Arizona offers one of the most valuable state R&D tax credits in the country, and many businesses conducting research activities may be missing out on substantial tax savings. If your company develops new products, improves processes, or invests in technical innovation within Arizona, you could significantly reduce your state income tax liability through the Arizona R&D Tax Credit.

What Is the Arizona R&D Tax Credit?

The Arizona R&D Tax Credit rewards businesses that invest in qualified research within the state. Extended through 2030, this credit supports innovation across technology, aerospace, biotechnology, manufacturing, and other research-intensive industries. The credit applies not only to work on new and improved products, but also complex manufacturing processes or techniques and most types of software development, too.

Key Benefits

• 24% credit rate on qualified expenses up to $2.5 million
• 15% credit rate on expenses above $2.5 million
• 10-year carryforward period for unused credits
• Available to all business entity types
• Small businesses with fewer than 150 employees may qualify for a 75% partial refund (requires Arizona Commerce Authority certification, subject to statewide $5M cap)

What Expenses Qualify?

The credit applies to Arizona-based research expenses including:

• Wages: Salaries for employees performing, supervising, or supporting qualified research
• Supplies: Materials and prototypes used in research processes
• Contract Research: 65% of payments to third-party contractors for qualified services
• Computer Rentals: Costs for computers and equipment leased for research activities

Who Is Eligible?

To qualify, your business must conduct qualified research activities in Arizona that meet federal R&D standards under IRC §41. All entity types may claim this credit:

• C Corporations: May claim both regular and basic research credits
• S Corporations: Credits can pass through to shareholders
• Partnerships/LLCs: Credits flow through to owners via Schedule K-1

Two Calculation Methods

Regular Method

This method compares your current year qualified research expenses to a historical base amount calculated from prior years’ activities.

Sample Calculation:

• Qualified expenses: $3 million
• Historical base amount: $500,000
• Excess expenses: $2.5 million
• Credit = $600,000 (24% × $2.5M)

If excess expenses are higher:

• Qualified expenses: $4.5 million
• Historical base amount: $500,000
• Excess expenses: $4 million
• Credit = $825,000 [(24% × $2.5M) + (15% × $1.5M)]

Alternative Simplified Credit (ASC)

This streamlined method uses 50% of your average qualified expenses over the prior three years as the base (or 0% if no prior expenses). The same tiered credit rates apply to the excess amount.

Important: Your calculation method selection is generally irrevocable without approval, so careful evaluation is essential.

Special Provisions

For Startups

New businesses benefit from favorable fixed-base percentages starting at 3% for the first five years, gradually phasing to 16% by year 10. This provision particularly benefits early-stage companies in aerospace and biotech sectors.

For Small Businesses

Businesses with fewer than 150 employees and Arizona Commerce Authority certification may receive a 75% refund of credits exceeding their tax liability, subject to a statewide $5 million annual cap allocated on a first-come, first-served basis.

University Collaborations

Credits related to university research partnerships use a separate calculation with a 5-year carryforward period and are not eligible for the partial refund option.

Why This Matters

The Arizona R&D Tax Credit provides substantial benefits for businesses investing in innovation:

• Significant reduction in state income tax liability
• No effective cap on nonrefundable credits
• Long carryforward period maximizes value
• Generous rates compared to other states
• Support for businesses of all sizes, from startups to large enterprises

Next Steps

To explore your eligibility and potential tax savings, please contact Alex Nelson at anelson@kbfadvisory.com. We can help you identify qualifying activities, calculate your credit using the most beneficial method, and ensure proper compliance and documentation.