Credit for Research and Development Expenditures

The South Carolina Research and Development Tax Credit is a nonrefundable state incentive that provides a five percent credit on qualified research expenditures conducted specifically within the state’s borders. This credit is designed to reduce up to fifty percent of a taxpayer’s remaining state income tax and corporate license fee liability after all other applicable credits have been utilized.

Structural Overview and the Legislative Intent of South Carolina Tax Incentives

The South Carolina Research and Development (R&D) tax credit, as codified in S.C. Code Section 12-6-3415, represents a cornerstone of the state’s transition from an agrarian and textile-based economy to a modern hub for advanced manufacturing, biotechnology, and information technology. The primary objective of this statute is to incentivize private sector investment in innovation by lowering the after-tax cost of research activities performed within South Carolina. Unlike federal incentives that often utilize a complex “base amount” calculation, South Carolina has opted for a more straightforward, expenditure-based approach to encourage both established firms and growing startups to anchor their technical operations in the state.

The legal architecture of the credit is inextricably linked to the federal Research and Experimentation Tax Credit under Internal Revenue Code (IRC) Section 41. This “piggyback” structure ensures administrative efficiency by allowing the South Carolina Department of Revenue (SCDOR) to leverage federal definitions of qualified research while maintaining state-specific limitations on geography and total tax offset. As the state continues to attract global automotive and aerospace leaders, the R&D credit functions not merely as a tax reduction tool but as a critical element of South Carolina’s competitive economic development portfolio.

Statutory Foundation: Analyzing S.C. Code Section 12-6-3415

The Research and Development Tax Credit is governed by Section 12-6-3415 of the South Carolina Code of Laws, which provides the legal authority for the credit’s calculation, eligibility, and carryforward provisions. Understanding the precise phrasing of this statute is essential for professional practitioners, as the SCDOR strictly adheres to the letter of the law in its audit and compliance functions.

Eligibility and the Federal Claim Requirement

The statute’s primary requirement is found in Subsection (A), which mandates that a taxpayer must claim a federal income tax credit pursuant to Section 41 of the Internal Revenue Code for increasing research activities for the taxable year. This creates a dependency; if a taxpayer is ineligible for the federal R&D credit—perhaps because they failed the “four-part test” or their activities were specifically excluded under IRC Section 41(d)(4)—they are automatically disqualified from the South Carolina state credit.

The credit is allowed against any tax due pursuant to Chapter 6 of Title 12 (Income Tax) or Section 12-20-50 (Corporate License Fees). This dual-application capability is significant for corporations, as the corporate license fee is a separate tax on a corporation’s capital and surplus, and being able to offset both liabilities provides a more robust incentive for capital-intensive R&D operations.

Calculation Methodology: The Five Percent Standard

The credit amount is set at five percent of the taxpayer’s qualified research expenses made in South Carolina. The phrase “made in South Carolina” is the most critical geographic nexus in the statute. While the federal credit might include expenses from across the United States, the South Carolina credit is restricted to the subset of those expenses that can be specifically traced to activities occurring within the state.

Annual Limitations and the Ordering Rule

Subsection (B) of the statute introduces two critical limitations: the fifty percent cap and the carryover limit. 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” means that the R&D credit is effectively used after credits that do not have such a limitation or that have a higher priority in the tax code.

Furthermore, any unused credit may be carried over to the immediately succeeding taxable years, provided that the carry-over may not be used for a taxable year that begins ten years or more from the date of the qualified research expenses. This ten-year window requires careful tracking of credit “vintages” to ensure that older credits are utilized before they expire.

Federal Conformity and the Four-Part Test in a State Context

South Carolina’s reliance on IRC Section 41 necessitates a deep understanding of the federal standards for qualified research. For an activity to generate qualified research expenses (QREs) for the South Carolina credit, it must satisfy the federal “four-part test” conducted within the state’s borders.

The Four-Part Test Framework

Test Component	Narrative and Technical Requirement
Technological in Nature	The research must fundamentally rely on the principles of physical or biological science, engineering, or computer science. Activities based on social sciences, arts, or humanities are excluded.
Permitted Purpose	The research must be intended to develop a new or improved business component, defined as a product, process, technique, formula, invention, or software, intended for sale, lease, license, or use in a trade or business.
Elimination of Uncertainty	The activity must be intended to discover information that would eliminate uncertainty regarding the capability, method, or appropriate design for developing or improving a business component.
Process of Experimentation	Substantially all of the activities must constitute a process of experimentation, which involves identifying one or more alternatives to achieve a result and conducting a systematic trial-and-error process to evaluate those alternatives.

Implications of Technical Uncertainty

In the context of the South Carolina R&D credit, the “Elimination of Uncertainty” prong often becomes the focal point of SCDOR inquiries. Technical uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing the component, or the appropriate design of the component. For a manufacturing firm in South Carolina trying to integrate a new composite material into an aerospace part, the uncertainty might involve how the material reacts to extreme thermal stress. The systematic testing of various prototypes under those stresses would constitute the “Process of Experimentation”.

Defining and Categorizing Qualified Research Expenses (QREs)

The South Carolina credit is calculated based on four primary categories of expenditures, provided they are incurred in the performance of qualified research within the state.

Internal Labor: Qualified Wages

Wages are typically the largest component of an R&D claim. These include salaries and compensation for employees who are directly engaged in research, as well as those who provide direct supervision or direct support of research activities.

• Direct Research: The actual “bench work” performed by engineers, scientists, or software developers.
• Direct Supervision: The immediate oversight of researchers, such as a lab manager who reviews experimental results or manages the daily research schedule.
• Direct Support: Activities that facilitate research, such as a technician cleaning lab equipment or a machinist building a prototype for an engineer.

Crucially, “overhead” wages—such as those for general administrative, accounting, or legal personnel—do not qualify, even if they support the company’s R&D department.

Tangible Inputs: Research Supplies

Supplies include any tangible property (other than land or improvements to land) that is used in the research process. This often includes raw materials used to build prototypes or chemicals and gases consumed during laboratory experiments. If a South Carolina manufacturer develops 50 different prototype iterations of a new valve, the cost of the steel, seals, and specialized components used in those 50 prototypes would qualify as QREs.

External Partnerships: Contract Research

When a South Carolina company hires a third party to perform qualified research on its behalf, the expenses are categorized as contract research. However, the state (following federal law) limits the eligible amount to 65% of the total payments to most contractors. If the contractor is a qualified research consortium or a non-profit scientific research organization, the eligible amount may increase to 75%.

A critical nuance for state-level tax planning is the location of the contractor. To qualify for the South Carolina R&D credit, the research must be performed in South Carolina. If a Charleston-based company pays a firm in Germany to perform stress testing, those expenses may qualify for the federal credit but are ineligible for the South Carolina credit.

Technology Infrastructure: Computer Rentals

Expenses paid for the right to use computers in the conduct of qualified research are eligible. In the modern era, this typically applies to “cloud computing” or time-sharing on supercomputers where the physical machine is used primarily for complex simulations or data analysis related to the research project.

Administrative Guidance: The South Carolina Department of Revenue’s Position

The SCDOR provides guidance through several types of advisory opinions, including Revenue Rulings, Revenue Procedures, and Information Letters. These documents provide the “how-to” for taxpayers attempting to comply with Section 12-6-3415.

Form TC-18 and the Calculation Process

The primary tool for claiming the credit is Schedule TC-18, “Research Expenses Credit”. The form’s structure reinforces the statutory limitations and provides a clear audit trail for the department.

Line Item	Description of Task
Line 1	Enter the total amount of qualified research expenses made in South Carolina.
Line 2	Multiply Line 1 by 5% (0.05). This represents the current year’s earned credit.
Line 3	Enter research expenses credit carried forward from previous years and attach a schedule.
Line 4	Total research expenses credit before limitations (Line 2 + Line 3).
Line 7	Subtract other credits from tax liability to find the “remaining liability.”
Line 8	Multiply the remaining liability by 50% to determine the annual cap.
Line 9	Enter the lesser of Line 4 or Line 8. This is the credit allowed for the year.

Revenue Procedure #16-1: Reporting Federal Changes

Because the state credit is contingent on the federal claim, any federal adjustment to the R&D credit has a ripple effect on the South Carolina liability. Under Revenue Procedure #16-1, C corporations must notify the SCDOR of any changes in taxable income or credits made by the IRS within 180 days of the “final determination”. The “final determination” is defined as the federal assessment date.

Taxpayers can use a streamlined reporting format provided in the procedure in lieu of filing a full amended return (Form SC 1120). This proactive reporting is vital, as the SCDOR has the authority to assess additional taxes based on these federal changes even if the standard three-year state statute of limitations has expired.

Entity-Specific Application: C Corporations, S Corporations, and Partnerships

The mechanism for claiming the R&D credit varies significantly depending on the taxpayer’s legal structure, although the underlying qualification of expenses remains identical.

C Corporations and Consolidated Groups

C corporations claim the credit directly to offset their income tax and corporate license fees. For corporations that are members of an affiliated group filing a consolidated return, the use of credits is determined on a combined basis. This means the credit can reduce the consolidated group’s total tax liability, regardless of whether the specific corporation that conducted the research would have had a liability on a separate-return basis. This consolidated treatment is a significant benefit for large multi-entity enterprises operating in South Carolina.

Pass-Through Entities (PTEs) and the Schedule K-1

For S corporations, partnerships, and LLCs treated as partnerships, the credit is calculated at the entity level but is not used by the entity itself. Instead, the credit is allocated to the partners or shareholders based on their ownership percentage.

• Reporting: The entity reports the credit on the owners’ South Carolina Schedule K-1.
• Claiming: The individual owners then claim their portion of the credit on their own individual income tax returns (Form SC 1040) using Schedule TC-18.
• Identification: The claimant must provide the name and FEIN of the pass-through entity on their TC-18 to allow the SCDOR to cross-reference the claim.

Individual taxpayers should be aware that their Social Security Numbers are required on the TC-18 for identification purposes, a mandate justified by the Social Security Privacy Act and state regulations.

The 50% Liability Limitation and the Strategic Ordering of Credits

A defining characteristic of South Carolina’s tax policy is the pervasive use of a 50% liability cap on several major business credits, including the R&D credit and the Jobs Tax Credit. This cap prevents a taxpayer from completely eliminating their tax liability using these incentives alone, ensuring that even highly subsidized firms contribute at least half of their “theoretical” tax to the state’s general fund.

Understanding the Ordering Sequence

The SCDOR provides specific guidance on the order in which credits must be applied. Because the R&D credit is limited to 50% of the remaining liability, it is structurally disadvantaged compared to credits that can offset 100% of liability.

Consider a taxpayer with a $100,000 tax liability and two credits: a $60,000 Conservation Credit (which has no percentage limitation) and a $60,000 R&D Credit (limited to 50% of remaining liability).

Scenario	Step 1	Step 2	Final Liability
Apply R&D First	$100k – $50k (cap) = $50k	$50k – $50k (Conservation) = $0	$0 (Carryovers: $10k R&D, $10k Cons.)
Apply Cons. First	$100k – $60k = $40k	$40k – $20k (R&D cap on $40k) = $20k	$20k (Carryover: $40k R&D)

As illustrated, the order of application can result in a different final tax payment and different carryover balances. The R&D credit instructions specifically state that it must be applied after all other credits, effectively forcing the less favorable “Apply Cons. First” result in the example above.

Small Business Context and the Evolution of the R&D Refund

South Carolina has long recognized that for small, pre-revenue startups, a nonrefundable tax credit with a ten-year carryforward is of limited immediate value. This has led to legislative attempts to modernize the R&D credit specifically for smaller employers.

Legislative Analysis of House Bill 3592 (H 3592)

House Bill 3592 was introduced to address the “cash flow gap” for South Carolina’s emerging tech sector. The bill proposed a significant amendment to Section 12-6-3415, specifically targeting taxpayers with less than 150 full-time employees.

The proposed reform would have allowed these small businesses to:

1. Claim the entire credit in one year: Bypassing the 50% annual limitation.
2. Receive a refund: If the credit exceeded the taxpayer’s liability, the SCDOR would refund the difference, up to a cap of 75% of the taxpayer’s liability.
3. Statewide Refund Cap: To protect the state’s budget, the total amount of such refunds would be capped at $5 million per year, with a pro-rata reduction for all claimants if the cap was exceeded.

While this specific refund provision represents a potential future outlook for South Carolina tax policy, the current law as reflected in the 2024 and 2025 codifications remains primarily nonrefundable for the standard R&D credit. Small businesses are encouraged to investigate other refundable or more flexible credits, such as the federal payroll tax offset for R&D or the South Carolina Angel Investor Credit (though the latter faced a sunset on December 31, 2025).

Integrated Case Study: Advanced Polymer Research and Development

To demonstrate the application of the law and revenue office guidance, we can analyze a hypothetical scenario involving a South Carolina-based materials science firm, “Carolina Polymers, Inc.”

Facts of the Case

In the 2024 tax year, Carolina Polymers, a C corporation, invested in developing a new biodegradable packaging material intended to replace traditional plastics in the beverage industry. The company performed all its research at its facility in Greenville, South Carolina.

The company’s 2024 expenditures were as follows:

• SC-Based Scientist Salaries: $500,000.
• Lab Technician (Direct Support): $80,000.
• Raw Materials for Prototypes: $120,000.
• Contract Testing at Clemson University: $100,000.
• Cloud Computing/Simulation Services: $50,000.

Step 1: Calculate Qualified Research Expenses (QREs)

Category	Actual Spend	Qualification Rate	Qualified Amount
Internal Wages	$580,000	100%	$580,000
Supplies	$120,000	100%	$120,000
Contract Research	$100,000	65%	$65,000
Computer Rental	$50,000	100%	$50,000
Total SC QREs			$815,000

Step 2: Calculate the Pre-Limitation Credit

Using the 5% rate specified in § 12-6-3415(A) 1:

Credit = $815,000 x 0.05 = $40,750

Step 3: Apply the 50% Liability Limitation

Assume Carolina Polymers has a South Carolina income tax liability of $60,000 and a Corporate License Fee of $5,000, for a total tax of $65,000. The company is also utilizing a $10,000 Job Tax Credit.

1. Total Tax Liability: $65,000.
2. Less Jobs Credit: $65,000 – $10,000 = $55,000 (Remaining Liability).
3. Calculate R&D Cap: $55,000 x 0.50 = $27,500.
4. Allowable Credit for 2024: The company uses $27,500 of its R&D credit.
5. Carryforward Calculation: $40,750 – $27,500 = $13,250.

This $13,250 can be carried forward for up to ten years, expiring in 2034.

Interaction with the South Carolina Jobs Tax Credit

For many R&D-intensive businesses, the most significant interplay is between the R&D credit and the Jobs Tax Credit (JTC). A “research and development facility” is one of the specific types of facilities that qualify for the JTC under Section 12-6-3360.

Qualifying as an R&D Facility for Jobs Credits

To qualify for the JTC, a facility must generally create a monthly average of at least ten new, full-time jobs. However, “Small Business” provisions allow firms with 99 or fewer employees to qualify by creating as few as two new full-time jobs.

The value of the JTC depends on the “tier” of the county where the facility is located.

County Tier	Annual Credit per New Job
Tier I (Developed)	$1,500
Tier II (Moderately Developed)	$2,750
Tier III (Under Developed)	$4,250
Tier IV (Least Developed)	$8,000

Source: SCDOR Information Letters and Revenue Rulings.

A research firm in a Tier IV county (like Marlboro or Allendale) could receive $8,000 per job per year for five years. This “stacking” of the R&D credit (5% of spend) and the Jobs Tax Credit (fixed dollar per person) creates a powerful incentive for locating high-paying R&D jobs in rural or distressed areas of South Carolina.

Procedural Safeguards: Audits, Appeals, and Documentation

The SCDOR maintains a robust audit program for tax credits, and the R&D credit is subject to significant scrutiny due to its complexity and the large dollar amounts often involved.

The Importance of Contemporaneous Documentation

To prevail in an SCDOR audit, a taxpayer must be able to substantiate their claim with contemporaneous documentation. The department does not accept “back-of-the-envelope” estimates or post-hoc justifications.

Critical documents include:

• Project Lists: A comprehensive list of all research projects active during the tax year.
• Time Tracking: Records that specifically link employee hours to qualified projects.
• Technical Documentation: Project plans, blueprints, failure reports, and test results that prove a process of experimentation occurred.
• Nexus Verification: Evidence that the work was performed in South Carolina, such as site badges, travel logs, or facility lease agreements.

Navigating the Appeals Process

If an audit results in a “Notice of Proposed Assessment,” the taxpayer has a window of time to protest the findings. The protest should be in writing and should clearly state the points of disagreement and the legal basis for the taxpayer’s position, referencing Section 12-6-3415 and relevant SCDOR advisory opinions. If the department and the taxpayer cannot reach an agreement, the case may move to the South Carolina Administrative Law Court.

Comparative Analysis: South Carolina vs. Regional Competitors

South Carolina’s R&D credit is often compared to those of neighboring states like North Carolina, Georgia, and Florida to determine the state’s relative attractiveness for new investment.

Feature	South Carolina	Georgia	North Carolina
Credit Rate	5% of all QREs	10% of QREs over base	Sunsetted (repealed)
Base Amount	No base required	Requires base calculation	N/A
Refundability	Nonrefundable	Refundable for some	N/A
Carryforward	10 Years	10 Years	N/A

Source: Industry analysis and multi-state tax comparisons.

South Carolina’s primary competitive advantage is the lack of a “base amount” calculation. In states like Georgia, a company must increase its R&D spending relative to a historical average to receive a significant credit. In South Carolina, a company receives a credit on the first dollar of qualified spending. This is especially beneficial for large, stable manufacturing plants that maintain a high but consistent level of R&D spending year-over-year.

Complementary Incentives: The Technology Intensive Facility Exemption

While the R&D credit focuses on income tax, South Carolina offers a powerful sales and use tax incentive for “Technology Intensive Facilities” that often goes hand-in-hand with R&D operations.

Under Section 12-36-2120(65), a sales tax exemption is available for computer equipment used in a technology-intensive facility if the taxpayer :

1. Invests at least $300 million in the facility over five years.
2. Creates at least 100 jobs over five years.
3. Maintains high compensation: The jobs must have an average cash compensation of at least 150% of the state per capita income.

For R&D labs that rely on massive supercomputing clusters or high-end server farms for simulations, the ability to purchase this hardware sales-tax-free can be as valuable as the income tax credit itself.

Future Outlook: Federal Tax Reform and Conformity Challenges

South Carolina’s tax system faces ongoing challenges due to changes at the federal level, such as those introduced by the Tax Cuts and Jobs Act (TCJA) of 2017. One of the most significant changes was the requirement under IRC Section 174 for taxpayers to amortize R&D expenses over five years rather than deducting them immediately.

While Section 12-6-3415 focuses on the credit (IRC Section 41) rather than the deduction (IRC Section 174), the state’s conformity process ensures that these changes are monitored by the General Assembly. Each year, the General Assembly reviews federal tax changes and adopts a “fixed-date conformity” statute, usually updating Section 12-6-40 to incorporate the IRC as of the previous December 31st. If the federal government were to significantly alter the R&D credit—for instance, by changing the definition of qualified research—South Carolina would have to decide whether to follow those changes or “decouple” from the federal law to maintain its own R&D policy.

Final Thoughts: Synthesizing the R&D Credit Narrative

The South Carolina Research and Development Tax Credit is a precisely calibrated instrument of state economic policy. By leveraging federal definitions through IRC Section 41 while eliminating the “base amount” hurdle, the state has created a “straightforward” 5% incentive that rewards the absolute volume of innovation occurring within its borders. However, the credit is not without its complexities; the 50% liability cap, the strict ten-year carryforward, and the absolute requirement for a South Carolina geographic nexus require vigilant tax planning and detailed documentation.

For the professional peer, the R&D credit should not be viewed in isolation. Its true power lies in its interaction with the Jobs Tax Credit, the Corporate License Fee offset, and the administrative streamlining offered by the SCDOR. As South Carolina continues to position itself as a global leader in high-tech manufacturing, the interpretation and application of Section 12-6-3415 will remain a critical focus for both tax administrators and the businesses that drive the state’s innovative capacity.