Iowa R&D Tax Credit: How to Qualify and Claim

The Iowa Research Activities Credit provides a financial incentive for businesses to invest in innovation by developing new products, improving existing ones, and advancing technological processes. Its structure is aligned with the federal research and development credit, and its purpose is to reward companies for increasing their investment in research activities year over year. This program directly lowers the after-tax cost of research and development, allowing businesses to allocate more resources toward growth.

The credit is available to corporations and pass-through entities operating within the following industries:

• Manufacturing
• Life sciences
• Agriscience
• Software engineering
• Aviation or aerospace

Business Eligibility Requirements

To qualify for the Iowa Research Activities Credit, a company must claim and be allowed the federal research credit for the same expenses in the same tax year. The Iowa credit is used to offset state income tax, and its partial refundability is designed to benefit businesses, including startups, that may not have a tax liability in a given year.

Each research activity must satisfy a “four-part test” to be eligible.

• The project must have a permitted purpose, with the goal of creating a new or improved business component in terms of its function, performance, reliability, or quality.
• The undertaking must be technological in nature, relying on principles of the physical sciences, biological sciences, engineering, or computer science.
• The activity must seek to eliminate uncertainty that exists at the outset of the project. This can relate to the capability of developing the product, its appropriate design, or the method for creating it.
• The business must engage in a process of experimentation. This involves evaluating one or more alternatives to resolve the technological uncertainty through modeling, simulation, or a systematic trial and error process.

Qualified Research Expenses

Identifying Qualified Research Expenses (QREs) forms the basis for the credit calculation. These are specific, direct costs for research and development activities conducted within Iowa for projects that meet the four-part test. Proper documentation and categorization of these costs are necessary for substantiating a claim.

The first category of expenditures is in-house research wages paid to employees for performing, supervising, or directly supporting qualified research activities. This includes the salaries of engineers developing a new product or a manager overseeing the R&D department. Unlike federal rules, Iowa does not apply the “substantially all” standard; only the portion of wages for time directly spent on qualified activities can be included.

The second category is supplies, which are costs for tangible property used and consumed during the research process, not including land or depreciable property. The eligibility of supply costs is being phased out. For tax years beginning in 2025, only 40% of these costs qualify. This percentage will decrease to 20% in 2026 and will be fully eliminated for tax years starting on or after January 1, 2027.

The final category is contract research expenses, which are payments to a third party for research. Only 65% of these costs are considered QREs, and the taxpayer must retain substantial rights to the research results and bear the financial risk. Common exclusions from all QRE categories include market research, routine quality control inspections, efficiency surveys, and any research conducted after commercial production has begun.

Calculating the Iowa Credit

Iowa provides two methods for calculating the Research Activities Credit using only Iowa-based QREs. The first is the Regular Credit method. Under this approach, the credit is 6.5% of the amount by which the current year’s Iowa QREs exceed a calculated “base amount,” a historical figure that ensures the credit is awarded for increasing research spending.

The base amount is determined by multiplying the company’s “fixed-base percentage” by its average annual gross receipts from the four preceding tax years. The fixed-base percentage is a ratio of aggregate QREs to aggregate gross receipts for a specific historical period, which can be complex to determine for new companies. The base amount can never be less than 50% of the current year’s QREs, which can limit the credit for companies with rapidly growing research budgets.

The second option is the Alternative Simplified Credit (ASC) method. This calculation is more straightforward as it does not require the complex base amount computation. The Iowa ASC is 4.55% of the current year’s Iowa QREs that exceed 50% of the average Iowa QREs from the three preceding tax years. If a taxpayer uses the ASC method for their federal credit, they are required to use the ASC method for their Iowa credit.

How to Claim the Credit

Once a business has confirmed its eligibility, tracked its Iowa-specific QREs, and calculated the credit amount, the next step is to formally claim it. The process involves completing specific state tax forms and attaching them to the annual Iowa income tax return.

Form IA 128 is used to claim the Regular Credit, while Form IA 128S is used for the Alternative Simplified Credit (ASC). These forms must be attached to the business’s main Iowa income tax return, such as the IA 1120 for a corporation or the IA 1040 for individuals and pass-through entities. The final credit amount is then carried to the appropriate line on the main tax return to reduce the calculated tax liability.

Credit Refundability and Application

The Iowa Research Activities Credit has no multi-year carryforward provision. The credit is first applied against the company’s current-year tax liability. If the credit exceeds the tax due, a portion may be refundable, which provides a direct cash benefit. This feature is advantageous for startups or businesses in a loss position that are still investing heavily in research and development.

The refundable portion of the credit is subject to a phase-down. For 2025, the refundable amount is limited to 70% of the credit that exceeds the tax liability. This percentage will decrease to 60% in 2026 and is capped at 50% for 2027 and subsequent years. A taxpayer can elect to have any overpayment credited to the following year’s tax liability, but it cannot be carried forward beyond that single year.