Corporate Income Tax (Chapter 6, Title 12)

The South Carolina Corporate Income Tax Act and the Statutory Framework of the Research and Development Tax Credit

The South Carolina Corporate Income Tax, established under Title 12, Chapter 6, imposes a flat five percent levy on the net taxable income of corporations, serving as the foundational liability against which various credits are applied. The Research and Development (R&D) tax credit, codified in Section 12-6-3415, provides a five percent incentive on qualified research expenditures to encourage technological innovation within the state’s borders.

The integration of corporate income tax law and specialized tax incentives represents a significant component of South Carolina’s economic development strategy. To understand the R&D tax credit, one must first navigate the broader regulatory environment of the South Carolina Income Tax Act, which governs how corporate income is defined, allocated, and taxed. This act, primarily housed within Title 12, Chapter 6 of the South Carolina Code of Laws, functions through a system of federal conformity, where the state adopts much of the Internal Revenue Code (IRC) while maintaining specific decouplings and modifications that reflect local legislative priorities. The R&D credit itself is a nonrefundable incentive that works in tandem with federal standards, requiring a taxpayer to successfully claim the federal credit under IRC Section 41 to qualify for the state-level benefit. This dependency creates a complex compliance environment where businesses must simultaneously adhere to federal definitions of qualified research while observing South Carolina’s unique limitations on credit utilization, particularly the fifty percent liability cap.

The Foundation of Corporate Taxation: Title 12, Chapter 6

The South Carolina Corporate Income Tax is an annual tax imposed at a rate of five percent on the South Carolina taxable income of every corporation transacting, conducting, or doing business within the state. The jurisdictional reach of this tax is broad, applying to income derived from any sources within South Carolina, whether the activities are carried on in intrastate, interstate, or foreign commerce. The statute defines “transacting,” “conducting,” and “doing business” as engaging in any activity for the purpose of financial profit or gain, a definition that encompasses a wide range of corporate actions from physical manufacturing to economic presence.

Federal Conformity and the Adoption of the Internal Revenue Code

South Carolina’s tax system is anchored by its conformity to the Internal Revenue Code. Section 12-6-40 stipulates that the state’s income tax laws conform to the IRC as amended through a specific date, which is periodically updated by the General Assembly. As of the most recent updates, South Carolina generally conforms to the IRC as amended through December 31, 2024, subject to specific exceptions outlined in Section 12-6-50. This conformity is crucial for the R&D credit because the state law explicitly adopts the federal definitions for qualified research expenses (QREs) as provided in IRC Section 41.

However, the state does not adopt all federal provisions. Section 12-6-50 lists sections of the IRC that are specifically not adopted, such as the additional first-year depreciation allowance under Section 168(k). Understanding these decouplings is vital for calculating the base “South Carolina Net Income,” which serves as the starting point for determining the tax liability that the R&D credit can offset.

Determination of South Carolina Taxable Income

The process of determining taxable income for a corporation involves allocating and apportioning its total income. For corporations doing business both within and outside South Carolina, the state employs specific formulas to determine the portion of income subject to the five percent tax. This “South Carolina Net Income” is the product of net income allocated and apportioned to the state, minus any South Carolina-specific net operating loss (NOL) carryovers.

The calculation of tax follows a precise sequence:

1. Calculate Total Net Income: Determine net income based on federal standards and state modifications.
2. Allocation and Apportionment: Assign a portion of that income to South Carolina based on the company’s business activities.
3. Deduct NOLs: Apply available South Carolina net operating losses.
4. Apply 5% Rate: Multiply the resulting taxable income by 0.05.
5. Deduct Nonrefundable Credits: Subtract credits like the R&D credit, subject to their respective limitations.
6. Account for Minimum Tax: Ensure the final tax is at least $50, the statutory minimum for most corporations.

The Research and Development Tax Credit: Section 12-6-3415

The South Carolina Research and Development (R&D) tax credit is a significant incentive designed to lower the cost of innovation. Codified in Section 12-6-3415, the credit is equal to five percent of the taxpayer’s qualified research expenses made in South Carolina during the taxable year. This state-level credit is available to any taxpayer who also claims a federal income tax credit for increasing research activities under IRC Section 41.

Policy Rationale and the Federal Link

The core of the South Carolina R&D credit is its reliance on federal standards. By tying eligibility to IRC Section 41, South Carolina leverages the rigorous “Four-Part Test” used by the IRS to define qualified research. This test requires that the research:

1. Has a Permissible Purpose, meaning it relates to a new or improved function, performance, reliability, or quality of a business component.
2. Aims to Eliminate Uncertainty regarding the development or design of a product or process.
3. Involves a Process of Experimentation, such as modeling, simulation, or trial and error.
4. Is Technological in Nature, fundamentally relying on principles of physical or biological sciences, engineering, or computer science.

Unlike the federal credit, which is an incremental credit based on spending above a historical base amount, the South Carolina credit is a flat five percent of the current year’s qualified expenditures, provided they are incurred within the state. This “no state base amount” feature makes the South Carolina incentive particularly attractive to consistent innovators who may not see a year-over-year increase in spending but maintain high levels of R&D activity.

Qualified Research Expenditures (QREs)

To calculate the credit, businesses must identify their South Carolina-specific QREs. These expenditures generally fall into four categories, mirroring federal definitions but restricted to activity within the state:

• Wages: Salaries and compensation for employees directly performing, supervising, or supporting qualified research in South Carolina.
• Supplies: Materials and prototypes consumed in the research process within the state.
• Contract Research: Payments to third parties for research conducted on the taxpayer’s behalf. Generally, sixty-five percent of these payments are considered QREs, though this can rise to seventy-five percent for payments to certain research consortia.
• Computer Rentals: Costs for the use of computers in conducting qualified research, which is increasingly applied to cloud-based computing services used for software development.

Revenue Office Guidance: The Role of the SCDOR

The South Carolina Department of Revenue (SCDOR) is the primary administrative body responsible for enforcing Chapter 6 and managing tax credit compliance. The Department provides guidance through a variety of official documents, including Revenue Rulings, Revenue Procedures, and Information Letters.

Revenue Rulings and the “True Object Test”

One of the most critical pieces of guidance for technology-driven companies is SC Revenue Ruling #03-5, which addresses the taxability of software and communications. While primarily a sales and use tax ruling, RR #03-5 is instrumental in defining the scope of technological activity in the state. The ruling establishes the “true object test” to determine if a transaction is a sale of tangible personal property or a non-taxable service.

In the context of R&D, this ruling helps clarify the treatment of custom software development. Custom programs—those prepared to the special order of a customer—are often treated as a service for sales tax purposes but may qualify as QREs for the R&D tax credit if the development process involves technical uncertainty and experimentation. The SCDOR has further clarified that software delivered electronically, where no physical media is involved, is generally considered an intangible and not subject to sales tax unless it falls under the definition of “communications”. This distinction is vital for software developers in South Carolina who are trying to balance their sales tax obligations with their R&D credit claims.

Advisory Opinions and Procedural Bulletins

The Department also utilizes Revenue Procedures and Information Letters to provide administrative clarity. For example, SC Information Letter #19-14 and SC Revenue Ruling #19-6 provide guidance on nexus standards for marketplace facilitators and remote sellers, which impacts whether a corporation has a filing requirement in the first place.

For businesses involved in environmental or land-use research, SC Revenue Procedural Bulletin #01-11 provides a framework for the transfer of credits, specifically regarding the conservation credit. While most South Carolina tax credits, including the R&D credit, are non-transferable, the procedural bulletin illustrates the Department’s rigorous requirements for documentation and notification when any credit is assigned to a succeeding taxpayer, such as during a corporate merger or asset transfer.

Limitation on Credit Use: The 50% Rule and Ordering

A defining characteristic of the South Carolina R&D credit is the limitation on its annual application. Pursuant to Section 12-6-3415(B), the credit used in any one taxable year cannot exceed fifty percent of the taxpayer’s remaining tax liability after all other credits have been applied.

The Sequence of Credit Application

South Carolina employs a strict ordering rule for tax credits. Nonrefundable credits like the R&D credit are generally applied after other credits that do not have such limitations. This “low priority” positioning means that if a company has multiple incentives—such as the New Jobs Credit or the Investment Tax Credit—those are subtracted from the tax liability first.

The remaining liability after these “higher priority” credits is the amount used to calculate the fifty percent cap for the R&D credit. This structure can lead to situations where a company has a significant R&D credit balance but is forced to pay a portion of its tax liability because of the fifty percent limitation.

Carryforward Mechanics

Unused portions of the R&D credit are not lost but can be carried forward for up to ten years from the date the expenses were incurred. This ten-year window is a rolling period, meaning each year’s credit has its own expiration date. It is incumbent upon the taxpayer to track these “vintages” of credits to ensure the oldest credits are used first.

If a corporation is involved in a merger or reorganization, Section 12-6-3410 and Section 12-6-3415 provide that a taxpayer may assign rights to unused credits to a succeeding taxpayer, provided all or substantially all of the assets of the business are transferred and the successor continues the qualifying activity.

Synergistic Incentives: The Headquarters Credit (§ 12-6-3410)

The R&D credit frequently interacts with the Headquarters Credit, found in Section 12-6-3410. This credit is designed to attract corporate management functions to the state, offering a twenty percent credit on qualifying real and personal property costs associated with establishing or expanding a headquarters facility.

Headquarters Definitions and Qualifications

To qualify as a “Headquarters,” a facility must house staff employees who handle financial, personnel, legal, planning, or information technology functions on a regional or national basis. A “National Headquarters” must plan and direct all aspects of the business unit’s operations, while a “Regional Headquarters” must be the sole office for a multi-state operation within a specific region.

The requirements for the Headquarters Credit are stringent:

1. Investment: At least $50,000 in qualifying real property costs.
2. Job Creation: The creation of at least 40 new full-time jobs performing headquarters functions.
3. Wage Threshold: These jobs must have gross wages equal to or greater than twice the per capita income of the state.

The Link to R&D Operations

Many companies that establish headquarters in South Carolina also locate their R&D divisions within these facilities. The Headquarters Credit incentivizes the physical infrastructure (the buildings and computers), while the R&D credit incentivizes the activity performed inside (the research wages and supplies). The SCDOR guidance clarifies that the Headquarters Credit is also subject to specific recapture rules if the taxpayer fails to maintain employment levels for a certain period, usually five to seven years.

Pass-Through Entities and Credit Allocation

A significant portion of R&D in South Carolina is conducted by entities other than C-Corporations, such as S-Corporations, Partnerships, and LLCs. Under Section 12-6-3310 and Section 12-6-3415, these entities are allowed to pass the credit through to their owners.

The Mechanics of Pass-Through

When an S-Corporation or Partnership generates an R&D credit, the entity itself does not use the credit to offset tax, as it generally has no entity-level income tax liability. Instead, the credit is allocated to each shareholder or partner according to their ownership share, as reflected on their South Carolina Schedule K-1.

Important regulatory nuances apply to pass-through entities:

• Owner-Level Limitation: The fifty percent liability limitation is applied at the level of the individual shareholder or partner. An individual taxpayer with a $10,000 personal income tax liability can only use $5,000 of R&D credits passed through from a business, regardless of how much credit the business generated.
• S-Corporation Priority: S-corporations must apply credits against any entity-level taxes (such as tax on built-in gains) before the remaining credit is passed through to shareholders.
• LLC Treatment: South Carolina follows federal tax treatment for LLCs. If an LLC is treated as a partnership for federal purposes, it is treated as a partnership for South Carolina purposes, and the R&D credit flows through accordingly.

Compliance, Documentation, and Audit Protection

Claiming the R&D tax credit requires rigorous documentation to withstand SCDOR audits. The Department has the authority to review the technical nature of the research as well as the accounting of the expenditures.

Filing Requirements: Form TC-18

To claim the credit, taxpayers must complete and attach Schedule TC-18, “Research Expenses Credit,” to their income tax return. This form requires the disclosure of:

• Total South Carolina qualified research expenses for the tax year.
• The name and Federal Employer Identification Number (FEIN) of any pass-through entity from which the credit was received.
• A multi-step calculation that accounts for other credits to determine the final allowable R&D credit based on the fifty percent limit.

Substantiating the Claim

Taxpayers are advised to maintain records that clearly link their expenses to qualified research activities. This includes:

• Payroll Records: Time-tracking or salary allocations for engineers, scientists, and support staff.
• Technical Documents: Project plans, white papers, and testing results that demonstrate the process of experimentation and the elimination of technical uncertainty.
• Vendor Invoices: Detailed receipts for research supplies and contract research payments that prove the work was performed in South Carolina.

The SCDOR generally observes a three-year statute of limitations for auditing income tax returns. However, if a taxpayer failed to claim the R&D credit in a prior year, they may file an amended return within this three-year window to claim the missed credit or establish a carryforward for future use.

Comprehensive Practical Example: The Greenville Robotics Scenario

To illustrate the application of Chapter 6 and the R&D credit, consider “Greenville Robotics,” a C-Corporation based in Greenville, South Carolina.

Year 1: Generating the Credit

In 2024, Greenville Robotics invests heavily in developing a new autonomous warehouse sorting system. Their financial records for the year show:

• Wages for SC-based R&D Engineers: $2,000,000
• Supplies used for Prototypes in SC: $500,000
• Contract Research paid to a SC University: $200,000
• Total SC QRE Calculation:

• Wages: $2,000,000
• Supplies: $500,000
• Contract Research: $200,000 \times 65% = $130,000
• Total QREs: $2,630,000

• Tentative R&D Credit: $2,630,000 \times 0.05 = \$131,500.

Year 1: Applying the Limitation

Greenville Robotics has a total South Carolina taxable income of $4,000,000.

1. Tax Liability (5% of $4M): $200,000.
2. Other Credits: The company also earned a New Jobs Credit of $50,000.
3. Remaining Tax Liability: $200,000 – $50,000 = \$150,000.
4. R&D Credit 50% Limit: $150,000 \times 0.50 = \$75,000.
5. Allowable R&D Credit for 2024: $75,000 (The lesser of the $131,500 earned or the $75,000 limit).
6. Final Tax Paid: $150,000 – $75,000 = \$75,000.
7. Carryforward to 2025: $131,500 – $75,000 = \$56,500.

Year 2: Strategic Carryforward Use

In 2025, the company has no new R&D expenses but has a tax liability of $100,000 after other credits.

1. Remaining Liability: $100,000.
2. R&D Credit 50% Limit: $100,000 \times 0.50 = \$50,000.
3. Credit Used from Carryforward: $50,000.
4. Remaining Carryforward to 2026: $56,500 – $50,000 = \$6,500.

Future Trends and Legislative Outlook

The South Carolina tax landscape is constantly evolving through legislative action. The General Assembly recently passed the “South Carolina Taxpayer Protection and Relief Act,” which aimed to simplify the tax code and provide rate reductions. This act reflects a broader trend of reducing individual income tax rates and consolidating brackets, which impacts how pass-through entities and their owners view the value of tax credits like the R&D incentive.

Furthermore, discussions regarding the refundability of the R&D credit continue. Historically, nonrefundable credits have been criticized for providing less value to pre-revenue startups that are conducting significant research but have no tax liability to offset. Legislative proposals, such as the various iterations of Bill H 3592, have attempted to allow small businesses with fewer than 150 employees to receive a refund for unused R&D credits, subject to an annual statewide cap. While these measures face scrutiny regarding their impact on the state’s general fund, they represent a potential shift toward a more aggressive “innovation-first” fiscal policy.

Final Thoughts: Strategic Integration of Corporate Law and Incentives

The South Carolina Research and Development tax credit is more than a simple deduction; it is a complex instrument of fiscal policy integrated into the Title 12, Chapter 6 corporate tax framework. Its value is maximized when businesses understand the interplay between federal conformity, state-level limitations, and Department of Revenue guidance. By adhering to the fifty percent liability cap and effectively managing carryforwards, corporations can significantly reduce their effective tax rate while fueling technological growth. As the state continues to refine its nexus standards for the digital economy and debate the refundability of credits for small businesses, the R&D credit remains a cornerstone of South Carolina’s commitment to industrial and technological advancement. For the tax professional, success in this domain requires a dual focus: maintaining rigorous federal-style documentation for technical activities while navigating the specific procedural requirements of the SCDOR and the South Carolina Code.