Wages for Qualified Services

Wages for Qualified Services in the context of the South Carolina Research and Development tax credit represent the portion of employee compensation paid for direct participation, supervision, or support of qualifying technological research activities conducted within the state. This fiscal metric, governed by South Carolina Code Section 12-6-3415, serves as the primary expenditure category for the five percent state credit and is strictly defined through conformity with federal standards under Internal Revenue Code Section 41.

The statutory architecture of South Carolina’s innovation incentives is designed to attract and retain high-value technical labor by providing a predictable and streamlined mechanism for credit generation. Under South Carolina law, the Research Expenses Credit—as it is officially designated in the State Income Tax Act—allows taxpayers to offset their corporate income tax, individual income tax, and corporate license fees by a percentage of their qualified research expenses (QREs). Unlike many other states that utilize a complex base-amount calculation to reward only incremental increases in spending, South Carolina offers a straightforward five percent credit on the total QREs incurred within its borders, provided the taxpayer is concurrently claiming the federal research credit for the same period. This requirement of a federal claim ensures that the technical rigor of the activities is vetted against federal standards, primarily the "Four-Part Test," which mandates that research be technological in nature, directed toward a new or improved business component, intended to eliminate technical uncertainty, and characterized by a process of experimentation.

The Statutory Nexus: South Carolina Code Section 12-6-3415

The legal authority for the South Carolina Research and Development credit is established in Section 12-6-3415 of the South Carolina Code of Laws. This statute is a model of legislative brevity, relying heavily on incorporation by reference to federal tax law. Subsection (A) specifies that a taxpayer who claims a federal income tax credit pursuant to Section 41 of the Internal Revenue Code (IRC) for increasing research activities for the taxable year is allowed a credit against state tax due equal to five percent of the taxpayer's qualified research expenses made in South Carolina.

The law further mandates that for the purposes of the state credit, the term "qualified research expenses" has the same meaning as provided for in Section 41 of the IRC. This direct link creates a "conformity bridge," wherein the state adopts federal definitions for what constitutes a "qualified service" and what constitutes "wages". This legislative choice minimizes the compliance burden on taxpayers by allowing them to utilize the same wage-tracking data for both federal Form 6765 and the state claim form.

While the credit generation is relatively straightforward, the application of the credit is subject to significant statutory limitations. Under Subsection (B) of Section 12-6-3415, the credit taken in any one taxable year may not exceed fifty percent of the taxpayer's remaining tax liability after all other credits have been applied. This ordering rule—where the R&D credit is applied last—is a critical nuance for tax planning, as it ensures that non-limited credits are utilized first to reduce the base liability before the R&D credit's fifty-percent cap is calculated.

Unused credits are not lost; rather, the statute allows for a ten-year carryforward period. This duration provides a tenable window for startups and research-heavy firms to realize the value of their incentives once they achieve profitability or a higher tax liability.

Federal Conformity: Defining Wages for Qualified Services

Because the South Carolina statute adopts the federal definitions from IRC Section 41, the meaning of "Wages for Qualified Services" must be interpreted through the lens of federal law and the accompanying Treasury Regulations. In the context of R&D, "wages" generally follow the definition provided in IRC Section 3401(a), which encompasses all remuneration for services performed by an employee for their employer, including the cash value of non-cash remuneration.

Qualified wages for the credit calculation typically include base salaries, hourly pay, and taxable bonuses paid to employees for time spent on qualifying activities. More complex forms of compensation, such as taxable stock options (at the time of exercise) or restricted stock vesting, may also qualify if they are included in the employee’s W-2 wages and are attributable to the performance of qualified services. However, the definition specifically excludes certain fringe benefits. For example, health insurance premiums, contributions to retirement plans (such as 401(k) matches), and other non-wage benefits do not qualify, even if they are deductible as business expenses, because they do not fall under the statutory definition of wages in Section 3401(a).

Wages are only eligible if they are paid for "qualified services," which federal law divides into three distinct categories of activity.

1. Engaging in Qualified Research: This includes the direct technical work performed by scientists, engineers, and software developers. In South Carolina, these individuals must be physically performing the work within the state’s borders to meet the geographic sourcing requirements.
2. Direct Supervision: Wages paid to individuals who directly oversee the technical research process qualify. This is more than general administrative management; it must involve the technical review of experimental results, the determination of research directions, or the technical guidance of the research team.
3. Direct Support: This category captures wages for individuals who may not be researchers themselves but whose work is integral to the R&D process. Examples include lab technicians who prepare materials for experiments, machinists who fabricate prototypes for testing, and data entry staff who compile raw experimental results for analysis.

A pivotal administrative simplification adopted by the South Carolina Department of Revenue (SCDOR) via its conformity to the IRC is the "Substantially All" rule. This rule states that if an employee performs qualified services for at least eighty percent of their total working time during a taxable year, one hundred percent of their wages may be treated as qualified research expenses. Conversely, if the employee’s qualified time falls below the eighty-percent threshold, the taxpayer must meticulously allocate and claim only the actual percentage of time spent on R&D. This rule underscores the importance of granular time-tracking for research staff, as the difference between seventy-nine and eighty percent qualified time can significantly impact the final credit amount.

Local State Revenue Office Guidance: The SCDOR Perspective

The South Carolina Department of Revenue provides administrative and interpretive guidance that bridges the gap between the high-level statutory language and the practical realities of tax filing. This guidance is disseminated through tax forms, revenue rulings, and the "Tax Incentives for Economic Development" manual.

One of the most significant pieces of recent state guidance is SCDOR Revenue Ruling 22-4. While the ruling primarily addresses the federal Employee Retention Credit (ERC), it clarifies the state's position on federal "add-back" requirements that stem from wage-based credits. Under federal IRC Section 280C, taxpayers are generally required to reduce their wage deduction by the amount of the research credit claimed to prevent a "double benefit".

South Carolina, however, has a longstanding position of allowing a deduction for wages that are disallowed at the federal level because of a federal tax credit, provided there is no corresponding South Carolina credit for those specific wages. Revenue Ruling 22-4 confirms that taxpayers may make a modification (subtraction) from their federal taxable income on the South Carolina return for any wages disallowed as a federal deduction under rules similar to Section 280C. This ensures that the base of South Carolina taxable income is not artificially inflated by the lack of a federal wage deduction.

The SCDOR mandates the use of SC Schedule TC-18, "Research Expenses Credit," for all taxpayers seeking to claim the incentive. The instructions for TC-18 reiterate that the credit is limited to five percent of QREs "made by the taxpayer in South Carolina during the tax year". The form requires taxpayers to disclose the name and Federal Employer Identification Number (FEIN) of any pass-through entity (such as a Partnership, S-Corporation, or LLC) from which they may be receiving a share of the credit via a Schedule K-1.

The Department also emphasizes that because the credit is nonrefundable and subject to the fifty-percent limit, the TC-18 form functions as a tracking mechanism for the ten-year carryforward period. Documentation of these calculations is paramount, as the SCDOR has the authority to examine both current and carryforward claims.

A recurring theme in SCDOR guidance is the strict geographic limitation of the credit. While the federal credit applies to research throughout the United States, the South Carolina credit is restricted to expenses "made in South Carolina". For "Wages for Qualified Services," this means the credit is generated based on where the employee is physically located while performing the service, not where the company is headquartered or where the intellectual property is owned. If a South Carolina firm employs remote researchers in other states, the wages for those individuals must be excluded from the state credit calculation, even if they are included in the federal calculation.

Interaction with Other South Carolina Incentives

The Research and Development credit does not exist in a vacuum; it is part of a broader suite of incentives, including the Jobs Tax Credit (JTC) and the Headquarters Credit. The SCDOR provides specific guidance on how these credits interact and the prohibition against "double dipping."

The Jobs Tax Credit is based on the number of new, full-time jobs created in the state, with the credit amount determined by the county's tier designation. In contrast, the R&D credit is based on the dollar amount of wages paid for specific technical activities.

A critical insight for taxpayers is that the same employee can often trigger both credits. For example, a newly hired engineer in a Tier IV county may count as a "new job" for the JTC and their wages may qualify as QREs for the R&D credit. While the credits are separate, the SCDOR requires that they be used one at a time to reduce the tax liability, and each is subject to its own fifty-percent limitation.

The Headquarters Credit incentivizes the establishment of national or regional headquarters in South Carolina. To qualify for the personal property component of this credit, a taxpayer must create at least seventy-five new full-time jobs performing headquarters-related functions or research and development functions. These jobs must have an average cash compensation level of more than one and one-half times the state per capita income. This higher wage threshold for headquarters staff creates a synergistic effect with the R&D credit; the high-paying jobs required for the headquarters incentive naturally generate larger QRE wage bases for the R&D credit.

SCDOR guidance establishes a clear hierarchy for using tax credits. Generally, credits must be used in the year they are earned based on tax liability. However, the R&D credit is specifically noted for its unique limitation: it can only offset fifty percent of the tax liability remaining after all other credits have been applied. This means if a taxpayer has $100 in tax and $60 in other credits, the R&D credit can only offset fifty percent of the remaining $40 ($20 total), regardless of how much R&D credit was actually earned.

The Audit Process and Documentation Standards

The SCDOR maintains a rigorous audit posture regarding tax credits, particularly those that mirror complex federal statutes like IRC Section 41. Guidance from the Department, often communicated during the "Field Audit" or "Desk Audit" process, emphasizes the necessity of substantiating both the financial and technical aspects of the claim.

To defend a claim for "Wages for Qualified Services," a taxpayer must provide more than just payroll records. The SCDOR typically looks for:

• Time Allocation Logs: Records showing the percentage of time each employee spent on qualifying vs. non-qualifying activities.
• Narrative Project Descriptions: Documentation that proves the activities met the federal Four-Part Test, including the specific technical uncertainties being addressed.
• Federal Form 6765: A copy of the federal filing is mandatory, as the state credit is contingent upon the federal claim.
• W-2 Reconciliation: Clear evidence that the wages claimed on Form TC-18 match the taxable wages reported to the state and federal governments.

The audit process begins with an Audit Appointment Letter (AS-5) or an Audit Request (I-366), and taxpayers are encouraged to use secure file-sharing tools like GoAnywhere to provide documentation. The Department's "Final Audit Packet" will detail any adjustments made to the credit, which could lead to a proposed assessment or a reduction in carryforward balances.

Practical Example: Integrated Credit Calculation

To synthesize the law and guidance, consider a hypothetical South Carolina firm, "Palmetto Biotech Solutions," located in Charleston (a Tier I county).

The company employs a team of specialists to develop a new diagnostic kit. The team includes:

• Senior Scientist: Salary of $200,000. Spends 90% of her time in the lab conducting experiments. Under the "Substantially All" rule, 100% of her wages ($200,000) are qualified.
• Project Manager: Salary of $120,000. Spends 85% of his time technically supervising the research team and 15% on HR and budgeting. Under the "Substantially All" rule, 100% of his wages ($120,000) are qualified.
• Lab Technician: Hourly wages totaling $60,000. Spends 50% of his time preparing samples for R&D and 50% on routine manufacturing for existing customers. Because he is below the 80% threshold, only 50% of his wages ($30,000) qualify.

Total Wages for Qualified Services = $350,000.

In addition to wages, the firm spent $50,000 on research supplies (reagents and test tubes) and $100,000 on contract research with a South Carolina university.

The earned South Carolina R&D credit is calculated as:

$$SC\ R\&D\ Credit = \$465,000 \times 0.05 = \$23,250$$

Palmetto Biotech has a state tax liability of $30,000 and is also claiming a Jobs Tax Credit of $5,000 for new hires.

1. Initial Tax Liability: $30,000.
2. Apply Jobs Tax Credit: The JTC is applied first. $30,000 - $5,000 = $25,000 remaining tax liability.
3. Calculate R&D Credit Limit: The R&D credit is limited to 50% of the remaining liability. $25,000 \times 0.50 = $12,500.
4. Credit Utilization: The firm uses $12,500 of its earned $23,250 credit.
5. Final Tax Payable: $12,500.
6. Carryforward: The unused portion of $10,750 ($23,250 - $12,500) is carried forward for up to ten years on the company’s Schedule TC-18.

Emerging Trends and Policy Implications

The meaning of "Wages for Qualified Services" is also being shaped by broader tax policy changes at the federal level, particularly the impact of the Tax Cuts and Jobs Act (TCJA) of 2017.

Beginning in 2022, federal law required the amortization of R&D expenses over five years under IRC Section 174, rather than allowing an immediate deduction. While this change significantly increased the upfront tax burden for many research-intensive firms, it did not eliminate the Section 41 credit. Because South Carolina’s credit statute (Section 12-6-3415) refers specifically to the Section 41 credit rather than the Section 174 deduction, the generation of the five-percent state credit remains intact even if the wages are being amortized for federal income tax purposes.

There is significant legislative momentum to reinstate the immediate deductibility of research wages. The "American Innovation and R&D Competitiveness Act of 2025" seeks to reverse the amortization requirement. If passed, this would further align the cash-flow benefits of the South Carolina credit with federal expensing, making the recruitment of research staff even more attractive within the state.

Final Thoughts and Strategic Considerations

The South Carolina Research and Development tax credit is a powerful, though meticulously regulated, tool for economic development. At its core, the definition of "Wages for Qualified Services" acts as the gatekeeper for the incentive, ensuring that only genuine, technical innovation conducted within the state receives fiscal support. By mirroring federal IRC Section 41, South Carolina provides a framework that is both familiar to corporate tax departments and rigorous enough to prevent abuse.

The guidance provided by the SCDOR, from Revenue Ruling 22-4 to the instructions on Form TC-18, creates a clear roadmap for compliance. Taxpayers who prioritize granular time-tracking, maintain robust technical documentation of their experiments, and understand the unique ordering rules for South Carolina credits can significantly lower their effective tax rate and reinvest those savings into further innovation. As the state continues to attract high-tech manufacturing, life sciences, and software development firms, the R&D credit will remain a cornerstone of its competitive advantage in the Southeastern United States.