Research & Development Tax Credits

Arizona Manufacturing Extension Partnership (MEP) 4/16/09

Key Points

• Many smaller manufacturers may not be taking full advantage of the federal R&D tax credit program.
• Small companies could claim a tax credit equal to 2% or more of their assets.
• Qualified research expenditures (QREs) can include process improvements.

Out of the IRS returns filed by “C” corporation manufacturers in 2005, a recent study by Ernst & Young identified only 4,921 that filed for the federal government’s research and development’s (R&D) tax credit—and that was a record amount. According to the IPC Government Relations Committee many smaller manufacturers have not been aware that they were conducting activities that would allow them to claim credit for qualified research expenditures (QREs).

Part of the reason is that not all manufacturers are aware that the term “qualified research,” as defined by the U.S. Code, includes investments in process improvements that “go well beyond product R&D.” These investments can also include the development of in-house software, product design, engineering, and quality assurance. In the case of small companies with less than five million in assets, the average credit was about 2% of the total assets (9% of total assets for companies with less than $500,000 in assets).

In general, the value of the credit equals the investment expenditures in excess of a defined base, multiplied by the established tax credit rate. The base amount is determined by a formula that measures the intensity of R&D, by reflecting it as a percentage of total gross receipts that were dedicated to R&D expenditures over the four preceding years. The credit is tied to an increase in this prior intensity.

By the end of 2004, there were 34 states that also offered R&D credits to companies that had corporate tax liabilities in those states. While many states follow the general design of the federal program, they tend to focus on facilitating growth in targeted economic sectors or specific technologies that the states wanted to pursue.

The following states offer R&D tax credits (starting with the oldest programs):

• More than 10 years old: Minnesota, Arkansas, California, Indiana, Iowa, West Virginia, Wisconsin, Colorado, Illinois, Kansas, Massachusetts, North Dakota, Oregon, Arizona, Connecticut, Maine, Missouri, New Jersey, North Carolina, Pennsylvania, Rhode Island, and Washington
• Less than 10 years old: Delaware, Georgia, Hawaii, Idaho, Maryland, Montana, New Mexico, South Carolina, Texas, Utah, Louisiana, and Ohio

Any company that may be eligible for federal or state R&D tax credits should have their tax accountant investigate. They should also determine whether the company is entitled to refunds for prior years.

The October 2008 Emergency Economic Stabilization Act (bailout bill) included a two-year extension of the federal R&D tax credit.

For further information regarding possible R&D Tax Credits, please contact Arizona MEP at 480-874-9100