Qualified Research Expenses (QREs)

Qualified Research Expenses in South Carolina represent the sum of in-state wages, supplies, and contract costs directly associated with technological experimentation aimed at developing or improving products or processes. This expenditure serves as the primary base for a five percent non-refundable tax credit used to offset corporate income tax and license fee liabilities for innovative businesses.

The landscape of innovation within the Palmetto State is underpinned by a robust statutory framework designed to align state-level incentives with federal standards while maintaining a distinct geographic focus on local economic growth. The South Carolina Research and Development (R&D) tax credit, as codified in S.C. Code Section 12-6-3415, functions as a powerful mechanism for companies to recover a portion of their investment in technical advancements. Unlike many other state credits that utilize a complex incremental calculation involving a historical base period, the South Carolina credit is primarily volume-based, applying a flat percentage to the total qualified expenditures made within the state. This structural simplicity is intended to reward immediate and substantial investment in the state’s technology sector, particularly benefiting manufacturing, software development, and life sciences industries that face high technical risks and substantial upfront costs.

Legislative Foundations and the Evolution of Section 12-6-3415

The authority for the South Carolina R&D credit is firmly rooted in the South Carolina Income Tax Act. The current version of the credit is the result of several legislative iterations intended to refine the incentive’s reach and simplify its administration. The credit was significantly shaped by 2000 Act No. 283, which became effective for taxable years beginning after June 30, 2001, establishing the foundational 5% rate and the 50% liability limitation. Subsequent amendments in 2003 and 2007 further clarified the definition of qualified research expenses and adjusted the carryforward provisions to better suit the long-term nature of high-tech development cycles.

The South Carolina Department of Revenue (SCDOR) administers this credit with a focus on federal conformity, meaning the state largely adopts the definitions and standards set forth by the Internal Revenue Service (IRS) under Internal Revenue Code (IRC) Section 41. This legislative choice minimizes the compliance burden on taxpayers by allowing them to utilize the same technical analysis for both their federal and state credit claims. However, the state maintains a strict geographic nexus requirement; while the federal credit applies to all research performed within the United States, the South Carolina credit is restricted to expenses “made in South Carolina”.

Detailed Definition of Qualified Research Expenses (QREs)

To understand the practical application of the South Carolina R&D credit, one must examine the specific components that constitute a “Qualified Research Expense.” Borrowing from IRC Section 41(b), South Carolina recognizes four primary categories of expenses that, when incurred in the pursuit of qualified research, are eligible for the 5% incentive.

Qualified Wages for In-State Research

Wages often represent the most significant portion of a taxpayer’s QRE portfolio. For the purposes of the South Carolina credit, “wages” are defined as compensation for which the employer is required to withhold federal income tax, typically as reported in Box 1 of Form W-2. To qualify, these wages must be paid to employees for “qualified services” performed within South Carolina. The term “qualified services” encompasses three distinct levels of activity:

The first level is “Direct Research,” which involves the actual performance of experimentation and technical work, such as a chemical engineer conducting lab tests or a programmer developing a new algorithm. The second level is “Direct Supervision,” involving the immediate management of researchers. This excludes high-level executive oversight that is purely administrative and focuses instead on supervisors who actively direct the technical path of a project. The third level is “Direct Support,” which includes the activities of individuals who assist researchers or supervisors, such as a lab technician cleaning specialized equipment or a machinist creating a prototype.

A critical administrative rule adopted by South Carolina is the “Substantially All” rule. If an employee spends 80% or more of their time performing qualified services, the taxpayer may include 100% of that employee’s wages as QREs. If the time spent falls below the 80% threshold, only the actual percentage of wages corresponding to the time spent on qualified services may be included.

Wage Component	Inclusion Status	Requirement for South Carolina Credit
Direct Research Wages	Included	Employee must be physically located in SC
Direct Supervision Wages	Included	Must be immediate technical supervision
Direct Support Wages	Included	Must be immediate assistance to QRA
Administrative Wages	Excluded	General overhead/HR/Accounting are ineligible
Executive Oversight	Excluded	Unless performing direct supervision

Qualified Supplies Consumed in Innovation

Supplies used in research are eligible QREs if they are tangible property other than land, improvements to land, or property subject to depreciation. In the context of South Carolina’s manufacturing and chemical sectors, this often includes raw materials used in the creation of prototypes, chemical reagents used in laboratory trials, and components used in the construction of first-of-their-kind models. The key distinction for supply eligibility is that the items must be used or consumed during the research process.

It is important to note that capital expenditures—such as the purchase of a building for a research lab or a large, depreciable piece of machinery—are not QREs. However, South Carolina offers other incentives for these types of investments, such as the Capital Investment Credit or specific property tax exemptions for research facilities, which can often be used in tandem with the R&D credit.

Contract Research Expenses and Third-Party Collaboration

Taxpayers often hire third parties, such as universities or specialized engineering firms, to perform research on their behalf. These costs are considered “Contract Research Expenses”. Under the IRC rules followed by South Carolina, only a percentage of these payments are considered qualified:

• General Contractors: 65% of the amount paid for qualified research services.
• Qualified Research Consortia: 75% of the amount paid to certain non-profit scientific research organizations.

For these expenses to qualify for the South Carolina credit, the research must be physically conducted within the state. If a South Carolina manufacturer contracts with an out-of-state university for a study, those expenses would be eligible for the federal credit but ineligible for the South Carolina credit. Furthermore, the contract must be for the “performance of research,” meaning the taxpayer must retain substantial rights to the results and must bear the financial risk of the research failing.

Computer Rental and Lease Costs for Research

In the era of digital transformation, South Carolina businesses increasingly rely on high-performance computing and cloud-based development environments. Payments made to a third party for the right to use computers for qualified research are eligible QREs. This typically applies to “Software-as-a-Service” (SaaS) fees for development platforms or “Infrastructure-as-a-Service” (IaaS) for running complex simulations. To be includable, the taxpayer must not be the owner or primary lessor of the computer; they must be paying for specific usage time dedicated to research activities.

The Four-Part Test: The Technical Standard for Qualified Research

South Carolina’s adoption of IRC Section 41 means that no expense is “qualified” unless it is incurred during a “Qualified Research Activity” (QRA). To be a QRA, an activity must satisfy the rigorous “Four-Part Test” used by the IRS and the SCDOR.

1. Section 174 Test (Permitted Purpose): The research must be intended to develop a new or improved “business component”. A business component can be any product, process, formula, invention, or software held for sale, lease, or license, or used in the taxpayer’s trade or business. The goal must be to improve functionality, performance, reliability, or quality.
2. Technological in Nature Test: The process must fundamentally rely on the principles of “hard” science, such as physics, biology, chemistry, engineering, or computer science. Research that relies primarily on social sciences, economics, or marketing does not qualify.
3. Elimination of Uncertainty Test: At the project’s inception, the taxpayer must encounter technical uncertainty regarding the capability or method of developing the component, or the appropriate design of the component. This distinction separates routine engineering—where the path to a solution is known—from qualified research—where the path must be discovered.
4. Process of Experimentation Test: The taxpayer must engage in a systematic process to evaluate alternatives and resolve the technical uncertainty. This typically involves modeling, simulation, systematic trial and error, or other evaluative techniques.

Activities that do not meet this test, such as research after the start of commercial production, adaptation of an existing product for a specific customer’s need, or duplication of an existing business component, are specifically excluded from generating QREs.

SCDOR Guidance and the Application of State Tax Law

The South Carolina Department of Revenue provides administrative and policy guidance that dictates how Section 12-6-3415 is applied in practice. This guidance is primarily disseminated through official forms, Revenue Rulings, and Information Letters.

Filing Requirements and Form TC-18

The primary mechanism for claiming the R&D credit is Schedule TC-18, “Research Expenses Credit”. Taxpayers must complete this form annually and attach it to their South Carolina income tax return. For corporations, this is the SC1120; for individuals receiving a pass-through credit, it is the SC1040 accompanied by the SC1040TC.

The TC-18 form serves as a worksheet to calculate the credit earned during the current year and to track carryforwards from previous years. It also calculates the critical liability limitation that governs how much of the credit can be used in a single period.

Line Item	Description	Calculation Significance
Line 1	Qualified research expenses made in South Carolina	The base for the current year credit
Line 2	Multiply Line 1 by 5% (.05)	The gross credit amount earned this year
Line 3	Credit carried forward from previous years	Inclusion of prior unused benefits
Line 4	Total credit before limitations (Line 2 + Line 3)	The total pool of available R&D credits
Line 8	50% of the taxpayer’s remaining tax liability	The statutory maximum credit allowed this year
Line 9	Lesser of Line 4 or Line 8	The final credit amount taken on the return

The 50% Liability Limitation and Ordering Rules

One of the most defining characteristics of the South Carolina R&D credit is the 50% limitation. Under S.C. Code Section 12-6-3415(B), the credit taken in any single taxable year may not exceed 50% of the taxpayer’s remaining tax liability after all other credits have been applied. This “ordering rule” means that the R&D credit is effectively used last.

For example, if a taxpayer has $100,000 in gross tax liability and claims a $60,000 Job Tax Credit (which itself may have a 50% limit), they must first reduce their liability with the Job Tax Credit before calculating the allowable R&D credit. If the remaining liability after the Job Tax Credit is $50,000, the maximum R&D credit allowed for that year would be $25,000 (50% of the remainder). This limitation ensures that taxpayers always pay at least a portion of their calculated state tax, even if they have substantial R&D investments.

Carryforward and Non-Refundability

The South Carolina R&D credit is non-refundable, meaning it cannot reduce a taxpayer’s liability below zero or result in a cash refund from the state. However, any unused portion of the credit can be carried forward for a period of 10 years. The 10-year clock begins from the date the qualified research expenses were made. This carryforward period provides a decade-long window for startups and cyclical businesses to utilize the benefits of their early-stage innovation as they move toward profitability.

Pass-Through Entity Considerations

For S-corporations, Partnerships, and LLCs, the R&D credit is calculated at the entity level. The entity then allocates the credit to its owners or partners based on their distributive share of income or ownership percentage. These owners claim the credit on their personal South Carolina income tax returns by providing the entity’s name and FEIN on their own Schedule TC-18. This structure ensures that the incentive is available to all types of businesses, not just large C-corporations.

Federal Tax Reform and South Carolina’s Conformity (2022-2025)

The treatment of research expenses has undergone dramatic shifts at the federal level, which in turn has created complexities for South Carolina taxpayers due to the state’s conformity processes.

The Impact of IRC Section 174 Capitalization

Beginning in 2022, the federal Tax Cuts and Jobs Act (TCJA) required businesses to capitalize and amortize research and experimental (R&E) expenditures over five years (for domestic research) or fifteen years (for foreign research). Previously, these costs could be immediately expensed in the year incurred. Because South Carolina’s income tax laws generally conform to the Internal Revenue Code as of a fixed date—currently December 31, 2024, for the most recent session—the state has followed these capitalization requirements.

This federal change created a significant tax burden for R&D-heavy companies, as they could no longer deduct 100% of their QREs against their current year income. However, the South Carolina R&D tax credit remained based on the total QREs incurred, not just the portion amortized that year. This allowed the credit to serve as a critical buffer against the increased tax liability caused by federal capitalization rules.

The One Big Beautiful Bill Act (OBBBA) of 2025

The federal landscape shifted again on July 4, 2025, with the signing of the One Big Beautiful Bill Act (OBBBA), which restored immediate expensing for domestic research costs under a new Section 174A for tax years beginning after December 31, 2024. This legislation also provided retroactive relief for small businesses (those with average annual gross receipts of $31 million or less), allowing them to amend their 2022-2024 returns to immediately expense previously capitalized costs.

South Carolina’s conformity to these new provisions is facilitated by Section 12-6-40, which ensures that if federal sections adopted by the state are extended by Congress, they are also extended for South Carolina purposes. This means that for the 2025 tax year and beyond, most South Carolina taxpayers will once again be able to immediately deduct their R&D costs for state income tax purposes while also claiming the 5% R&D credit on those same expenditures.

Interaction with Other South Carolina Incentives

The R&D tax credit is part of a larger ecosystem of South Carolina incentives. Sophisticated taxpayers often “stack” these benefits to maximize their total tax savings.

Job Tax Credits vs. R&D Credits

Many companies that perform R&D are also creating new jobs. The South Carolina Job Tax Credit provides a per-job credit for five years, ranging from $1,500 to $25,000 per year depending on the county’s economic tier. While the same wages can be used to qualify for both the Job Tax Credit and the R&D Credit, the credits have different rules. The Job Tax Credit is based on the number of new full-time positions, while the R&D credit is based on the dollar amount of wages and other expenses.

Capital Investment Credit

Manufacturers locating or expanding in South Carolina may also claim a Capital Investment Credit of up to 2.5% of their investment in new production equipment. Because QREs specifically exclude depreciable equipment, there is no direct overlap in the expenses claimed; rather, the two credits complement each other by rewarding both the “brains” (R&D) and the “brawn” (manufacturing equipment) of an enterprise.

Property Tax Exemption for R&D Facilities

Under S.C. Code Section 12-37-220(B)(34), new or expanded facilities engaged in research and development activities may be eligible for a five-year exemption from county property taxes. This provides an additional layer of incentive for companies to build their research centers within South Carolina, as it reduces the recurring cost of maintaining the physical space where the qualified research is performed.

Practical Example: Palmetto BioSystems, Inc.

To illustrate the complex interplay of QREs, liability limits, and administrative guidance, we consider the case of Palmetto BioSystems, Inc., a hypothetical life sciences company located in Charleston, South Carolina.

Background and Activities

In 2024, Palmetto BioSystems (PBS) developed a new, high-efficiency filtration system for pharmaceutical manufacturing. The project involved designing a new membrane (Business Component), facing uncertainty about whether the membrane could maintain integrity at high temperatures, and conducting a series of 500 lab trials (Process of Experimentation) relying on molecular chemistry and mechanical engineering.

Identification of South Carolina QREs

PBS identified the following expenses, all incurred at their Charleston facility:

• Wages: Four senior scientists spent 90% of their time on the project. Total Wages: $400,000. Under the “Substantially All” rule, 100% of their wages qualify ($400,000). Two lab assistants spent 40% of their time on the project. Total Wages: $100,000. Only 40% qualifies ($40,000). Total Qualified Wages: $440,000.
• Supplies: Specialized polymers and disposable testing vials. Total Supplies: $120,000.
• Contract Research: PBS paid the Medical University of South Carolina (MUSC) $100,000 to perform independent verification of the membrane’s filtration rate. Qualified Contract Research (65% of $100,000): $65,000.
• Total SC QREs: $440,000 + $120,000 + $65,000 = $625,000.

Credit Calculation and Application

The South Carolina R&D credit is 5% of the total SC QREs.

• Credit Earned: $625,000 x 0.05 = $31,250.

For the 2024 tax year, PBS has a South Carolina corporate income tax liability of $50,000. They also have a $10,000 Child Care Credit from another program.

1. Gross Liability: $50,000.
2. Less Other Credits: Subtract Child Care Credit ($10,000).
3. Remaining Liability: $40,000.
4. Calculate 50% Limit: 50% of $40,000 = $20,000.
5. Allowable R&D Credit: The lesser of the Credit Earned ($31,250) or the 50% Limit ($20,000).
6. Credit Taken in 2024: $20,000.
7. Carryforward to 2025: $31,250 – $20,000 = $11,250.

Compliance, Audit Readiness, and Record-Keeping

The South Carolina Department of Revenue maintains the right to audit R&D tax credit claims to ensure that the activities were truly innovative and the expenses were properly documented. Because the credit is based on technical facts, the quality of a company’s documentation is often more important than the calculation itself.

Technical Documentation Requirements

Taxpayers should maintain a contemporary “R&D Project File” that includes:

• Project charters defining the technical objectives and the uncertainties faced.
• Laboratory notebooks and experimental logs showing the dates and results of testing.
• Evidence of the process of experimentation, such as CAD revisions or failure reports.
• Contracts for third-party research specifying that PBS owns the resulting intellectual property and bears the financial risk.

Financial Documentation Requirements

To substantiate the QRE figures, the taxpayer must provide:

• Payroll records mapping employee time to specific research projects.
• Invoices for supplies with clear descriptions showing they were used for R&D.
• Forms TC-18 for all years in the carryforward chain to prove the origin of the unused credits.

Strategic Outlook and Future Considerations

The South Carolina R&D tax credit continues to be a cornerstone of the state’s economic strategy. By providing a 5% incentive on the total volume of research spending, the state encourages a high level of technical activity that supports a high-skilled workforce and attracts global industries.

As we look toward 2026 and beyond, several factors will influence the value of this credit for South Carolina businesses:

1. State Corporate Income Tax Rates: South Carolina maintains a competitive 5% corporate income tax rate. While this low rate is generally positive for business, it means that the 50% liability limitation on credits is more easily reached, making the 10-year carryforward provision a critical component of the credit’s value.
2. Remote Work and Nexus: As more technical employees work from home, companies must be diligent in tracking where research is actually performed. For a remote researcher to generate South Carolina QREs, they must be physically working within the state.
3. Inflation and Wage Growth: Because the credit is volume-based (a percentage of total dollars spent), as wages for engineers and scientists increase due to inflation, the absolute dollar value of the R&D credit naturally rises, providing an automatic hedge against the increasing costs of innovation.

Final Thoughts

The South Carolina Research and Development tax credit offers a powerful, conformist, and volume-driven incentive for businesses to push the boundaries of technology within the Palmetto State. By aligning with federal definitions while maintaining a strict local focus, the credit supports the state’s most innovative sectors and ensures that South Carolina remains a top-tier destination for the industries of the future.