Additional Savings Through State R&D Tax Credits

Many businesses are familiar with the federal Research & Development (R&D) tax credit, which provides substantial savings for eligible companies engaged in qualified research and innovation activities. Credit has been an important funding component of many innovation programs for years, yet tax savings for eligible R&D activities do not end with federal incentives. In many cases, there is a state level R&D credit, which often mirrors the federal version with minor differences in eligibility, credit calculation, and use requirements. Unfortunately, not every state offers an R&D credit, but legislation is constantly changing, creating new opportunities. For example, Hawaii will no longer offer the credit after 2025, while the state of Missouri just re-enacted its state credit. The potential for additional tax savings creates a compelling benefit for companies. To help clients, prospects, and others, JLK Rosenberger has summarized the key details below.

Who Can Claim the State Credit?

Corporations and other pass-through entities can claim the credit depending on the state. For example, in Delaware, S-corporations, C-corporations, Partnership, Sole Proprietors, and Individuals can apply. For the States of Connecticut, Florida, and Kansas, the state R&D credits are available for C-corporations only. In the State of Kentucky, if your business invests in facilities used for research, you can claim the credit.

How to Claim the State Credit

Each state is unique; therefore, some states require an annual application. Some states allow credit claims on original returns, whereas others will enable you to claim state credit on amended returns.

For states that require an annual application, the submission deadline can differ from the federal filing timeframes. For example, you must submit the R&D credit annual application in Delaware by September 15th. The State of Pennsylvania requires submission of the annual application by December 1st. There are a few additional nuances in some states. In the State of Maryland, the deadline for submitting R&D applications is November 15th; however, expenses recorded on the current application reflect expenses incurred in the previous calendar tax year. Certain states allocate a fixed amount of state credits into a pool, and it is on a first-come-first-serve basis. In these states, submitting your application well before the due date is more beneficial.

How to Calculate the State Credit

Since individual states have unique needs in terms of R&D, each state maintains its individual rules for state qualification and how to calculate the state credit. Some may require certain documentation to be kept as part of the credit calculations for either determining a historical R&D period to compare current year research expenditures to or for eligibility. However, there are many similarities to one or both of the Federal calculation methodologies. In general, the credit is based on a percentage of the ratio of excess expenditures of the current year as compared to expenditures during a historic time period.

Some states incorporate the federal amounts filed into the state calculations. For example, the State of Delaware offers two calculation methodologies that mirror the Federal calculations. Method A follows the Federal ASC calculation but utilizes the average of the four preceding years for the historical R&D period instead of the average of the three preceding years. For method B, Delaware’s state R&D credit calculation is a straightforward 50% of the Federal ASC calculated credit amount.

In the State of Rhode Island, the R&D credit calculations also utilize Federal numerical information. Rhode Island’s QRE is equal to the Federal QRE divided by the Federal base (historical period). The state then allows for a credit rate of 22.5% for resultant QREs up to 111,111 and then 16.9% for expenditures over that threshold. While Rhode Island’s credit calculation consists of more intricate nuances, the State of Nebraska allows for a simple 15% of the Federal credit amount. Other states, such as California, Connecticut, and Idaho, also allow for a calculation methodology that does not require prior-year QREs.

Other states have developed their own unique calculation methods. For example, in the State of Louisiana, the historical base calculation is equal to 80% of the average research expenditures of the prior three years. However, for small companies with less than 50 employees in Louisiana, the credit rate is a generous 30%. For companies that employ 51-99 employees, the rate decreases to 10%, and for companies with 100+ employees, this decreases to 5%. This incentivizes start-ups and small-to-medium-sized businesses operating in Louisiana. Adding another layer to Louisiana’s R&D credit complexity, taxpayers who received a Federal SBIR or SBTT grant are allowed a credit equal to 30% of the award received during the tax year (40% prior to tax year 2017).

How the State R&D Credit Generated Can be Implemented or Used

In general, the state R&D credits can be used to offset current tax owed and future tax owed for states that allow the credit to carry forward. Certain states will also allow the credit to be carried back. For example, North Dakota allows for carryback of R&D credits for up to three years. Any unused credit can then forward for up to 15 years. In certain states, such as Pennsylvania, taxpayers who claimed the PA R&D credit sell unused credits. For the State of California, credits may be allocated across members in a controlled group.

Summary of states offering an R&D tax credit:

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State-based R&D tax credits can provide additional tax savings to businesses that claim the federal R&D incentive. Since regulations differ between states, consulting with a qualified tax advisor to evaluate your situation and determine if additional savings can be realized is important. If you have questions about the information outlined above or need assistance claiming the R&D tax credit, JLK Rosenberger can help. For additional information, call 949-860-9902 or click here to contact us. We look forward to speaking with you soon.