As we go to press with this issue, the Obama administration is set to release a proposal to extend the research credit permanently and increase the alternative simplified credit (ASC) rate to 17 percent from 14 percent. Expect to see more on this in the coming weeks and months as we head into November elections.
As Congress continues to drag its feet on the latest round of federal extenders, taxpayers are scratching their heads as to how the expiration of a number of popular tax provisions may affect their business. Among these provisions is the R&D tax credit. Prior to its latest expiration on December 31, 2009, the credit had been renewed by Congress a dozen times since its inception in 1981.
What Effect Does This Have on State R&D Credits?
While federal extenders legislation continues to be a focal point of consideration, taxpayers must also examine how the absence of an extenders package influences R&D tax credits at the state level. Each state has its own set of rules and definitions for calculating the credit. Additionally, the credit’s expiration date at the state level is not the same as at the federal level. Therefore, maintaining the process and documentation, even while the credit is expired at the federal level, may still be just as important.
Below is a brief summary of the tax credit criteria for a few of the states with significant R&D incentives. Among those with R&D tax credits, the following states represent some of the largest concentrations of research expenditures:
- Arizona allows taxpayers to claim a credit for research and development activities based on the rules of IRC Section 41 with certain modifications (termination provision; proportionate eligible expenses for two or more taxpayers; and a requirement that research be conducted in Arizona). There are special methods of calculating the credit depending on the year in which a taxpayer incurred and claimed qualified expenditures. Unused credit may be carried forward for 15 years. For taxable years beginning on or after December 31, 2009, a taxpayer claiming a research and development credit that exceeds the taxes otherwise due (or where there are no taxes due) and employing fewer than 150 persons in its trade or business may elect to receive a refund of 75 percent of the excess credit in lieu of carrying the excess forward. As of the date of this publication, the Arizona R&D tax credit is permanent.
- California allows taxpayers to claim a credit for research and development activities based on the rules of IRC Section 41 with certain modifications (e.g., a unique definition of “gross receipts”; and differences in base period calculation, basic research and credit percentages). There is no limit to the number of years unused California research credit can be carried forward. Taxpayers in California may elect an alternative incremental research credit (AIRC) similar to that outlined in IRC Section 41. For tax years beginning on or after January 1, 2010, amended California Senate Bill SBX6 9 increased California’s AIRC percentages to equal the federal percentages in effect as of January 1, 2007 (rather than January 1, 2005). Although California has yet to adopt an alternative simplified credit (ASC), legislation proposed in June would eliminate the AIRC election and replace it with the ASC. The new ASC regime would increase the traditional credit for qualifying research expenditures from the existing 15 percent to 20 percent. Importantly, California taxpayers do not have to claim the federal credit in order to claim the California credit. The California R&D credit is currently available indefinitely.
- Massachusetts allows taxpayers to claim a credit for research and development activities against its corporate excise tax. Similar to California’s, the Massachusetts R&D tax credit is generally determined in accordance with IRC Section 41 requirements with certain modifications (e.g., differences in base period calculation and credit percentage; and credit applied to excise tax liability in excess of $25,000 is reduced to 75 percent). Massachusetts also allows for a sales tax exemption for certain items purchased and used directly in research and development activities. As of the date of this publication, the Massachusetts R&D tax credit is permanent.
- New Jersey allows taxpayers to claim a credit for research and development activities against its corporation business tax. The credit follows calculation guidelines similar to those outlined in IRC Section 41 with certain modifications (e.g., differences in base period calculation and credit percentage; and a limit on credit to 50 percent of tax liability). Unused credit may be carried forward for seven years. The New Jersey R&D tax credit is currently set to expire on November 24, 2014.
- North Carolina allows eligible taxpayers a research and development tax credit against franchise, corporate income, or personal income tax for qualified North Carolina research expenses. Eligible taxpayers must satisfy the requirements relating to the wage standard, health insurance, environmental impact, and safety and health programs in order to claim the credit. For tax years beginning on or after January 1, 2007, the credit is equal to a percentage of the expenses:
Small business: 3.25 percent. Research conducted in a development Tier 1 area: 3.25 percentOther research costs: 1.25 percent for expenses up to $50 million; 2.25 percent for expenses between $50 million and $200 million; 3.25 percent for expenses above $200 million. North Carolina research university expenses: 20 percent.
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