State Level R&D Tax Credit Programs: The Ultimate Guide for Founders and CEO's

As a founder or CEO, have you been looking for a way to boost innovation and development in your company? As we know, research and development (R&D) can play a crucial role in enabling companies to improve their products and services. However, carrying out such activities can also be expensive, and many companies struggle to allocate the necessary funds.

This is where state-level R&D tax credit programs come into play. These incentives can provide crucial financial support for businesses that are conducting qualified R&D activities. In this blog post, we’ll delve into the specifics of state-level R&D tax credit programs and how they can help you and your team.

What exactly are state-level R&D tax credits?

State-level R&D tax credits are special benefits that state governments give to companies to motivate them to do more research and development (R&D) work. Think of it like a reward system: if a company spends money on R&D activities, like developing new products or improving their manufacturing processes, the state can offer them a discount on their state income taxes. This discount is based on how much the company spends on these research activities.

Every state that offers this kind of tax credit has its own rules. So, the amount of the discount and what counts as a qualified research expense can be different from one state to another. Some states might be really generous with their credits, while others might offer a smaller benefit.

The idea behind these state-level R&D tax credits is to make it easier and more attractive for companies to invest in R&D. When companies spend money on research, they're often taking a risk because they're not sure if their new ideas will work out. These tax credits help reduce that risk. They give companies a financial boost and encourage them to keep coming up with innovative ideas, which can lead to better products and technologies. This not only helps the companies but can also be good for the economy and job creation in the state.

Which states have R&D tax credit programs?

Across the United States, as many as 38 states offer their own versions of R&D tax credit programs. Well-known programs include those in states like California, New York, Texas, Massachusetts, and Ohio. Each of these states has unique rules for their R&D tax credits, including how much of your research expenses you can get back as a credit and what types of research activities are eligible.

For instance, in California, companies can receive a credit for up to 15% of their qualified expenses on in-state research activities. This is especially beneficial for businesses engaged in developing new or improved products, processes, or software. If a company spends money on salaries for their R&D staff, supplies for experiments, or even certain types of research contracted to third parties in California, these expenses might qualify for the credit. Plus, if a company's R&D expenses in a current year exceed its average over the previous three years, California offers an additional credit for this excess amount at 24%.

Before applying for any state R&D tax credit, it's crucial to dive deep into the specific regulations of each program. This ensures you can accurately assess which state program aligns best with your company's activities and financial goals. For example, a company primarily conducting R&D in software development might find one state's program more favorable due to its specific eligibility criteria for software-related research.

Understanding these nuances can significantly impact the benefit your company receives from the program.

What qualifies for the R&D Tax Credit?

To be eligible for state-level R&D tax credits, companies must conduct qualified R&D activities that satisfy specific criteria. The Internal Revenue Service (IRS) defines R&D as activities that satisfy the four-part test. These four parts include the activities related to the creation of new, improved, or technically advanced products or processes.

For example, the R&D activities might be related to developing new software, creating new products, or enhancing existing products. As per the IRS, by spending time on these activities, companies can then claim R&D expenses under their respective state-level tax credit program.

Things to Keep in Mind

For companies looking to benefit from R&D tax credits, there are a few key things to keep in mind.

Entity Structure

Most participating states recognize C-Corporations, S-Corporations, LLCs, and Partnerships as qualifying innovation tax credit entities. However, some states like Florida, Rhode Island, and Connecticut only allow C-Corporations to qualify for the benefit. Additionally, Massachusetts allows both C-Corporations and S-Corporations to file for deductions.

Deadline for Filing

Typically, taxpayers are obligated to claim the R&D tax credit while submitting their state tax return, as per local regulations. Nevertheless, specific states like Virginia, Pennsylvania, New Hampshire, Florida, Maryland, Arkansas, and Delaware offer varying deadlines for filing the credit.

Carryforward Credit

The duration of carryforward credits varies among participating states. In some jurisdictions, local laws permit an unlimited carryforward period, while others specify specific timeframes ranging from 3 to 20 years. Moreover, some states may permit or prohibit carrying forward credits from previous years.

How to Maximize your State R&D Credits

It's essential to keep detailed records of your R&D activities. This will be necessary when calculating and claiming R&D tax credits.

Secondly, it’s a good idea to work with an experienced accountant or tax professional to ensure that you maximize your tax credit eligibility. For example, some expenses related to R&D credit activities might be more eligible for tax credits than others. Finally, align your R&D activities with your company's long-term strategic goals to ensure that you see meaningful benefits from your efforts.

State-level R&D tax credit programs can provide crucial financial support for companies engaging in qualified R&D activities and can help them achieve their strategic objectives. By implementing the tips outlined above, and carefully researching program specifics, companies can benefit from these incentives.

These programs may differ from state to state, but the benefits of these programs remain significant. Companies with ambitious R&D goals should explore and take advantage of these opportunities to help their innovations come to life.

Additional FAQ about State-Level R&D Tax Credits:

What Companies are Eligible for State R&D Credits?

In most of the 38 states offering R&D Tax Credits, a range of business types including C-Corporations, S-Corporations, LLCs, and Partnerships are eligible to apply. However, it's important to note the exceptions: Connecticut, Florida, and Rhode Island exclusively allow C-Corporations to file for these credits. Meanwhile, Massachusetts extends this eligibility to both C-Corporations and S-Corporations. Always check your state's specific regulations to understand your company's eligibility.

What is the Deadline to File R&D Tax Credits in each state?

The deadline to file State R&D Tax Credits usually aligns with your tax return due date, including extensions. However, some states may have specific deadlines. For instance, in states such as Arkansas, Delaware, Florida, Maryland, New Hampshire, Pennsylvania, and Virginia, the deadlines to file State R&D Tax Credits can vary from the usual tax return dates. Each of these states sets its own specific deadlines, which may not necessarily align with your tax return due date. It's important to check the individual deadlines for these states to ensure you don't miss out.

Do R&D Tax Credits Count as State Aid?

R&D tax credits are generally not considered as state aid. They are tax incentives offered to businesses to encourage investment in research and development. These credits reduce tax liability and are not direct subsidies or grants from the state. However, the interpretation of these credits can vary by jurisdiction, so it's important to consult with a tax credit expert like TaxTaker.

Which States do not offer R&D tax credits?

Currently, 14 states do not offer R&D tax credits. If your business is in Alabama, North Carolina, Washington, Alaska, Oklahoma, West Virginia, Michigan, Mississippi, Oregon, Montana, South Dakota, Wyoming, Nevada, or Tennessee, you won't find state-level R&D tax credits there. While many other states use these credits to encourage innovation, these 14 have different approaches or incentives for businesses. However, don't let this discourage you, we advise you to explore other available state-specific or federal incentives to support your R&D activities.

Does Texas have an R&D credit?

Technically, Texas doesn't offer an R&D tax credit in the traditional sense, like an income tax credit directly tied to research and development expenses. Instead, Texas provides two different types of incentives for businesses engaged in R&D:

1. Sales and Use Tax Exemption: This allows businesses to avoid paying sales tax on certain items they buy or rent for R&D purposes.
2. Franchise Tax Credit: While not a direct R&D tax credit, this is a credit against the franchise tax (a type of business tax in Texas) based on your qualified research expenses.

Just remember, you can't use both these benefits at the same time for the same expenses, but you can choose differently each year.