Your Location Really Matters – Especially with Claiming the R&D tax credit!
Numerous states provide their own versions of the R&D Tax Credit to eligible businesses. As is the case with the federal R&D Tax Credit, which requires businesses to carry out research within the United States to qualify for the credit, so too does each state mandate that such research is carried out within the state for a company to be eligible for the credit offered by that state. A business can be eligible for tax credits in each state in which it conducts research if the business operates in multiple states.
It is strongly recommended that you look at the R&D tax credit map to determine whether or not your state provides an R&D tax credit.
R&D Tax Credit Map: Benefits by State
Many states offer the R&D tax credit benefits, and these state programs generally adhere to the federal regulations and IRS guidance on what kinds of expenses count as Qualified Research expenditures (QREs).
- Companies in Colorado’s certified enterprise zones are the only ones eligible for this incentive.
- Only C-corporations are allowed in Connecticut.
- The state of Florida makes its resources available to specific industries required to provide a letter stating that the applicant works in a qualifying industry.
- Only high-tech companies that meet certain requirements can access this resource in Hawaii.
- Only C-Corps are permitted in the state of Kansas.
- Construction of research facilities is only permitted in the state of Kentucky.
- Maine’s additional (super credit) was eliminated in 2014, but a 10-year carryforward was allowed. Regular credit remains.
- Two R&D credits, a growth credit and a basic credit, are available to residents of Maryland. Only online applications will be accepted.
- The application deadline is June 30 in New Hampshire.
- Only Life Science is eligible in New York
- Ohio: CAT Tax
- The deadline for submitting online applications in Pennsylvania is 9/15
- Only C-Corps allowed in Rhode Island
As you work to improve the cash flow in your company, you may find that the R&D Tax Credit can become an economic boon for you. You might be eligible for a reduction in the amount of federal taxes you owe if your business relies on hard sciences or uses technology to develop or improve products or processes. This reduction would be proportional to the qualified costs your company incurred.
Four-Part Test for R&D Tax Credit
A test consisting of four parts can assist you in determining whether or not the activities of your company are eligible for the R&D credit.
1. Permitted Purposes
In order to be eligible for the research and development credit, the activity must relate to the function, effectiveness, reliability, performance, or composition of a new or improved business component. You do not necessarily need to find new innovations or advancements in your industry; rather, you only need to find something that may be innovative or something new to you and your company’s processes or products.
2. Technological In Nature
At its core, the activity that is carried out must rely on principles derived from either the physical sciences, computer science, biological sciences, or engineering. For instance, if you are in the food production industry, merely putting more salt into your product will not necessarily qualify; however, a method that is based on hard sciences to enhance the flavor of your product might, and so would similar methods that are designed to keep food much fresher for a longer period of time.
3. Elimination Of Any Uncertainty
The purpose of the business’ activity must be to find information that will remove doubts about the capacity or method for developing a better or improving a product or process or about the suitability of the product design.
4. Step-By-Step Procedure Of Experimentation
The eligible activities must be those that constitute the process of experimentation, which may include simulation, evaluation of alternative approaches, affirmation of hypotheses by trial and error, testing and/or modeling, or the modification or elimination of hypotheses.
In addition to the definitions that are stipulated by the four-part test, some examples of activities that could qualify for the credit include those that are performed in furthering or advancing the design of an existing process or product, as well as those that are performed in order to correct significant design defects, obtain considerable cost reductions, or enhance function. The costs of designing, building, and testing pre-production prototypes and models are also eligible for reimbursement in some cases.
Let’s say you run a manufacturing company that specializes in the development of eyewear, and you want to raise your company’s productivity by 10–15 percent. You may be able to claim the R&D credit for any expenses incurred while analyzing the raw materials, contemplating the development of new molds, and determining the appropriate heating and cooling temperatures for the raw material and/or molds in question.
Similarly, if you have a product controlled by software, the expenses of developing new software to make a product more dependable and efficient may qualify for a tax credit. If you are in the business of architecture or engineering, the costs associated with researching and implementing environmentally friendly technology may qualify.
Other activities that might be eligible for the credit include:
- Conceptual formulation, design, and testing of potential alternatives for product or process.
- Startup of activities involving a new component or process.
- Design time, tool design and testing, and similar activities.
Some activities will not qualify for the R&D credit, including funded research, ordinary testing and inspection, research done outside the United States, reverse engineering, adaptation of an existing product component to a particular customer’s requirement or need (for example, adapting a computer program you sell to meet the needs of a particular customer), and research done in foreign countries.
Materials and supplies that were used and were consumed in the process qualify as qualified costs, as do wages paid to employees directly involved in the R&D, in direct supervision of the R&D, and in direct support of the R&D. Services done by outside contractors in either of the four parts of the test also qualify, so long as you retain substantial rights in what the contractors do.