Excess Qualified Research Expenses

Excess Qualified Research Expenses (EQRE) constitute the portion of a taxpayer’s Utah-based research spending that surpasses a calculated historical baseline known as the base amount. These expenses serve as the taxable basis for the five percent incremental component of the Utah Research and Development tax credit, rewarding increased innovation investment within the state.

Statutory Foundations of the Utah Research and Development Credit

The Utah Research and Development (R&D) tax credit is established primarily under two distinct sections of the Utah Code, structured to address different categories of taxpayers. Corporate entities fall under the purview of Utah Code Ann. § 59-7-612, which governs the credit against corporate franchise and income taxes. For individuals, estates, trusts, and pass-through entities such as S-corporations and partnerships, the equivalent provisions are found in Utah Code Ann. § 59-10-1012. These statutes are designed to harmonize with federal law while maintaining strict geographical boundaries to ensure the fiscal benefit incentivizes local economic activity.

The legislative intent behind the “Excess” calculation is to provide a targeted incentive for growth. By requiring a baseline of spending (the base amount), the state avoids subsidizing routine research expenditures that a company would have incurred regardless of the credit, focusing instead on rewarding the expansion of research departments and the initiation of new, technically uncertain projects within Utah’s borders.

The Three-Component Credit Architecture

Utah employs a unique hybrid credit system that distinguishes it from many other states. A taxpayer meeting the statutory requirements may claim three separate nonrefundable tax credits simultaneously:

Credit Component	Statutory Rate	Basis of Calculation	Carryforward Period
Incremental Research Credit	5%	Qualified Research Expenses (QREs) that exceed the base amount	14 Years
Basic Research Credit	5%	Payments to qualified organizations for basic research that exceed the base amount	14 Years
Total Research Credit (Volume)	7.5%	Total qualified research expenses for the current taxable year	0 Years (Must use in current year)

The term “Excess Qualified Research Expenses” specifically refers to the calculation used for the first component, although a similar “excess” logic applies to the basic research component. The 7.5% volume credit, by contrast, does not require a base amount subtraction but lacks the 14-year carryforward safety net, making it a “use it or lose it” incentive for the current tax year.

Technical Definition of Qualified Research Expenses (QREs)

To calculate the “excess” portion of research spending, a taxpayer must first determine the total Qualified Research Expenses (QREs) incurred during the taxable year. Utah law incorporates the federal definitions provided in Section 41 of the Internal Revenue Code (IRC), but strictly limits their application to research activities conducted within the state.

Incorporation of IRC Section 41(b) and 41(d)

The Utah Code mandates that the credits be calculated as provided in IRC § 41, and the definitions of that section apply to the calculation. To be considered “qualified research,” the activity must satisfy the federal “Four-Part Test”:

1. Section 174 Test: The expenditures must be eligible for treatment as research and experimental expenditures under IRC § 174, meaning they must be incurred in connection with the taxpayer’s trade or business and represent research and development costs in the experimental or laboratory sense.
2. Technological in Nature Test: The research must fundamentally rely on the principles of physical or biological sciences, engineering, or computer science.
3. Permitted Purpose Test: The research must be intended to discover information that would eliminate technical uncertainty concerning the development or improvement of a “business component,” which includes products, processes, computer software, techniques, formulas, or inventions.
4. Process of Experimentation Test: Substantially all of the activities (typically interpreted as 80% or more) must constitute a process of experimentation involving the evaluation of alternatives through testing, modeling, simulating, or systematic trial and error.

Geographical Limitations: The “Utah-Only” Rule

Unlike the federal credit, which applies to research conducted across the United States, Utah’s credit is strictly limited to costs incurred for research performed in Utah. Per Utah Code § 59-7-612(4)(d) and § 59-10-1012(3)(d), QREs include only:

• In-house Research Expenses: Wages paid to employees for performing, supervising, or directly supporting qualified research physically within Utah.
• Supplies: Tangible property (excluding land and depreciable property) used or consumed in the research process in Utah, such as materials for prototypes or lab chemicals.
• Contract Research Expenses: Payments to third-party contractors for research performed on the taxpayer’s behalf in Utah. Generally, only 65% of these payments qualify, though this increases to 75% for payments to qualified research consortia.

Exclusion of the Alternative Incremental Credit (AIC)

A specific caveat in Utah law is that the tax credits do not include the alternative incremental credit (AIC) provided for in IRC § 41(c)(4). Taxpayers must use either the Regular Credit method or the Alternative Simplified Credit (ASC) method, as discussed in subsequent sections of this report.

The “Excess” Mechanism: Calculating the Base Amount

The “excess” portion of QREs is derived by subtracting the “base amount” from current-year QREs. If the result is positive, the taxpayer has Excess Qualified Research Expenses eligible for the 5% incremental credit.

The Regular Credit Method Base Amount Calculation

Under the regular credit method, the base amount is a product of two factors: the fixed-base percentage and the average annual gross receipts for the four taxable years preceding the current credit year.

The formula is expressed as:

Base Amount = Fixed-Base Percentage × Average Gross Receipts (Prior 4 Years)

Determination of the Fixed-Base Percentage (FBP)

For established companies, the fixed-base percentage is determined by the ratio of aggregate QREs to aggregate gross receipts for a historical base period (typically 1984–1988), capped at 16%. For “start-up” companies—defined as those that did not have both gross receipts and QREs in at least three years during the 1984–1988 period—the percentage is initially fixed at 3% for the first five years of research activity.

Utah-Specific Gross Receipts Sourcing

Crucially, for Utah credit purposes, “gross receipts” include only those attributable to sources within Utah, as provided in the state’s UDITPA (Uniform Division of Income for Tax Purposes Act) provisions. This requires taxpayers to look at their Utah-apportioned revenue rather than total company-wide revenue. This regionalized base amount ensures that the credit is relative to the taxpayer’s economic presence specifically in Utah.

The 50% Minimum Base Amount Rule

A critical provision in both federal and Utah statutes is the 50% minimum base amount rule. This rule stipulates that in no event shall the base amount be less than 50% of the current taxable year’s QREs.

The implication of this rule is that the maximum “excess” amount eligible for the 5% incremental credit is effectively capped at 50% of the current year’s research spending. For a company that experiences an explosive growth in research activity (e.g., doubling its R&D budget year-over-year), the incremental credit will only apply to half of that spending, preventing an outsized fiscal drain on state revenues while still providing a significant incentive for the increase.

Start-up Provisions and Irrevocable Elections

Utah law provides several accommodations for newer businesses or businesses new to research activities within the state. These provisions are designed to lower the barrier for emerging tech sectors and startups.

The Start-up Company Definition and Phasing

Under federal rules adopted by Utah, a company is treated as a start-up if it had no gross receipts and QREs in the historical 1984–1988 base period. These companies use a 3% fixed-base percentage for their first five years, after which the percentage is phased in based on actual experience.

Research Year	Fixed-Base Percentage
Years 1–5	3.00%
Year 6	1/6 of actual aggregate QRE/GR for years 4–5
Year 7	1/3 of actual aggregate QRE/GR for years 5–6
Year 8	1/2 of actual aggregate QRE/GR for years 5–7
Year 9	2/3 of actual aggregate QRE/GR for years 5–8
Year 10	5/6 of actual aggregate QRE/GR for years 5–9
Year 11+	Actual aggregate QRE/GR for any 5 years between years 5–10

The Utah Irrevocable Election

A significant departure from federal practice is found in Utah Code § 59-7-612(4)(a)(iii)(A), which allows a taxpayer to elect to be treated as a start-up company regardless of whether they meet the specific federal criteria for that status. Once made, this election is irrevocable. This is particularly advantageous for established national companies that are launching their first research initiatives in Utah; they can benefit from the low 3% fixed-base percentage rather than having to use a base amount derived from their national historical data.

Alternative Simplified Credit (ASC) Method

Taxpayers who find the historical record-keeping requirements of the Regular Credit method too burdensome, or whose research spending has fluctuated significantly, may opt for the Alternative Simplified Credit (ASC) method.

The ASC method calculates the base amount using research spending from the three immediately preceding years, rather than historical 1980s data or gross receipts. Under the ASC approach, the credit is typically 7.5% (in the Utah context) of the current year’s QREs that exceed 50% of the average QREs for the three preceding years.

Base Amount(ASC) = 0.5 × Average Utah QREs (Prior 3 Years)

If a taxpayer has no QREs in any of the three preceding years, the credit is simply 6% of the current year’s QREs. Utah’s adoption of the ASC method remains subject to the same geographical sourcing rules as the regular method.

Revenue Office Guidance and Reporting Requirements

The Utah State Tax Commission (USTC) provides administrative oversight and guidance for claiming research credits. While the underlying law is found in the Utah Code, the Commission provides practical instructions through its forms, publications, and webinars.

Reporting on Tax Forms: Code 12

The research activity credit is identified on Utah tax forms by code “12”.

• Corporations: Report the credit on Form TC-20A, Part 4.
• Individuals: Report on Form TC-40A, Supplemental Schedule, Part 4.
• Pass-through Entities: The credit is calculated at the entity level and allocated to owners (partners or shareholders) via Schedule K-1, who then claim it on their individual returns.

The Role of Publication 14

Utah State Tax Commission Publication 14 is the “Withholding Tax Guide”. While it does not explicitly detail the R&D credit calculation, it is an essential piece of guidance for any business claiming the credit. This is because the majority of QREs typically consist of wages. Publication 14 outlines the requirements for withholding Utah income tax from employees working in the state. To substantiate a research credit claim, a taxpayer must be able to prove through their payroll records (aligned with Pub 14 requirements) that the employees whose wages are being claimed as QREs were indeed subject to Utah withholding and performed their work within the state.

Documentation and Record Keeping

The Tax Commission explicitly notes that there is no specific worksheet or form provided by the state to perform the R&D calculation; instead, taxpayers are instructed to “keep all related documents with your records”. This places a significant burden on the taxpayer to maintain “contemporaneous documentation”. In the event of an audit, the taxpayer must be able to produce:

• Project descriptions and engineering logs proving the “Four-Part Test” was met.
• Payroll records mapping employee time to specific qualified projects.
• Receipts for supplies consumed in research.
• Contracts and invoices for Utah-based contract research.

Administrative Rules and Order of Credits

Utah Administrative Rule R865-6F-27 establishes the sequence in which credits must be applied against corporate franchise tax liability. This is a critical point of guidance because it affects how the carryforward provisions are utilized.

The order of application is:

1. Nonrefundable credits without a carryforward: This includes the 7.5% total research credit.
2. Nonrefundable credits with a carryforward: This includes the 5% incremental credit on Excess QREs.
3. Refundable credits.

Because the 7.5% volume credit cannot be carried forward, it must be used first to offset tax liability. Any remaining liability can then be offset by the 5% incremental credit. If the 5% incremental credit exceeds the remaining tax liability, it may be carried forward for up to 14 years. This 14-year period is notably longer than many other states, providing a significant long-term benefit for capital-intensive companies.

Interaction with Unitary Groups and Sourcing

For purposes of the research credit, a unitary group—as defined in Section 59-7-101—is considered a single taxpayer. This means that the QREs and gross receipts of all members of the unitary group are aggregated when calculating the base amount and the final credit.

UDITPA and Revenue Sourcing

The calculation of the base amount requires identifying gross receipts attributable to Utah sources under UDITPA. Administrative Rule R865-6F-8 provides general rules for the allocation and apportionment of net income. For most businesses, this involves a three-part formula based on property, payroll, and sales factors. However, special rules apply to specific industries:

• Financial Institutions: Rule R865-6F-32 provides the methodology for apportioning income for banks and credit card issuers.
• Publishing Companies: Rule R865-6F-31.
• Telecommunications: Rule R865-6F-33.

Taxpayers must ensure that their “Utah Gross Receipts” used in the R&D base amount calculation are consistent with the receipts used in their general apportionment formula on their corporate tax return.

Example Calculation: Excess QREs and the Utah Credit

To clarify the application of these rules, consider the following example for “High-Tech Utah, LLC,” a software development firm filing for the 2024 tax year.

Step 1: Identify Current Year Utah QREs

The firm spent the following in Utah during 2024:

• Wages for software engineers: $2,000,000
• Supplies (cloud server instances used for testing): $100,000
• Contract research (paid to a Utah university): $200,000 (at 65% = $130,000)

Total Current Year Utah QREs: $2,000,000 + $100,000 + $130,000 = $2,230,000.

Step 2: Determine Average Utah Gross Receipts (Prior 4 Years)

The firm’s Utah-apportioned gross receipts were:

• 2023: $10,000,000
• 2022: $8,500,000
• 2021: $7,000,000
• 2020: $6,500,000

Average Utah Gross Receipts: ($10M + $8.5M + $7M + $6.5M) / 4 = $8,000,000.

Step 3: Calculate the Base Amount

The firm is an established company with a Fixed-Base Percentage (FBP) of 5%.

1. Calculated Base: 5% of $8,000,000 = $400,000.
2. 50% Minimum Rule Check: 50% of current QREs ($2,230,000) = $1,115,000.
3. Final Base Amount: Since $1,115,000 is greater than $400,000, the Base Amount is $1,115,000.

Step 4: Calculate Excess Qualified Research Expenses (EQRE)

Excess QREs = Current QREs – Base Amount

Excess QREs = $2,230,000 – $1,115,000 = $1,115,000.

Step 5: Final Credit Values

The firm calculates its three-part credit:

• Incremental Credit: 5% of $1,115,000 (EQRE) = $55,750 (14-year carryforward eligible).
• Volume Credit: 7.5% of $2,230,000 (Total QREs) = $167,250 (Must use in 2024).
• Total Utah R&D Credit: $55,750 + $167,250 = $223,000.

Comparative Context: Utah vs. Regional Competitors

When evaluating the impact of the Excess QRE definition, it is useful to compare Utah’s framework with other states. The definition of “excess” is almost universally a function of current spending versus a historical base, but the rates and carryforward provisions vary significantly.

State	Rate on Excess	Carryforward	Notable Rules
Utah	5% (Incremental)	14 Years	Unique 7.5% volume credit stack
California	15% (Incremental)	Indefinite	Uses federal base rules
Arizona	24% / 15%	10–15 Years	Tiered rates; refundable for small biz
Florida	10% (Incremental)	5 Years	C-Corps only; strictly target industries
Oregon	15% (Incremental)	5 Years	Focus on semiconductor industry

Utah’s 14-year carryforward for incremental credits is one of the most generous in the nation, providing a longer window for start-ups that may have high R&D spending but no tax liability in their early years to eventually capture the full value of the credit.

Summary of Statutory and Revenue Office Guidance

The Utah R&D tax credit framework is a sophisticated mechanism for rewarding technological advancement within the state. The meaning of “Excess Qualified Research Expenses” is intrinsically linked to the concept of the base amount—a measure of the taxpayer’s historical research intensity relative to their Utah revenue. By subtracting this baseline from current-year spending, the law ensures that the 5% incremental credit component is applied only to new growth.

Revenue office guidance, primarily through the Utah State Tax Commission, emphasizes compliance with federal Section 41 definitions and strict adherence to Utah-specific sourcing for both expenses and gross receipts. While the 14-year carryforward provides substantial long-term value, the lack of a standardized state calculation form places a high premium on meticulous, contemporaneous record-keeping by the taxpayer.

Ultimately, the definition of “Excess” in Utah serves as a fiscal bridge between routine business operations and high-growth innovation, positioning the state as a competitive hub for research-intensive industries such as software development, biotechnology, and advanced manufacturing.