Research in the Social Sciences, Arts, or Humanities (Exclusion)

Research in the social sciences, arts, or humanities is strictly excluded from the South Carolina Research Expenses Tax Credit because it fails the statutory requirement for activities to be technological in nature. This exclusion, codified via federal conformity, distinguishes non-qualifying observational studies and creative endeavors from the experimental laboratory research eligible for the five percent state incentive.

The South Carolina Research Expenses Tax Credit, as governed by S.C. Code § 12-6-3415, functions as a targeted fiscal incentive designed to stimulate technological innovation and industrial development within the state. The legislative intent of the credit is to alleviate the tax burden on companies that engage in high-risk, high-reward research and development (R&D) activities that rely on the hard sciences to create new or improved business components. However, the breadth of this incentive is fundamentally curtailed by the state’s adoption of federal definitions and exclusions found in Section 41 of the Internal Revenue Code (IRC). Specifically, the exclusion of research in the social sciences, arts, or humanities (SSAH) serves as a critical boundary for eligibility, ensuring that the credit is not applied to theoretical, observational, or creative pursuits that do not fundamentally advance technological knowledge through experimental methodologies. This exclusion is reinforced through various South Carolina Department of Revenue (SCDOR) administrative guidance, including revenue rulings that insist on an experimental or laboratory sense for qualifying activities.

Statutory Framework and the Mechanism of Federal Conformity

The operational lifeblood of the South Carolina Research Expenses Tax Credit is its direct link to the federal research credit. S.C. Code § 12-6-3415(A) provides that a taxpayer claiming a federal income tax credit pursuant to IRC Section 41 for increasing research activities for the taxable year is allowed a credit against South Carolina income taxes and corporate license fees. The amount of this credit is equal to five percent of the taxpayer’s qualified research expenses (QREs) made within the State of South Carolina. Because the state statute explicitly defines QREs as having the same meaning as provided for in IRC Section 41(b), the federal exclusions are inextricably woven into the state’s tax fabric.

The federal framework under IRC Section 41(d) defines qualified research through a rigorous four-part test, each element of which must be satisfied to transform an activity from a mere business expense into a creditable research expenditure. The exclusion of social sciences, arts, and humanities is not merely a negative list but is a consequence of the second and fourth pillars of this test: the Technological in Nature requirement and the Process of Experimentation requirement. Research that does not fundamentally rely on the physical or biological sciences, engineering, or computer science is disqualified by definition.

South Carolina’s commitment to this federal definition is evidenced by its history of conformity. S.C. Code Section 12-6-1130 and subsequent updates ensure that South Carolina generally follows the federal Internal Revenue Code as it existed on a specific date, currently updated through December 31, 2023. This conformity means that as the IRS clarifies the meaning of the SSAH exclusion through Treasury Regulations and case law, the state of South Carolina automatically adopts those clarifications for its own 5% credit.

Defining the Exclusion: The Meaning of Social Sciences, Arts, and Humanities

The term research in common parlance often includes any systematic investigation into a subject. However, for the purposes of the South Carolina Research Expenses Tax Credit, the law applies a much narrower lens. The exclusion for Social sciences, etc. is found in IRC Section 41(d)(4)(G), which explicitly states that qualified research shall not include any research in the social sciences, arts, or humanities. Treasury Regulation § 1.41-4(c)(8) provides the authoritative interpretation of this phrase, clarifying that it encompasses all areas of research other than research in a field of laboratory science (such as physics or biochemistry), engineering, or technology.

The Social Sciences Boundary

Social science research typically involves the study of human behavior, society, and social relationships. While modern social science uses empirical data and complex statistical modeling, it remains non-qualifying because its fundamental principles do not derive from the physical or biological sciences. The IRS and SCDOR view these activities as lacking technological uncertainty in the laboratory sense.

Examples of excluded social science research include:

• Economic Models and Theories: Developing a new model to predict interest rate fluctuations or consumer spending habits. Even if the developer uses advanced computer programming to run the model, the uncertainty being resolved is economic in nature, not technological.
• Management and Efficiency Surveys: Research into organizational behavior, employee productivity techniques, or management styles. These are specifically barred under federal law and corroborated by South Carolina Revenue Ruling #87-8.
• Sociological and Psychological Studies: Research into group dynamics, educational outcomes, or psychological responses to stimuli. A South Carolina entity conducting measurement theory applications for the social sciences would find its activities excluded regardless of their academic rigor.
• Accounting Procedures: The development of a new methodology for tracking internal costs or financial reporting. While a business component in the broadest sense, it fails the technological test because it relies on the principles of accounting and finance.

The Arts and Humanities Boundary

The arts and humanities exclusion prevents the application of the research credit to creative, historical, and literary works. This is particularly relevant in South Carolina’s growing creative economy, where firms may develop films, digital media, or architectural designs.

1. Aesthetic vs. Functional Design: Under the federal permitted purpose test, research is not qualified if it relates to style, taste, cosmetic, or seasonal design factors. Therefore, research into the most visually appealing way to design a user interface is an aesthetic (artistic) endeavor, whereas research into a more efficient way to code the interface to reduce latency is a technological endeavor.
2. Literary and Historical Projects: Research in connection with literary, historical, or similar projects—such as the production of books, sound recordings, video tapes, or films—is explicitly excluded. This exclusion remains even if the project is undertaken for a commercial purpose, as the underlying activity does not satisfy the technological requirement.
3. Cultural and Linguistic Research: Studying the evolution of language or cultural trends is a humanities-based pursuit. Even if linguistic data is processed using natural language processing (NLP) software, the research into the linguistic patterns themselves (rather than the algorithm used to process them) is excluded as research in the humanities.

SCDOR Guidance and Administrative Rulings

The South Carolina Department of Revenue has issued several key guidance documents that reinforce the narrow, technological definition of research. These documents provide the bridge between the high-level federal statutes and the daily operations of South Carolina taxpayers.

Revenue Ruling #87-8: The Laboratory Sense Requirement

One of the most significant state-level interpretations of research is found in SCDOR Revenue Ruling #87-8. Although this ruling focuses on sales and use tax limitations for machinery, it provides a foundational definition of research and development used by the Department. The ruling defines machinery for research and development as machinery used directly and exclusively in research and development in the experimental or laboratory sense for new products, new uses for existing products, or for improving existing products.

The ruling explicitly excludes several categories of activity that align with the SSAH exclusion:

• Efficiency surveys and management studies.
• Consumer surveys and market research.
• Economic surveys.
• Advertising and promotions.
• Research in connection with literary, historical, or similar projects.

By insisting on a laboratory sense, the SCDOR effectively precludes most social science or humanities research, which is typically conducted in an office or field setting and focuses on human or economic data rather than physical matter or biological organisms.

Revenue Ruling #21-9: The Used Directly and 50% Use Rule

Further refining the state’s stance, Revenue Ruling #21-9 addresses machines used in research and development. To qualify for state tax benefits, a machine must be used directly and primarily in qualifying research. The ruling notes that indirect uses, such as administrative uses or uses not in the experimental or laboratory sense, are non-qualifying.

If a piece of equipment is used for social science data analysis more than 50% of the time, it loses its status as an R&D machine for sales tax purposes. This highlights a critical insight: South Carolina law views the setting and the nature of the inquiry as inseparable. Research that takes place in a non-laboratory environment is viewed skeptically and is often categorized as an administrative or management function rather than qualifying R&D.

Policy Manuals and General Business Credits

The South Carolina Tax Incentives for Economic Development manual (SCTIED) provides additional context in Chapter 2, Part C, regarding General Business Credits. While it notes that the Research Expenses Tax Credit is equal to 5% of QREs, it emphasizes the Federal Claim Requirement. This administrative directive forces taxpayers to justify their research against the federal four-part test, which is specifically designed to weed out non-technological research.

The manual also clarifies that South Carolina does not adopt certain federal bonus depreciation or interest limitation provisions, but it does adopt the definitions of research activities found in IRC Section 41. This selective adoption signifies that while the state may diverge on purely fiscal accounting (like depreciation), it maintains strict alignment on the definition of innovation.

The Interface with the Headquarters and R&D Facility Credit

A common area of confusion for South Carolina taxpayers is the relationship between the Research Expenses Tax Credit (§ 12-6-3415) and the Corporate Headquarters Credit (§ 12-6-3410). While the former is an expenditure-based credit that strictly excludes SSAH, the latter is a facility-based credit that has a broader operational definition.

Facility vs. Expenditure Credits

S.C. Code § 12-6-3410 allows a credit of 20% for real property costs and tangible personal property costs associated with establishing or expanding a headquarters or research and development facility. To qualify for the personal property portion of this credit, the facility must result in at least 75 new full-time jobs performing research and development related functions and services.

There is a nuanced distinction here: a facility may be considered an R&D facility for the purposes of the headquarters credit even if some of its staff are engaged in research that would be excluded from the 5% expenditure credit. For example, a facility that houses both physicists (qualifying) and economic researchers (excluded) might qualify for the 20% real property credit under § 12-6-3410 if it meets the job creation and wage thresholds. However, when calculating the 5% Research Expenses Credit under § 12-6-3415, the firm would be required to exclude the wages of the economic researchers from the Qualified Research Expenses total.

Administrative Compliance: Claiming the Credit and the TC-18 Mechanism

The exclusion of social sciences, arts, and humanities is operationalized through the tax return filing process. Taxpayers are required to use Schedule TC-18, Research Expenses Credit, to calculate and claim the benefit.

The TC-18 Calculation Logic

The form follows a strict sequential logic that enforces state limitations.

1. Identification of SC QREs (Line 1): The taxpayer must enter qualified research expenses made only in South Carolina. This requires a granular accounting of wages, supplies, and contract research. Any researcher engaged in excluded social science activities must have their wages stripped from this line.
2. Federal Claim Verification: The instructions explicitly state that the credit is available to those claiming a federal Income Tax credit for research expenses… pursuant to Section 41. This acts as a primary filter; if a taxpayer cannot justify the expense to the IRS as a technological inquiry, they cannot report it to the SCDOR.
3. The 50% Limitation (Lines 5-9): Unlike the federal credit, the South Carolina credit is capped at 50% of the taxpayer’s remaining tax liability after all other credits (like the New Jobs Credit) have been applied.
4. Carryforward Management (Line 10): Any unused credit can be carried forward for 10 years.

Documentation and Audit Standards

Because the SSAH exclusion is a frequent point of contention during audits, the SCDOR recommends maintaining rigorous documentation. This includes:

• Project records and lab notes that demonstrate the experimental or laboratory sense of the research.
• Time-tracking reports that show which employees were engaged in qualified technological activities versus excluded management or marketing studies.
• A copy of Federal Form 6765 and any supporting workpapers used for the federal credit claim.

The SCDOR maintains a three-year statute of limitations for auditing and amending returns to claim missed credits. However, if the IRS extends its audit window for the federal research credit, the taxpayer must be aware that the state may also adjust its assessments based on federal findings regarding the SSAH exclusion.

Practical Example: Contrasting Qualified and Excluded Research

To synthesize the application of South Carolina law and SCDOR guidance, consider a hypothetical technology firm based in Spartanburg, Vortex Innovations, LLC. The company is developing a new autonomous drone for agricultural spraying and conducts three distinct research projects.

Project 1: The Flight Control Algorithm (Qualified)

• Activity: Developing a new computer vision algorithm to identify specific weed types in low-light conditions.
• Methodology: Iterative coding and testing of neural network layers to reduce false positives.
• State Analysis: This activity is technological in nature (computer science). It addresses technical uncertainty (the accuracy of the algorithm under specific lighting). It involves a process of experimentation (evaluating different neural architectures).
• Result: The wages for the software engineers and the cost of cloud computing for training the model are Qualified Research Expenses eligible for the 5% credit.

Project 2: The User Interaction Study (Excluded – Social Science)

• Activity: Researching how farmers interact with the drone’s remote control and whether a voice-activated interface increases adoption rates.
• Methodology: Surveying 500 farmers and conducting focus groups to analyze their psychological comfort with autonomous machines.
• State Analysis: This is research in the social sciences (psychology/sociology). It is also a consumer survey and market research, which are specifically excluded by SCDOR Revenue Ruling #87-8.
• Result: The wages for the social scientists and the costs of the surveys are Excluded Expenditures and cannot be used to calculate the credit.

Project 3: The Market Elasticity Analysis (Excluded – Social Science/Management)

• Activity: Determining the optimal price point for the drone to maximize market share while accounting for competitors’ pricing.
• Methodology: Statistical analysis of economic data and historical purchasing trends in the agricultural sector.
• State Analysis: This is an economic survey and management study aimed at marketing and promotion. It does not rely on the physical or biological sciences.
• Result: These costs are Excluded Expenditures.

Financial Synthesis for Vortex Innovations

If the company spent $500,000 on Project 1, $200,000 on Project 2, and $100,000 on Project 3, their tax calculation on Form TC-18 would be as follows:

Deeper Insight: The Rationale and Future of the SSAH Exclusion

The exclusion of the soft sciences from R&D tax incentives is a deliberate policy mechanism intended to direct state investment toward sectors with the highest technological spillover. The South Carolina General Assembly, by mirroring the federal code, accepts the premise that technological innovation in the physical and biological sciences provides a unique economic benefit that warrants a direct subsidy, whereas innovation in the social sciences often benefits the individual firm through improved internal efficiencies or better marketing.

The Technical vs. Human Uncertainty Distinction

At the heart of the exclusion is the distinction between technical uncertainty and human uncertainty. Technical uncertainty (e.g., Is it possible to make this battery last 50 hours?) is viewed as a hurdle that requires hard-science experimentation. Human uncertainty (e.g., Will people buy this product if it is blue?) is a business risk. South Carolina’s tax policy, through the Research Expenses Credit, aims to subsidize the former, not the latter.

The Internal-Use Software (IUS) Challenge

As South Carolina’s economy becomes more service-oriented, many social science-based companies are attempting to re-cloak their activities as software development. For instance, a firm developing an automated efficiency survey tool might claim that the coding of the tool is qualified research. However, the law provides a high threshold of innovation test for internal-use software, requiring the software to be innovative, involve significant economic risk, and not be commercially available. This ensures that purely administrative or social-science applications of software do not bypass the exclusion.

Future Outlook and Conformity Risks

The future of the SSAH exclusion in South Carolina is tied to the federal legislative environment. Recent changes to IRC Section 174, which now requires the capitalization and amortization of R&D expenses rather than immediate expensing, have increased the tax cost of research for many South Carolina firms. While the state credit remains at 5%, the underlying definition of qualified research remains a point of intense scrutiny during both state and federal audits.

Furthermore, as the distinction between hard and soft science blurs—particularly in the fields of biotechnology and neural computing—the SCDOR may eventually need to issue more specific guidance. For now, the laboratory sense requirement of Revenue Ruling #87-8 remains the definitive barrier for social sciences, arts, and humanities.

Summary of Exclusions and Limitations under South Carolina Law

The South Carolina Research Expenses Tax Credit remains one of the state’s most powerful tools for economic development, but its power is precision-guided toward the technological. For firms conducting research in the social sciences, arts, or humanities, the lack of a 5% credit is not a reflection of the research’s value, but a reflection of a statutory framework that prioritizes the experimental laboratory over the theoretical or observational study. Compliance requires a deep understanding of these boundaries and a commitment to documenting the technological nature of all claimed activities.