Income Tax (Individual, Corporate, Fiduciary)

The South Carolina Research Expenses Credit is a nonrefundable tax incentive that allows taxpayers to reduce their income tax or corporate license fee liability by 5% of qualified research expenditures incurred within the state. This credit is available to individuals, corporations, and fiduciaries, provided they concurrently claim the federal research credit for the same taxable year under Internal Revenue Code Section 41.

Fundamental Principles of South Carolina Income Taxation in the R&D Context

To understand the South Carolina Research Expenses Credit, one must first analyze the broader architecture of the South Carolina Income Tax Act, codified in Chapter 6 of Title 12. The state’s tax system is characterized by a significant degree of federal conformity, as established in Section 12-6-40, which adopts the Internal Revenue Code (IRC) as the foundational baseline for determining taxable income. This conformity simplifies the compliance process for taxpayers, as the state generally accepts federal adjustments, exemptions, and deductions with limited modifications. However, the application of tax credits, such as the Research Expenses Credit under Section 12-6-3415, operates as a distinct state-level mechanism that reduces the final tax liability after the federal-based income calculation is complete.

Corporate Income Tax and the License Fee Nexus

The corporate income tax, governed by Section 12-6-530, is imposed at a flat rate of 5% on the South Carolina taxable income of every corporation, whether domestic or foreign, that conducts business within the state. For the purpose of the R&D credit, the Corporate Income Tax is not the only relevant liability; Section 12-6-3415 specifically allows the credit to be applied against Corporate License Fees imposed under Section 12-20-50. The Corporate License Fee is an annual fee based on the corporation's paid-in capital and surplus, essentially serving as a franchise tax for the privilege of doing business in South Carolina.

The dual applicability of the R&D credit against both income tax and license fees is a critical feature for capital-intensive industries. For instance, a manufacturing corporation establishing an R&D facility may incur significant initial expenses that result in a net operating loss for income tax purposes during the first few years. Because the R&D credit can offset the Corporate License Fee, the taxpayer still derives immediate value from the credit despite the absence of an income tax liability. This mechanism reflects a legislative intent to support long-term innovative investment by providing a floor of tax relief regardless of immediate profitability.

Individual Income Tax and Pass-Through Allocation

For individual taxpayers—including sole proprietors, partners in a partnership, members of an LLC, and shareholders in an S-corporation—the South Carolina income tax is imposed under Section 12-6-510. Unlike the flat corporate rate, the individual tax rate has historically been graduated. However, recent legislative reforms have sought to lower the top marginal rate significantly. For tax year 2024, the top rate was 6.2%, and it has been reduced to 6% for the 2025 tax year.

In the context of the R&D tax credit, individuals typically claim the credit through their interest in pass-through entities (PTEs). South Carolina follows the federal tax treatment of PTEs, meaning the entity itself generally does not pay income tax; instead, items of income, deduction, and credit flow through to the owners. The R&D credit is allocated to owners based on their ownership share as reported on the South Carolina Schedule K-1.

A unique provision for pass-through businesses in South Carolina is found in Section 12-6-545, which allows an optional reduced income tax rate of 3% on active trade or business income. Taxpayers must carefully evaluate whether claiming this reduced rate on income affects the utility of the R&D credit. Because the R&D credit is limited to 50% of the tax liability, a lower tax rate on active business income may inadvertently increase the amount of the R&D credit that must be carried forward to future years.

Fiduciary Income Tax and Trust Structures

The South Carolina Department of Revenue (SCDOR) defines a fiduciary as an individual or entity holding the character of a trustee for a resident or nonresident estate or trust. Fiduciaries are subject to tax under Section 12-6-510, using the same rate schedule as individuals. Resident estates and trusts must file Form SC1041 if they are required to file a federal return or if they have South Carolina taxable income.

The application of the R&D credit to fiduciaries is particularly complex due to the Electing Small Business Trust (ESBT) rules. Under Section 12-6-535, the S-corporation portion of an ESBT is taxed at the highest marginal rate (6% for 2025) rather than the graduated rates. Since R&D credits frequently originate from S-corporations engaged in high-tech manufacturing, many trusts find themselves claiming the credit against this high-rate liability. The credit is nonrefundable for fiduciaries and is subject to the same 50% liability limitation that applies to individuals and corporations. If the trust distributes its income to beneficiaries, the credit must generally follow the distribution, appearing on the beneficiary’s Schedule K-1 and reducing their personal tax liability.

Statutory Framework of South Carolina Code Section 12-6-3415

The Research Expenses Credit is explicitly defined in South Carolina Code Section 12-6-3415. The statute is comprised of two primary subsections that dictate the calculation and application of the incentive.

Calculation and Federal Dependency

Subsection (A) of Section 12-6-3415 establishes the gatekeeper requirement: a taxpayer is only eligible for the South Carolina credit if they claim a federal income tax credit under IRC Section 41 for increasing research activities during the same taxable year. This means that if a taxpayer fails to meet the federal criteria—such as the Four-Part Test or the requirement for incremental spending over a base period—they are statutorily barred from the state credit, even if they have significant research expenditures in South Carolina.

The credit is equal to 5% of the taxpayer's qualified research expenses (QREs) made within South Carolina. The term qualified research expenses is defined by cross-referencing IRC Section 41(b), ensuring that the state remains in lockstep with federal definitions of eligible wages, supplies, and contract research.

Limitations and Carryforward Provisions

Subsection (B) imposes a strictly enforced limit: the credit used in any single year cannot exceed 50% of the taxpayer's remaining tax liability after all other credits have been applied. This ordering rule effectively places the R&D credit at the bottom of the priority stack for tax offsets.

Unused credits may be carried forward for a period of 10 years. This 10-year window is slightly shorter than the 15-year carryforward allowed for the New Jobs Credit under Section 12-6-3360, highlighting the need for taxpayers to monitor their credit expiration dates carefully.

Statutory Component	Section 12-6-3415 Requirement	Regulatory Implementation
Credit Rate	5.0% of SC QREs	Calculated on Form TC-18
Federal Linkage	Must claim IRC § 41 Credit	Must have Federal Form 6765
Annual Limit	50% of remaining liability	Computed after all other credits
Carryforward	10 Taxable Years	Tracked by year of origin
Tax Types	Income Tax & License Fees	Chapter 6 & Section 12-20-50

Defining Qualified Research Expenditures in the South Carolina Context

The determination of what constitutes a qualified research expense made in South Carolina is the most frequent point of contention during SCDOR audits. Because the state uses the federal definition under IRC Section 41(b), taxpayers must categorize their expenses into four specific buckets, all of which must have a physical and economic nexus to South Carolina.

Research Wages and the Professional Criterion

Wages paid to employees performing, supervising, or supporting research are often the largest component of a claim. To qualify, the employee must be physically present in South Carolina when the work is performed. The SCDOR looks to the nature of the work performed; under associated guidance for similar credits (such as the Headquarters Credit), professional employees are defined as those whose primary duty requires knowledge of an advanced type in a field of science or learning characterized by a prolonged course of specialized study.

In the R&D context, the work must be original, creative, and non-standardized. For example, a software engineer in Charleston developing a new encryption algorithm would qualify, whereas a technician in the same office performing routine bug fixes on existing software might not, as the latter lacks the requisite technical uncertainty and process of experimentation mandated by the federal four-part test.

Supplies and Tangible Property Use

Supplies include any tangible personal property, other than land or improvements to land and property subject to depreciation, which is consumed or used in the research process. In South Carolina, the interaction between the R&D credit and Sales and Use tax is critical. While research supplies are eligible for the 5% credit, they may also be subject to use tax if they are withdrawn from the taxpayer's own inventory.

SCDOR Revenue Ruling #16-10, while often discussed in the context of lodging, provides a broader interpretative framework for withdrawals for use. If a manufacturer in Greenville produces a specialized polymer to be used exclusively in an R&D prototype, the withdrawal of that polymer for research purposes is a taxable event for use tax purposes based on its fair market value. However, the cost of that polymer (including the tax paid) would then be categorized as a qualified research supply expense for the 5% R&D income tax credit.

Contract Research and Third-Party Vendors

Taxpayers often outsource specialized research to universities or private laboratories. Under the IRC rules adopted by South Carolina, only 65% of the amount paid to an outside vendor for qualified research is eligible for the credit. If the payment is made to a qualified research consortium, the limit increases to 75%.

A vital requirement for the state credit is that the third-party research must be performed within South Carolina. If a Columbia-based pharmaceutical company contracts with a lab in North Carolina, those expenses are entirely excluded from the South Carolina R&D credit, even though they remain eligible for the federal credit. This geographic restriction emphasizes the credit’s role as an economic development tool intended to build the state's internal technical infrastructure.

Computer Rentals and Cloud Computing

As research shifts toward digital simulation and high-performance computing, the computer rental category has gained prominence. South Carolina allows expenses for computers or equipment leased and used directly in qualified research activities. In the modern era, this typically includes cloud computing costs for processing big data or running simulations. For these costs to qualify for the South Carolina credit, the taxpayer must be able to demonstrate that the computing resources were utilized by employees or systems located within the state.

Local State Revenue Office Guidance and Administrative Application

The SCDOR provides guidance through a hierarchy of advisory opinions, ranging from high-precedence Revenue Rulings to Information Letters.

The Role of Revenue Ruling #16-10 and Interpretative Authority

Revenue Ruling #16-10 is an administrative statement that addresses the application of tax laws to specific sets of facts. While its primary focus is on the accommodations tax and sales tax exemptions for lodging, it is frequently cited in broader tax incentives manuals because it reinforces the SCDOR’s position on the vendor nature of South Carolina taxes and the valuation of tangible property.

For R&D taxpayers, the guidance in rulings like #16-10 and #14-4 is essential for understanding Economic Nexus. If a company hires an out-of-state vendor to perform R&D services, the company must determine if that vendor has nexus with South Carolina. If the vendor does not collect South Carolina sales tax, the taxpayer may be required to remit use tax directly to the SCDOR. Full compliance with these sales and use tax rulings is a prerequisite for a clean audit of the R&D credit, as auditors often look for matching use tax payments on supply and contract research invoices.

Per Capita Income Figures and the Wage Differential

A distinct form of local guidance is the annual Information Letter detailing the state and county per capita income (PCI) figures. While the R&D credit itself does not have a wage floor, it is often claimed in tandem with the Job Tax Credit (§ 12-6-3360) or the Headquarters Credit (§ 12-6-3410), both of which use PCI to determine eligibility and credit amounts.

For example, a small business with 99 or fewer employees can qualify for a Job Tax Credit if they create two or more jobs. However, if the gross wages of those jobs do not amount to at least 120% of the lower of the county or state average PCI, the credit amount is cut in half.

Per Capita Income Reference Year	State Per Capita Income Figure	Relevant Guidance
2023	$50,391 (approx.)	IL 23-XX
2024	$53,618	IL 24-20
2025	$57,332	IL 25-23

Taxpayers conducting R&D must monitor these figures because research and development facilities are specifically listed as qualifying facilities for the traditional Job Tax Credit. This allows an R&D company to potentially stack a $5,000 per-job tax credit on top of the 5% R&D credit, provided they meet the wage thresholds defined in the annual PCI Information Letters.

IRC Section 163(j) and Business Interest Expense Decoupling

Another critical piece of administrative guidance is Revenue Ruling #21-2, which addresses South Carolina’s decoupling from the federal limitation on business interest expense (BIE). Under the federal Tax Cuts and Jobs Act (TCJA), IRC Section 163(j) limits the deduction for interest expense to 30% (or 50% under the CARES Act) of adjusted taxable income.

South Carolina has chosen not to follow this limitation. This is relevant for R&D companies that are heavily leveraged with debt used to finance research equipment or laboratory construction. For state income tax purposes, the full interest expense is deductible in the year incurred, which may create a larger South Carolina net operating loss compared to the federal return. This modification to federal taxable income can significantly alter the remaining tax liability against which the R&D credit is applied.

Intersection with the Corporate Headquarters Credit (§ 12-6-3410)

For many years, the Corporate Headquarters Credit and the R&D Credit were seen as complementary incentives that could be easily combined. Recent legislative changes, however, have introduced a divergence in how research and development functions are treated.

The Exclusion of R&D Jobs from Headquarters Counts

The South Carolina Corporate Headquarters Credit provides a 20% credit for the real property costs (design, construction, and development) and the tangible personal property costs (machinery and equipment) incurred when establishing or expanding a headquarters facility. Historically, employees performing research and development services were counted toward the job creation requirements for this credit.

Effective for tax years beginning after 2023, the law generally makes it easier for entities like LLCs to qualify for the Headquarters Credit and reduces the job requirement from 75 to 40. However, a major trade-off in this legislation is that jobs for research and development related functions no longer count toward the 40-job creation requirement for the Headquarters Credit.

This change has a profound implication for R&D-intensive companies. While the facility itself—including labs and high-tech equipment—remains eligible for the 20% property credit if it is part of a headquarters, the staffing must consist of executive, administrative, or professional workers performing headquarters-related functions such as financial, legal, or planning services. This creates a situation where a company must maintain two distinct sets of personnel records: one for the 5% R&D credit (targeting the researchers) and one for the 20% Headquarters Credit (targeting the management staff).

Stacking and Ordering of Credits

Because the R&D credit is limited to 50% of the remaining tax liability after other credits, it is usually taken after the Headquarters Credit. If a corporation uses the Headquarters Credit to reduce its liability by 80%, the R&D credit can only offset 50% of the tiny amount of tax that is left. This ordering rule ensures that the state does not allow a taxpayer to completely zero out their tax liability through a combination of stackable incentives, unless those incentives are specifically designated as refundable (which R&D and Headquarters credits are not).

Procedural Requirements for Individuals, Corporations, and Fiduciaries

The SCDOR requires specific forms and schedules to be attached to the tax return for a credit claim to be valid. Failure to provide the required documentation can lead to the immediate disallowance of the credit.

Form TC-18: The Research Expenses Credit Schedule

Form TC-18 is the primary calculation document for all R&D claimants. The form requires the taxpayer to:

1. Enter the total SC QREs for the year.
2. Multiply by 5% to determine the current year credit.
3. Add any R&D credit carryforwards from previous years (up to 10 years).
4. Calculate the 50% limitation based on the taxpayer's specific liability on Form SC1040 (Individuals), SC1120 (Corporations), or SC1041 (Fiduciaries).

Form SC1040TC and SC1120TC

These forms serve as summaries for all nonrefundable tax credits claimed on the return. The Research Expenses Credit is assigned Code 018. Taxpayers must list the credit name, code, and amount on these summary forms and attach them to the front of their tax return.

The Fiduciary Filing Process (SC1041)

Fiduciaries face a unique challenge in filing because they must distinguish between credit portions retained by the trust and portions distributed to beneficiaries. If the credit is retained, the fiduciary includes Form TC-18 with the SC1041. If the credit is distributed, the fiduciary must issue a South Carolina Schedule K-1 to each beneficiary, specifying their share of the R&D credit. The fiduciary must also ensure that the trust’s FEIN is clearly provided on all forms to avoid processing delays in the SCDOR’s MyDORWAY system.

Comprehensive Practical Example: The Multigenerational Tech Estate

To illustrate the integration of these laws and guidance, we consider a complex scenario involving a C-corporation, a pass-through entity, and a fiduciary.

The Entities

1. Innovation Labs, Inc. (C-Corp): Conducts $10,000,000 in SC QREs. Also expanding its national headquarters in Greenville.
2. SolarTech LLC (Pass-Through): Conducts $2,000,000 in SC QREs. Owned 50% by an individual and 50% by a trust.
3. The Sterling Trust (Fiduciary): Owns 50% of SolarTech LLC.

Step 1: Innovation Labs, Inc. (Corporate)

Innovation Labs calculates a gross R&D credit of $500,000 ($10,000,000 x 5%).

However, Innovation Labs also qualifies for the Headquarters Credit. Its property costs were $5,000,000, yielding a $1,000,000 Headquarters Credit ($5,000,000 x 20%).

- Total Tax Liability: $1,500,000.
- Minus Headquarters Credit: $1,500,000 - $1,000,000 = $500,000 remaining liability.
- R&D Credit 50% Limit: 50% of $500,000 = $250,000.
- R&D Credit Used: $250,000.
- Carryforward: $500,000 (earned) - $250,000 (used) = $250,000 (Available for 10 years).

Step 2: SolarTech LLC and The Sterling Trust

SolarTech LLC earns an R&D credit of $100,000 ($2,000,000 x 5%).

It issues a Schedule K-1 for $50,000 to the Sterling Trust.

The Sterling Trust has a tax liability of $100,000 on its S-corporation income (taxed at the top rate of 6.2% as an ESBT).

- Trust Tax Liability: $100,000.
- Other Credits: $0.
- R&D Credit 50% Limit: 50% of $100,000 = $50,000.
- R&D Credit Used: $50,000.
- Final Tax Due: $50,000.

Step 3: Local Guidance Compliance

The trust must attach Form TC-18 to its SC1041, noting that the credit was received from SolarTech LLC (providing SolarTech's FEIN). The individual owner of SolarTech must also attach TC-18 and SC1040TC to their personal return.

Summary of Audit Risks and Mitigation Strategies

The South Carolina Research Expenses Credit is a highly scrutinized incentive. Taxpayers should be aware of several red flags that trigger SCDOR audits:

1. Discrepancy with Federal Claim: If a taxpayer amends their federal return to reduce the R&D credit (perhaps following an IRS audit), they must also amend their South Carolina return. Failure to do so is a common source of assessments.
2. Lack of Geographic Nexus: Claiming wages for remote employees who live and work in North Carolina or Georgia is a frequent error. While recent legislation for the Job Development Credit allows some remote workers to count, the R&D credit statute under § 12-6-3415 remains strictly focused on expenses made in South Carolina.
3. Inadequate Substantiation of Experimental Nature: Simply performing high-end engineering is not enough. The taxpayer must document the technical uncertainty and the specific testing or trial-and-error process used to resolve it.
4. Incorrect Ordering: Applying the R&D credit before other credits, thereby bypassing the 50% limitation, will result in the immediate recalculation of the return and a bill for additional tax, interest, and penalties.

By carefully navigating the statutory requirements of Section 12-6-3415 and integrating the administrative guidance found in SCDOR Revenue Rulings and Information Letters, individuals, corporations, and fiduciaries can leverage this credit to significantly reduce their cost of innovation within the State of South Carolina. The 10-year carryforward and the ability to offset both income and license fees provide a robust financial safety net for the state's most innovative enterprises.