Advertising or Promotions (Exclusion)

Under South Carolina law, the Advertising or Promotions exclusion refers to the statutory disqualification of expenses related to market research, commercial testing, and aesthetic development from the state’s five percent research tax credit. This exclusion ensures that the credit is strictly applied to technical innovation and the resolution of scientific uncertainties rather than the commercial exploitation or public branding of a business component.

The South Carolina Research and Development (R&D) tax credit, codified under Section 12-6-3415 of the South Carolina Code of Laws, serves as a cornerstone of the state’s strategy for fostering a high-technology industrial base. By providing a nonrefundable credit against corporate income tax, individual income tax, or corporate license fees, the state effectively subsidizes the wages, supplies, and contract research costs incurred by businesses seeking to develop new or improved products and processes. However, this incentive is not an open-ended grant for all business activities. Instead, it is governed by a strict set of definitions inherited from federal law through the state's conformity with the Internal Revenue Code (IRC). Central to these definitions is the exclusion of "market research, testing, or development (including advertising or promotions)" found in IRC Section 41(d)(4)(D).

The policy rationale for this exclusion is rooted in the fundamental distinction between the "discovery" of information and the "dissemination" of information. The R&D credit is designed to offset the inherent risks associated with technical uncertainty—the possibility that a scientific or engineering goal cannot be achieved despite the investment of significant resources. In contrast, advertising and promotions are activities undertaken once technical uncertainty has largely been eliminated. These commercial efforts focus on consumer preference, market share, and brand positioning, which, while vital for business success, do not satisfy the state’s requirement for technological advancement in the physical or biological sciences. Consequently, South Carolina Department of Revenue (SCDOR) guidance, particularly Information Letter #21-14, reaffirms that the state mirrors federal law in surgically removing these commercial costs from the calculation of qualified research expenses.

Statutory Origins and Federal Conformity in South Carolina

The South Carolina Income Tax Act is designed to follow the federal tax structure with significant fidelity, a concept known as "piggybacking" or federal conformity. Section 12-6-40 of the South Carolina Code states that the state’s income tax laws conform to the Internal Revenue Code as amended through a specific date—most recently updated to include changes through December 31, 2024. This conformity simplifies compliance for taxpayers, as they can generally use their federal taxable income as a starting point for their state returns, subject to specific modifications listed in Section 12-6-50.

When the South Carolina General Assembly enacted the research and development tax credit in 2001 (effective for taxable years beginning after June 30, 2001), it chose to tether the state's incentive directly to the federal "Credit for Increasing Research Activities" under IRC Section 41. Section 12-6-3415(A) explicitly provides that "for the purposes of this credit, qualified research expenses has the same meaning as provided for in Section 41 of the Internal Revenue Code". By adopting this federal definition, South Carolina automatically incorporated the body of federal law, treasury regulations, and court cases that define the boundaries of qualified research—including the explicit exclusions for advertising and promotional activities.

Key Statutory Component	South Carolina Provision	Federal Reference
Primary Authorization	S.C. Code § 12-6-3415	IRC § 41
Credit Percentage	5% of Qualified Research Expenses	20% of Incremental Expenses (Standard)
Definitions	Adopts IRC § 41(b) definitions	IRC § 41(b), (d)
Excluded Activities	Adopts IRC § 41(d)(4) exclusions	IRC § 41(d)(4)
Utilization Limit	50% of Remaining Tax Liability	N/A (Federal limits vary by AMT status)
Carryforward	10 Years	20 Years

This statutory alignment means that a South Carolina taxpayer cannot claim the state R&D credit unless they have also qualified for (or would qualify for) the federal R&D credit for the same expenditures. While the South Carolina credit rate is fixed at five percent of total qualified research expenses (QREs) made within the state, rather than being based on an incremental "base amount" as is typical for the federal credit, the underlying activities must satisfy the rigorous "Four-Part Test" of IRC Section 41(d).

The Meaning of "Advertising or Promotions" in R&D Tax Law

The term "Advertising or Promotions" is not defined as a separate business entity in the tax code but as a functional category of excluded activity within the broader umbrella of "market research, testing, or development". To understand the meaning of this exclusion in the context of the South Carolina credit, one must analyze the distinction between research in the "experimental or laboratory sense" and research in the "commercial or social sense".

In the experimental sense, research is undertaken to discover information that would eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the component, or the appropriate design of the component. In contrast, advertising and promotions focus on the "appropriate appeal" of the component. This includes efforts to determine which aesthetic features will drive sales, which demographics are most likely to purchase the product, and how the product should be presented to the public.

The exclusion specifically targets the following sub-categories of activities:

Market Research and Testing

This encompasses any activity focused on determining whether a market exists for a product or how a product will perform commercially. For example, a South Carolina manufacturer of home appliances might conduct "focus groups" to determine if consumers prefer a matte finish or a glossy finish on a new refrigerator. While this involves data collection and analysis, it is "market research" because the information discovered relates to consumer taste and style rather than the technical capability of the refrigerator to maintain temperature.

Advertising Expenses

Advertising refers to the paid dissemination of information through various media channels—print, television, digital, or radio—to promote a business component. In the context of the South Carolina credit, the wages paid to in-house graphic designers or the fees paid to outside agencies for creating promotional campaigns are strictly excluded. Even if the advertising agency uses advanced computer modeling to create a hyper-realistic commercial, the activity remains promotional because it does not contribute to the technical development of the product itself.

Commercial Promotions

Promotions include activities designed to increase short-term sales or awareness, such as trade shows, product giveaways, and coupon campaigns. While these activities often require technical support—such as engineers attending a trade show to explain the product—the time spent by those engineers is generally excluded as "marketing support" rather than "qualified research". If an activity’s primary purpose is to "showcase" rather than "solve," it falls under the exclusion.

Efficiency Surveys and Management Studies

Closely linked to the advertising exclusion in IRC Section 41(d)(4)(D) are efficiency surveys and management studies. These are activities aimed at improving the business of research rather than the content of research. For instance, if a South Carolina biotechnology firm hires a consultant to evaluate how to reorganize their laboratory layout to improve workflow (a "management study"), these costs are excluded even if they lead to a more efficient R&D process. The law distinguishes between technical processes (which are qualified) and management/business processes (which are excluded).

South Carolina Revenue Office Guidance

The South Carolina Department of Revenue (SCDOR) provides essential clarity on the application of tax laws through a hierarchy of advisory opinions. These include Revenue Rulings (which are the department's highest level of guidance), Revenue Procedures, and Information Letters. Regarding the R&D tax credit and the advertising exclusion, several pieces of guidance are paramount for the practitioner.

Information Letter #21-14: The Primary Regulatory Reference

SCDOR Information Letter #21-14 serves as a crucial document for South Carolina taxpayers claiming the R&D credit. The letter explicitly clarifies the department’s position on exclusions, stating that the term "qualified research" specifically excludes several activities, with "advertising or promotions" listed alongside market research and efficiency surveys. The letter emphasizes that these state-level exclusions are intended to be consistent with the federal definitions found in IRC Section 41.

This guidance is instrumental during the audit process. SCDOR auditors use Information Letter #21-14 to verify that taxpayers have not included "marketing department" wages or "creative agency" invoices in their calculation of qualified research expenses. The letter serves as a warning that the department will look beyond the job titles of employees to the actual nature of the work performed. If a software company in Charleston claims the wages of "User Experience (UX) Designers," the auditor will likely look to this guidance to determine if the designers were solving technical software bugs (qualified) or merely adjusting the color palette for promotional appeal (excluded as advertising/style).

Revenue Ruling #18-9 and the Machinery Exemption Context

While not directly about the income tax credit, Revenue Ruling #18-9 (and related guidance on research and development machines under Code Section 12-36-2120(56)) provides a parallel perspective on the state's view of R&D. The sales and use tax exemption for R&D machines also excludes "advertising, promotion, or research in connection with literary, historical, or similar projects".

In Revenue Ruling #23-3 and the South Carolina Sales Tax Manual, the department notes that for a machine to qualify for the R&D exemption, it must be used "directly and primarily" (more than 50% of the time) in research and development in the experimental or laboratory sense. Machines used for "indirect" purposes—such as printing promotional brochures or managing a marketing database—are considered non-qualifying uses. This reinforces a consistent thematic application across the entire South Carolina tax code: advertising and promotions are inherently "non-research" activities.

The Tax Incentives for Economic Development (SCTIED) Manual

The SCDOR publishes an annual "Tax Incentives for Economic Development" manual, which provides a comprehensive overview of business credits, including the Section 12-6-3415 research credit. The manual instructs taxpayers to calculate the credit on Form TC-18 and reaffirms the 50% liability limitation. Importantly, it reminds taxpayers that the credit is limited to "qualified research expenses made in South Carolina," requiring a nexus between the activity and the state. This implies that even if an advertising campaign is run by a South Carolina firm, it cannot be included because it fails the federal definition of a QRE, regardless of where the expense was incurred.

SCDOR Guidance Type	Relevant Document	Application to Advertising Exclusion
Information Letter	IL #21-14	Direct exclusion of advertising/promotions from R&D credit.
Revenue Ruling	RR #25-1 (and related)	Exclusion of advertising from R&D machine exemptions.
Policy Manual	SCTIED 2025 Edition	Administrative framework for claiming QREs on Form TC-18.
Tax Forms	Form TC-18	Instructions specifically reference IRC § 41(b) definitions.

Application of the Exclusion to the "Four-Part Test"

The South Carolina R&D tax credit is an "activity-based" credit, meaning that every project claimed must satisfy a rigorous four-part test derived from federal law. The advertising and promotions exclusion is primarily enforced through the failure of promotional activities to satisfy one or more of these four components.

The Section 174 Test (Elimination of Uncertainty)

The first requirement is that the expenditures must be research and experimental costs within the meaning of IRC Section 174. These are costs paid or incurred "in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense".

Advertising fails this test because it does not seek to eliminate uncertainty about the development of a product, but rather to eliminate uncertainty about the sale of a product. Once the design of a product is certain enough to be promoted to the public, the R&D phase has effectively ended. South Carolina law, following the logic of the "Shrinking-Back Rule" in Treasury Regulation Section 1.41-4(b)(2), requires that if a project has both technical and promotional components, the taxpayer must isolate the technical components and only claim those. If the uncertainty relates to "consumer acceptance," it is an excluded market survey.

The Technological in Nature Test

The second test requires that the research be undertaken to discover information that is "technological in nature". This means the process of experimentation used to discover the information must "fundamentally rely on principles of the physical or biological sciences, engineering, or computer science".

Most advertising and promotional activities rely on the "social sciences," such as psychology, sociology, or economics. IRC Section 41(d)(4)(G) explicitly excludes any research in the social sciences, arts, or humanities. For instance, a study to determine if a specific advertisement increases "brand trust" in the South Carolina market is a study in psychology, not a study in physics or engineering. Therefore, it is excluded from the R&D credit.

The Business Component Test

The research must be intended to be useful in the development of a "business component" of the taxpayer. A business component is any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license by the taxpayer or used in the taxpayer’s trade or business.

While an advertisement might be considered a "product" in a colloquial sense, it is not a "business component" for the purposes of the R&D credit unless it is the product being developed for sale (e.g., a digital marketing firm developing a new proprietary ad-serving algorithm). For a typical South Carolina manufacturer, the "business component" is the physical product or the manufacturing process. The advertisement for that product is a "side activity" that does not satisfy the technical requirements of the business component test.

The Process of Experimentation Test

The final, and often most difficult, requirement is that "substantially all" (80% or more) of the activities must constitute elements of a "process of experimentation". This is a systematic trial-and-error methodology, such as modeling, simulation, or the evaluation of multiple design alternatives, used to achieve a technical result.

Advertising often involves "A/B testing" (showing two different ads to different groups to see which performs better). While this looks like experimentation, it is "market testing," not technical experimentation. It does not rely on the principles of engineering to solve a structural or functional problem; it relies on statistical observation to solve a commercial problem. Furthermore, IRC Section 41(d)(3)(B) explicitly states that a process of experimentation does not include research relating to "style, taste, cosmetic, or seasonal design factors". This directly excludes the aesthetic work often involved in promotional design.

The "Substantially All" Rule and the 80% Threshold

In South Carolina, as in federal law, the application of the R&D credit is governed by the "substantially all" rule. This rule has profound implications for how the advertising exclusion is applied to employee wages. For an individual's services to qualify for the credit, they must be engaged in "qualified services," which include:

• Engaging in qualified research itself.
• Directly supervising qualified research.
• Directly supporting qualified research.

The "substantially all" rule (the 80% rule) states that if at least 80 percent of the services performed by an individual for the taxpayer during a taxable year consist of qualified services, then 100 percent of the individual's wages can be treated as qualified research expenses.

However, if an employee’s time is split between research and advertising, the exclusion becomes a "cliff". If a product engineer in Spartanburg spends 25% of their time assisting the marketing department by speaking at promotional seminars and 75% of their time on technical design, the taxpayer cannot claim 100% of their wages. Because the employee failed the 80% threshold, the taxpayer must carefully allocate only the 75% of wages that were actually spent on research. Conversely, if the engineer spent 15% of their time on promotional support and 85% on technical research, the company can claim 100% of the wages—meaning the "excluded" promotional activity is effectively subsidized as part of the 20% "non-qualified" bucket allowed by the rule.

Scenario	% of Time on Research	% of Time on Advertising	Claimable Wages	Regulatory Logic
Scenario A	90%	10%	100%	Satisfies 80% "Substantially All" rule.
Scenario B	70%	30%	70%	Fails 80% rule; must bifurcate and exclude ad time.
Scenario C	40%	60%	40%	Fails 80% rule; primary function is non-qualified.
Scenario D	10%	90%	0%	Research is "incidental"; entire wage likely excluded.

Case Analysis: The Boundary of "Commercial Production"

A frequent point of contention in South Carolina audits is the point at which R&D ends and "commercial production" (and therefore advertising) begins. IRC Section 41(d)(4)(A) explicitly excludes any research conducted after the beginning of commercial production of a business component.

Treasury Regulation Section 1.41-4(c)(2) provides that a business component is considered ready for commercial production when it "meets the basic functional and economic requirements of the taxpayer". Activities that occur after this point are deemed non-qualified, including:

• Preproduction planning for a finished product.
• "Tooling up" for mass production.
• Trial production runs.
• Troubleshooting related to production equipment.
• Marketing and promotional planning.

For a South Carolina taxpayer, this means that even if they are still "experimenting" with how to advertise the product most effectively, the credit has already ceased to apply because the technical development is complete. If a company in Rock Hill develops a new textile weave, the R&D credit covers the engineering of the loom and the chemical composition of the yarn. However, as soon as the weave is finalized and the company begins printing catalogs or designing a social media "launch campaign," those activities are classified as "post-production" and are excluded under both the commercial production exclusion and the advertising exclusion.

The Role of "Correction of Flaws" vs. "Debugging"

Auditors often look at "debugging" activities as evidence that a product has entered the commercial production phase. While the "correction of flaws" can be a qualified research activity if it requires a new process of experimentation to solve a functional uncertainty, simple "debugging" (routine fixes to make a product ready for sale) is considered a post-production activity. This is critical for software firms in South Carolina’s "Silicon Harbor," where the line between "beta testing" (which may be qualified research) and "launch promotion" (which is excluded) is often blurred.

South Carolina Administrative Law Court and S.C. Supreme Court Perspectives

The South Carolina Administrative Law Court (ALC) and the South Carolina Supreme Court have established a standard of strict construction for tax credits. In cases such as Duke Energy Corp. v. S.C. Dep’t of Revenue, the courts have emphasized that tax credits are a "matter of legislative grace" and must be strictly construed against the taxpayer and in favor of the taxing authority.

In the context of the R&D credit, this judicial philosophy means that if a taxpayer cannot clearly prove that an expense falls outside the advertising exclusion, the court will likely side with the SCDOR’s determination to disallow it. The court’s decision in Orthofix, Inc. v. South Carolina Department of Revenue (while dealing with sales tax exemptions) reaffirms that taxpayers must meet every "statutory requirement as written" to qualify for tax relief.

Furthermore, the ALC’s recent sourcing decisions (e.g., U.S. Bank N.A. v. S.C. Department of Revenue) indicate a rigorous approach to how "income-producing activities" are defined. This rigor extends to the R&D credit; the department and the courts will examine whether the "activity" being performed was truly a scientific one or merely a commercial one.

Federal Case Law Influence: Phoenix Design Group and Smith

Since South Carolina conforms to federal definitions, US Tax Court decisions are highly persuasive in South Carolina audits. In Phoenix Design Group, Inc. v. Commissioner (2025), the court denied R&D credits because the taxpayer failed to demonstrate that they engaged in a true "process of experimentation". The court noted that "basic calculations on available data" were not investigative activities.

This is particularly relevant to the advertising exclusion. If a South Carolina firm claims that its "market analysis" involved "experimental" A/B testing of different ad headlines, the Phoenix Design ruling would suggest that such activities do not meet the technical threshold for the credit. The court’s requirement for "investigatory activity" that acquisition of information to solve a technical (not market) uncertainty acts as a judicial barrier to reclassifying promotional costs as research costs.

Calculation Methodology and the Exclusion Impact

To appreciate the fiscal impact of the advertising exclusion, one must look at the mathematical integration of the 5% credit on the South Carolina tax return (Form SC1120 or SC1040). The calculation of the credit is a multi-step process that requires the surgeon-like removal of excluded costs at each level of the "Qualified Research Expense" (QRE) definition.

Qualified Research Expenses are defined by IRC Section 41(b)(1) as the sum of "in-house research expenses" and "contract research expenses".

In-House Research Expenses: The Wage Factor

Wages represent the largest component of most R&D claims. Under IRC Section 41(b)(2)(D), "wages" has the meaning given by IRC Section 3401(a)—essentially all remuneration for services performed. However, only "qualified services" can be included.

The advertising exclusion impacts wages by disqualifying any time spent on:

• Creative meetings for product branding.
• Writing sales copy or technical manuals for the end-user (unless the manual is a "functional requirement" for technical testing).
• Planning and attending marketing events.
• Conducting consumer preference surveys.

In-House Research Expenses: The Supply Factor

Supplies include any tangible property (other than land or depreciable property) used in the conduct of qualified research.

The advertising exclusion impacts supplies by disqualifying:

• Materials used to create "marketing prototypes" (units that are technically complete but being used for photo shoots or display).
• Office supplies for the marketing department.
• Supplies used for trade show giveaways or promotional "samples".
• Computer server time used for running promotional websites or customer databases (as opposed to technical simulations).

Contract Research Expenses

Taxpayers can include 65 percent of any amount paid to a third party for qualified research.

The advertising exclusion impacts contract research by disqualifying payments to:

• Marketing agencies.
• Market research firms.
• Consultants hired for "efficiency studies" or "management reorganization".
• Public relations firms.

Mathematical Representation of the South Carolina Credit

The South Carolina Research Expenses Credit (C_SC) is calculated as:

C_SC = 0.05 × (W_Q + S_Q + C_Q + 0.65 × R_ext)

Where:

• W_Q = Qualified wages (excluding all promotional/administrative time).
• S_Q = Qualified supplies (excluding all promotional/depreciable materials).
• C_Q = Qualified computer rental/lease costs for R&D.
• R_ext = Contract research payments (must satisfy the "Three-Part Test" for contract research: 1. Payment contingent on success; 2. Taxpayer retains substantial rights; 3. Payment is for qualified research activities).

If the taxpayer fails to exclude advertising or promotional costs, the value of W_Q, S_Q, and R_ext will be overstated, leading to an incorrect credit amount that is vulnerable to SCDOR audit and recapture.

Detailed Example: South Carolina Aerospace Tech, Inc.

To illustrate the application of these rules, consider a hypothetical South Carolina company, Palmetto Aerospace Tech, Inc., located in the Charleston region. The company is developing a new, lightweight composite drone for commercial agricultural use (crop monitoring and precision spraying).

The Project Components

In the 2024 tax year, the company spends $1,000,000 on the "Crop-Hover" project. The expenditures are broken down as follows:

Activity Category	Description	Amount	R&D Credit Status
Aeronautical Engineering	Wages for engineers solving flight stability in high winds.	$400,000	Qualified
Material Science	Testing new carbon-fiber alloys for chemical resistance.	$200,000	Qualified
Brand Identity	Graphic design for the drone’s "sleek" outer shell and logo.	$50,000	Excluded (Advertising)
Market Feasibility	Focus groups with SC farmers to determine price point.	$75,000	Excluded (Market Research)
Prototypes	Building 5 functional units for technical stress testing.	$100,000	Qualified (Supplies)
Promotional Video	Hiring a drone cinematography crew for a "cool" ad.	$40,000	Excluded (Promotional)
Trade Show	Cost to showcase the drone at the National Ag-Expo.	$35,000	Excluded (Promotional)
Software Debugging	Routine fixes to the user-interface (UI) before launch.	$100,000	Excluded (Post-Production)

Analysis of Exclusions

Under South Carolina guidance (Information Letter #21-14) and federal law (IRC Section 41), Palmetto Aerospace must exclude the Brand Identity, Market Feasibility, Promotional Video, Trade Show, and Software Debugging costs.

1. Advertising or Promotions (Exclusion): The $50,000 for graphic design, $40,000 for the promotional video, and $35,000 for the trade show are classic promotional costs. They do not resolve a technical uncertainty; they resolve a commercial visibility problem.
2. Market Research (Exclusion): The $75,000 for focus groups is an excluded survey. Testing a farmer’s "willingness to pay" is not a process of experimentation in the physical or biological sciences.
3. Post-Production (Exclusion): The $100,000 for UI debugging is excluded because it occurs after the drone’s "basic functional requirements" have been met. It is considered a commercialization activity rather than qualified research.

Final Credit Calculation for Palmetto Aerospace

• Total Project Cost: $1,000,000
• Excluded Costs: $300,000
• Qualified Research Expenses (QREs): $700,000
• South Carolina R&D Credit (5%): $35,000.

Tax Liability Impact

If Palmetto Aerospace has a South Carolina tax liability of $100,000, and they have already claimed $40,000 in Job Tax Credits:

1. Liability after other credits: $60,000.
2. R&D Credit Limitation (50%): $60,000 x 0.50 = $30,000.
3. Usable R&D Credit: $30,000.
4. Carryforward to Year 2: $5,000 (The unused portion).

If the company had improperly included the $300,000 in promotional and market research costs, their claimed credit would have been $50,000 instead of $35,000. In an audit, the SCDOR would disallow the $15,000 difference, assess a 20% penalty, and charge interest back to the date the return was filed.

Interaction with Other South Carolina Business Incentives

South Carolina offers a diverse "portfolio" of business incentives, and it is common for a single project to touch multiple credits. However, the advertising and promotional exclusion is handled differently across these programs.

The Job Tax Credit (Section 12-6-3360)

The Job Tax Credit provides a per-job credit for companies creating new full-time jobs in South Carolina. Unlike the R&D credit, the Job Tax Credit does not necessarily exclude "marketing" or "advertising" personnel, provided they are part of a "qualifying facility" (such as a corporate office or research facility). A company could create 10 new jobs in its marketing department and receive the Job Tax Credit for those employees, while simultaneously being prohibited from including those same employees' wages in its R&D credit claim.

The Corporate Headquarters Credit (Section 12-6-3410)

A taxpayer that establishes or expands a national or regional headquarters in South Carolina can receive a credit equal to 20% of the qualifying real and personal property costs. A "headquarters" is defined as a facility where "headquarters-related functions and services" are performed, which includes "planning, directing, and controlling" operations. Marketing and advertising are often core headquarters functions. Therefore, a company might receive a 20% credit on the computers and desks used by its marketing team under the Headquarters Credit, even though those same computers and the marketing team's work are excluded from the R&D credit.

The Textiles Communities Revitalization Act (Section 12-65-20)

For taxpayers rehabilitating abandoned textile mills, credits are available for "rehabilitation expenses". These expenses include demolition, environmental remediation, and construction. However, like the R&D credit, the textile credit focuses on the "physical site" and excludes "advertising" or "promotional" costs associated with selling the finished units (e.g., if the mill is converted to condos). The logic is consistent: tax credits incentivize the creation or improvement of the physical/technical asset, not its marketing.

Compliance, Audit Defense, and Substantiation

The SCDOR does not require a pre-approval process for the R&D credit; instead, it is claimed on an "honor system" during the tax filing process, subject to subsequent audit. Therefore, the burden of proof for distinguishing R&D from advertising rests entirely on the taxpayer.

Documentation Strategies to Overcome the Exclusion

To successfully defend a South Carolina R&D credit claim, a business must have "contemporaneous documentation" that proves the technological nature of the work. To address the advertising exclusion specifically, the documentation should include:

1. Functional Specifications vs. Branding Briefs: Maintain records showing the technical requirements of the product (e.g., "The drone must lift 50lbs") as opposed to the branding requirements (e.g., "The drone must look futuristic").
2. Engineering Logbooks: Daily or weekly logs from engineers that document technical failures and design iterations. This proves a "process of experimentation" was occurring rather than a "marketing review".
3. Bifurcated Time-Tracking: If a key researcher spends part of their time on sales support, their time should be tracked separately. Using a single "Project Manager" code for both R&D and Marketing is an audit red flag.
4. Vendor Contracts: For contract research, ensures the contract specifies that the third party is performing technical testing or engineering, not market analysis or creative design.

The SCDOR Audit Process

SCDOR audits typically begin with a request for the "nexus" of the research (proving it was done in South Carolina) and a list of the business components. Auditors will often cross-reference the R&D wage claim with the company’s organizational chart. If they see individuals from the "Business Development" or "Marketing" departments included, they will likely issue a "Department Determination" disallowing those costs based on Information Letter #21-14.

Future Outlook: Legislative and Administrative Changes

The landscape of South Carolina research and development taxation is subject to the periodic updates of the state's conformity date. As of the 2024-2025 period, several factors may influence the future interpretation of the advertising exclusion.

Impact of the Tax Cuts and Jobs Act (TCJA) Amortization

Under federal law (as updated by the TCJA), Section 174 expenses must now be amortized over five years (for domestic research) or fifteen years (for foreign research), rather than being immediately deductible. While South Carolina generally follows federal amortization rules, the "qualified research expense" definition for the credit (Section 41) remains distinct from the deduction (Section 174). However, the requirement that an expense must first be a "Section 174 expense" to qualify for the Section 41 credit remains intact. This means that the exclusion of advertising (which is generally a Section 162 ordinary business expense, not a Section 174 research expense) is more firmly established than ever.

Proposed "Job Creation and Competitiveness Act of 2025"

Legislation introduced in the South Carolina Senate (S. 131) proposes to repeal Chapters 6 and 20 of Title 12 and enact a new "South Carolina Job Creation and Competitiveness Act". While the full text and eventual passage are uncertain, such a wholesale revision of the tax code would likely involve a re-evaluation of all business credits. However, given the competitive need to align with national standards, it is highly probable that any new R&D incentive would continue to exclude commercial advertising to prevent the "dilution" of the credit's technical purpose.

Technological Evolution: AI and Digital Marketing

As South Carolina businesses increasingly use Artificial Intelligence (AI) for both R&D and marketing, the line between "software development" (qualified) and "automated advertising" (excluded) will become a major administrative challenge. The SCDOR will likely need to issue new Information Letters addressing whether the development of an AI model for "predictive marketing" qualifies as R&D (likely yes, if solving a technical computer science problem) or if the use of that model to generate ads is excluded (likely yes).

Summary of Actionable Recommendations for Taxpayers

The "Advertising or Promotions (Exclusion)" is not merely a line item to be checked; it is a fundamental filter that defines the nature of a South Carolina R&D credit claim. To ensure compliance with SCDOR guidance and South Carolina law, taxpayers should adopt the following professional standards:

• Strict Adherence to IL #21-14: Treat the exclusions listed in Information Letter #21-14 as "per se" disqualifications. Any expense that touches advertising, promotions, or market surveys should be removed from the initial data pull for Form TC-18.
• Engineering-Centric Documentation: Build the R&D tax file from the perspective of the "lab" rather than the "front office." The narrative should focus on mechanical failure, code latency, chemical instability, or structural stress—avoiding any mention of "customer appeal" or "market fit".
• Bifurcation of Mixed-Use Activities: Where a task involves both R&D and marketing (such as a "technical demonstration" for a client), use a conservative time-allocation methodology. The 80% rule is a useful safe harbor, but it should not be used to "hide" significant promotional work.
• Nexus Verification: Ensure that all QREs claimed are "made in South Carolina." A promotional campaign run out of a New York office for a South Carolina product fails both the nexus test and the advertising exclusion test.

By understanding the deep statutory and administrative roots of the advertising exclusion, South Carolina businesses can maximize their legitimate tax incentives while minimizing the risk of costly and intrusive audits. The R&D credit remains one of the state’s most powerful tools for economic growth, provided it is used to fuel the fire of invention rather than the engine of promotion.