Research and Development Tax Credits
Federal Research & Development Tax Credits
The Research & Development (R&D) Tax Credit is a federal tax incentive intended for businesses of all types and sizes to conduct applied R&D within the U.S. that will lead to new, improved, or technologically advanced products, processes, principles, methodologies, or materials. A tax credit can be used to offset income tax liabilities on a dollar-for-dollar basis, thereby lowering a company’s effective tax rate and increasing cash flow. Recently, the criteria for qualifying for R&D tax credits have been redefined, becoming more lenient to now include a larger group of businesses. In fact, a company may qualify if it has simply invested time, money, and resources toward the advancement and improvement of its products and processes.
The Federal R&D tax credit (in Sec. 41) is a 20% incremental credit on qualified R&D expenses that exceed a base amount or a 14% incremental credit under the alternative simplified credit regime. Due to the federal credit’s incremental nature (where only qualified costs over a base amount are eligible for the credit), the maximum federal benefit is often 6.5% of qualified R&D expenses.
State Research and Development Tax Credits
State R&D incentives play an important role in the states’ ability to compete for and attract new investments and jobs. Numerous states have recently enhanced R&D incentives—giving more options to taxpayers looking to invest further in R&D or even relocate some expenses to a more taxpayer favorable jurisdiction. Many state governments reward taxpayers with income tax credits for increasing R&D spend. In some states, companies may take a credit against their state income or franchise tax equal to a percentage of their qualified R&D expenditures over some base amount (the credit typically can be carried forward or backward for a specified number of years). States generally use the federal definition of qualified R&D in their tax codes. Some states have refundable R&D tax credits. The most transparent component of the value of a state's tax credit is the credit rate. These credit rates currently range from a low of 1% to a high of 20%, equivalent to the federal rate. A number of states offer different credit rates for different levels of R&D spending, typically with the rate lower for higher tiers of R&D (in order to provide greater incentive to small businesses and start-ups to perform R&D).