncertainty.
2. Identifying one or more alternatives intended to eliminate the uncertainty.
3. Conducting an evaluative process, such as modeling, simulation, or systematic trial and error, to test those alternatives.

Enhanced Incentives for Life Sciences Facilities

South Carolina provides special benefits for companies that meet the statutory definition of a "Life Sciences Facility." This designation is separate from the R&D tax credit but often applies to the same set of taxpayers.

To qualify as a "Life Sciences Facility," a business must:

• Be engaged in pharmaceutical, medicine, and related laboratory instrument manufacturing, processing, or research and development.
• Invest at least $100 million in a single project.
• Create at least 200 new full-time jobs at the project.
• Meet specific average cash compensation requirements, often at least 150% of the state per capita income.

Benefit	Standard R&D Entity	Life Sciences Facility
R&D Tax Credit	5% of SC QREs	5% of SC QREs
Property Tax	Standard R&D Exemption (5 yrs)	Enhanced Negotiated Fees-in-Lieu of Tax
Sales Tax	Exemption for R&D Machines	Enhanced Exemptions for Life Sciences
Jobs Tax Credit	Standard Tiers ($1,500 - $8,000)	Potential for higher "Service-Related" tiers

The "Life Sciences Facility" designation highlights the state’s desire to attract massive, science-driven campuses where R&D and manufacturing are integrated. For these large investors, the 5% R&D tax credit is a critical component of the overall incentive package.

Procedural Compliance and the TC-18 Form

Claiming the Research Expenses Credit in South Carolina requires the submission of SC Schedule TC-18. This form must be attached to the taxpayer's income tax return (e.g., SC1120 for corporations or SC1040 for individuals).

The TC-18 form is structured to calculate the credit and apply the statutory limitations. Taxpayers must report their qualified research expenses made in South Carolina on Line 1. The credit is then calculated on Line 2 as 5% of that amount.

The 50% Limitation Calculation

A common point of error for taxpayers is the calculation of the 50% liability limit. The instructions for TC-18 and the general rules provided by the SCDOR clarify that the credit can only offset up to 50% of the tax liability after all other credits are applied.

Mathematical Representation of the Limitation:

Let L_total be the total tax liability before any credits.

Let C_others be the sum of all other non-R&D tax credits (such as New Jobs Credits or Investment Tax Credits).

Let L_remaining be the remaining liability:

L_remaining = max(0, L_total - C_others)

The maximum R&D credit that can be claimed in the current year (C_RD_allowed) is:

C_RD_allowed = min(C_RD_earned + C_RD_carryover, 0.50 × L_remaining)

Any amount of the credit that exceeds this 50% limit is carried forward for up to 10 years. If a taxpayer fails to use the credit within 10 years from the date of the original expenses, the credit expires.

Pass-Through Entities

For partnerships, S-corporations, and LLCs, the credit is earned at the entity level but passed through to the owners on their respective SC K-1 forms. The owners then claim the credit on their own returns (individual or corporate) and are subject to the 50% limitation based on their own tax liability.

Example: Pharmaceutical Formulation and Process R&D

To illustrate the application of these principles, consider a hypothetical South Carolina company, "Astra-Bio Sciences," based in Greenville. The company is developing a new injectable medication to treat chronic inflammation.

The Scientific Objective

Astra-Bio Sciences aims to create a formulation that remains stable at room temperature, whereas current market alternatives require refrigeration. This objective requires the company to synthesize a new stabilizing protein.

The Research Activities

The company’s research team, consisting of molecular biologists and chemical engineers, engages in the following:

1. Protein Synthesis (Biological Science): Using recombinant DNA technology to create variations of the protein. This relies on the principles of genetics and biochemistry.
2. Stability Testing (Physical Science): Subjecting the various protein formulations to thermal stress tests to observe chemical degradation. This relies on the principles of chemistry and thermodynamics.
3. Process Development (Engineering): Designing a new filtration process to remove impurities from the synthetic protein during the manufacturing phase.

Encountering Technical Uncertainty

At the start of the project, Astra-Bio Sciences is uncertain whether adding a specific surfactant will stabilize the protein without causing it to aggregate (clump). The existing literature does not provide a definitive answer for this specific protein structure.

The Process of Experimentation

The company identifies three different surfactants as potential stabilizing agents. They create three batches (prototypes) and measure the aggregation rate of the protein in each batch over a six-month period. They use computer modeling to simulate the molecular interactions between the surfactants and the protein.

Qualification Analysis

• Permitted Purpose: The goal is to improve the functionality (shelf-life) of the product.
• Elimination of Uncertainty: The company did not know if the surfactants would work or which design was appropriate.
• Technological in Nature: The process relied on biology (protein synthesis) and chemistry (degradation analysis).
• Process of Experimentation: The company used modeling and systematic trial and error to evaluate alternatives.

Calculation of the South Carolina Credit

For the tax year 2024, Astra-Bio Sciences incurs the following SC-based QREs:

• Wages for Biologists and Engineers: $800,000.
• Lab Supplies (Chemicals and Proteins): $200,000.
• Contract Research paid to a SC Medical University: $100,000 (includable at 65%): $65,000.

Total SC QREs: $1,065,000.

SC R&D Credit Earned: $1,065,000 × 0.05 = $53,250.

Applying the Limitation

Astra-Bio Sciences has a South Carolina corporate income tax liability of $100,000. They also have $20,000 in other credits (e.g., New Jobs Credit).

1. Liability after other credits: $100,000 - $20,000 = $80,000.
2. Statutory R&D limit: $80,000 × 0.50 = $40,000.
3. Credit allowed for 2024: $40,000.
4. Carryforward to 2025: $53,250 - $40,000 = $13,250.

Judicial Interpretations and Administrative Deference

The landscape of South Carolina tax law is also shaped by the judiciary, particularly regarding how much deference the courts should give to the SCDOR’s interpretations of these statutes.

The Duke Energy Corp. v. SCDOR Precedent

In the 2025 case Duke Energy Corp. v. South Carolina Department of Revenue, the South Carolina Court of Appeals addressed a dispute involving the Investment Tax Credit under S.C. Code § 12-14-60. While the specific credit differs from the R&D credit, the legal principle established is universally applicable to South Carolina tax incentives.

The SCDOR had interpreted a statutory limitation of $5 million as a "lifetime cap" for the taxpayer. Duke Energy argued that the cap was "annual." The Court of Appeals found that the statute was not ambiguous and that it explicitly allowed the credit for "any taxable year." Crucially, the court held that while it is generally deferential to the SCDOR's interpretation, it cannot provide deference when that interpretation conflicts with the plain language of the statute.

For R&D taxpayers, this ruling is a "nice reminder" that the SCDOR's guidance—while authoritative—is not the final word if it restricts the credit beyond the plain text of S.C. Code § 12-6-3415. If the SCDOR were to attempt to narrow the definition of "biological science" beyond the federal Treasury regulations, the courts would likely favor the taxpayer if the taxpayer’s activities fit within the plain federal meaning adopted by the state.

The "One-Subject Rule" and Tax Reform

In South Carolina Public Interest Foundation v. Harrell, the State Supreme Court reviewed the constitutionality of the Research and Development Tax Credit Reform Act of 2007 (Act 110). The court found that parts of the act violated the "one-subject rule" of the South Carolina Constitution because they bundled unrelated subjects (like methane gas credits and amusement park exemptions) into a single bill. However, the court upheld the core R&D credit provisions as they were sufficiently related to the act’s primary purpose of promoting economic development and revenue generation. This case underscores the legislative stability of the R&D credit, even amidst broader constitutional challenges to tax legislation.

Documentation Requirements and Audit Defense

The burden of proof for claiming the Research Expenses Credit lies entirely with the taxpayer. In an audit, the SCDOR will typically look for contemporaneous documentation that substantiates both the costs (QREs) and the qualifying nature of the activities (the Four-Part Test).

Substantiating Physical and Biological Science Claims

To defend a claim involving the physical or biological sciences, a taxpayer should maintain:

1. Technical Reports and Memos: Documents that outline the specific scientific uncertainties and the hypotheses being tested.
2. Lab Notebooks and Project Logs: Proof that a process of experimentation actually occurred. This is particularly important for biological sciences, where iterations may take months or years.
3. Personnel Records: Detailed time-tracking that allocates employee hours to specific research projects rather than general administration or commercial production.
4. Supply Invoices and Vendor Contracts: Verification that the materials used were non-depreciable and that the research performed by third parties was conducted on the taxpayer's behalf and at their risk.

Documentation Type	Purpose in Audit	Source Relevance
Form W-2 / Payroll Registers	Verify the wage base for SC employees
Project Descriptions	Link activities to physical/biological science principles
Testing Results / Prototypes	Prove the "Process of Experimentation" limb
Contract Research Agreements	Prove the taxpayer bore the "Risk and Rights"

The "Shrinking-Back" Rule

In complex R&D environments, it is often difficult to qualify an entire large-scale project. The federal "Shrinking-Back" rule, adopted by South Carolina, allows a taxpayer to apply the Four-Part Test to a smaller subset of elements within a larger product if the larger product as a whole does not qualify. For example, if a new pharmaceutical manufacturing line (the large component) is not considered qualified because the manufacturing method is already known, the taxpayer may "shrink back" and claim the credit for a specific new biological sensor (the subset) within that line that did involve technical uncertainty and a process of experimentation.

Interplay with Other South Carolina Tax Credits

South Carolina’s tax landscape is unique in that many credits overlap or have specific ordering requirements.

The Headquarters Credit (§ 12-6-3410)

Taxpayers that establish a corporate headquarters in South Carolina may be eligible for a credit equal to 20% of real property costs and 20% of tangible personal property costs. To qualify for the personal property component, a taxpayer must create at least 75 new full-time jobs performing either headquarters-related functions or "research and development related functions."

This is a critical nexus. A company that establishes an R&D-focused headquarters may qualify for the Headquarters Credit and its ongoing R&D expenses may qualify for the Research Expenses Credit. However, the SCDOR’s ordering rules and the 50% liability cap on the Research Expenses Credit mean that taxpayers must carefully model their credit utilization.

The Investment Tax Credit (§ 12-14-60)

This credit applies to manufacturing and productive equipment. The SCDOR manual states that this credit does not apply to property to which other tax credits apply, such as the Headquarters Credit, unless the taxpayer waives those other credits. However, the Research Expenses Credit is generally considered an "expense-based" credit rather than a "property-based" credit, so the conflict is less frequent.

Future Outlook: Refundability and Economic Strategy

As of late 2024 and heading into 2025, South Carolina’s legislative focus remains on maintaining a simple, conformist R&D credit to compete with regional peers like Georgia and North Carolina. While South Carolina’s credit is currently nonrefundable, some regional competitors have experimented with refundability for small businesses. South Carolina’s strategy, instead, has been to offer the 10-year carryforward and to focus on lowering the overall corporate income tax rate, which makes the 50% liability limit of the R&D credit a more manageable hurdle for mature companies.

The state's Department of Commerce and the SCDOR continue to view the Research Expenses Credit as a "critical" tool for the South Carolina economy. By rewarding innovation within the state, South Carolina aims to attract high-paying jobs in the sciences and engineering, which in turn fuels the state’s tax base through individual income tax and sales tax.

Summary of Scientific and Regulatory Compliance

The South Carolina Research and Development tax credit is a powerful, yet strictly governed, incentive that rewards activities fundamentally grounded in the physical and biological sciences. By adopting the federal IRC Section 41 standards, South Carolina provides a familiar framework for multi-state corporations while maintaining specific state-level procedural guidance through the SCDOR.

Taxpayers wishing to utilize this credit must move beyond routine troubleshooting and demonstrate a commitment to experimental research. This involves identifying technical uncertainties that can only be resolved through principles of chemistry, physics, biology, or engineering, and documenting that resolution through a systematic process of experimentation. With a 5% credit rate, a 10-year carryforward, and a 50% liability cap, the South Carolina Research Expenses Credit remains a cornerstone of the state's economic development strategy for the high-technology sector.