The Texas research tax credit rewards taxpayers for engaging in research activities in Texas before the end of the 2009 reporting period.
Qualified Research Activities
Most state research tax credits incorporate or are based on the definition of qualified research activities in the federal research tax credit. The federal research tax credit defines qualified research activities using a four-part test. It also includes several limitations. A handful of state research tax credits only adopt some of the federal requirements and very few or none of the exclusions set out in federal law. A few states implement custom definitions. In addition, the research tax credits for most states are limited to research activities that occur within the state. A few state statutes limit their tax credits to activities performed within specific geographic areas within the state. The Texas research tax credit adopts the federal definition of qualified research activities and its limitations. It is limited to research activities conducted in Texas.
Qualified Research Expenses
Most state research tax credits incorporate or are based on the definition of qualified expenses in the federal research tax credit statute. For purposes of the federal research tax credit, qualified research expenses can include wages, contractor, supply, and computer rental expenses. Other states have custom definitions of what expenses are qualified. In addition, the research tax credits may be limited to expenses incurred within the state or certain geographic areas within the state. The Texas research tax credit adopts the federal definition of qualified research expenses. It also limits the credit to expenses incurred in Texas. Qualified research xpenses are doubled if the expense is made in a strategic investment area.
Definition of Gross Receipts
The research tax credits many states is computed by comparing the taxpayer’s qualified research expenses to their gross receipts for one or more years. For example, the federal research tax credit compares the taxpayer’s qualified research expenses in the current year with its gross receipts for the prior four years. The gross receipts may be limited to receipts or income from property owned or from business conducted in the state or those derived from the sale of property that is sold to customers in the state.
The definition of gross receipts is the defining characteristic of the Texas research tax credit. For purposes of the Texas research tax credit, gross receipts includes receipts from the sale of real, tangible, or intangible property held for sale to customers in the ordinary course of the taxpayer’s trade or business that is delivered or shipped to a purchaser in Texas or for services provided in Texas. Given this definition, there will generally be a large difference between the taxpayer’s qualified research expenses and gross receipts if the taxpayer performs substantial research activities in Texas that result in products or services sold primarily outside of Texas. This difference between the taxpayer’s gross receipts and qualified research expenses can significantly amplify the amount of the taxpayer’s Texas research tax credits.
Research Tax Credit Percentage
Research tax credits are often a percentage of the taxpayer’s qualified research expenses. The percentage varies from state to state; generally ranging from 1 to 20 percent. The Texas research tax credit equals 5 percent.
Research Tax Credit Dollar Limitation
A number of states impose a dollar limit on the amount of expenses that can qualify for the research tax credit. Other states limit the amount of their research tax credits that taxpayers can claim in any one tax year. The Texas research tax credit available in any one year is limited to 50 percent of the amount of the taxpayer’s franchise tax liability.
Incremental or Non-Incremental Research Tax Credit
Most state research tax credits are incremental. This refers to the credit being conditioned on the taxpayer increasing its research spending in the credit tax year and some specific prior tax year or years. The prior tax years are often referred to as the “base period.” Many states adopt the federal base period tax years of 1984 through 1989, or later years if the taxpayer did not exist or began its research activities after 1991. Other states identify a number of years prior to the credit year as the base period tax years. A few states have non-incremental research tax credits which simply reward taxpayers for incurring qualified research expenses. The Texas research tax credit adopts the federal base period tax year scheme.
Research Tax Credit Carryback and Carryforward
Most states allow unused research tax credits to be carried back and forward for one or more tax years and forward indefinitely. These credits can then be used to reduce tax liabilities in the other tax years. Other states require research tax credits to be used within a set period of time. Research tax credits not used within this time simply expire. The Texas research tax credit cannot be carried back; however, unused credit can be carried forward for twenty years.
Refundable Research Tax Credit
A few states have refundable research tax credits. Refundable tax credits can be used to obtain a refund of taxes even if the taxpayer is not obligated to pay any tax to the state. Non-refundable tax credits can only be used to reduce the taxpayer’s state tax liability. The Texas research tax credit is not refundable.
Substantiation Requirements
Some states only allow taxpayers research tax credits if they create and retain specific documents. This may require the taxpayer to develop and retain records that identify the taxpayer’s research expenses and, in some cases, the research activities. Other states expressly or implicitly adopt the general documentation requirement for the federal research tax credit. This general requirement essentially says that the taxpayer is to keep sufficient records to substantiate its research tax credits. It does not identify any specific documents that must be developed or retained. The Texas research tax credit does not identify any specific substantiation requirements.
