With the passage of The American Taxpayer Relief Act of 2012 (the Act), the research credit was extended for years 2012 and 2013. In addition, the Act amended the rules for computing the credit when there is an acquisition of a major portion of a trade or business or a separate unit of a trade or business.
First, with respect to asset acquisitions under the new law, a taxpayer that acquires a trade or business (acquiring entity) prorates the acquired entity’s qualified research expenses (QREs) and/or gross receipts for the portion of the credit year beginning on the date of the acquisition and ending on the last day of the controlled group’s tax year. The new law also provides guidance in the event the acquiring entity has a different tax year than the acquired entity.
Second, the Act modifies the research credit allocation among controlled group members. Under the new rules, the research credit is allocated to controlled group members based on each member’s proportionate share of the group’s QREs. This modification eliminates the need to compute stand-alone computations for each member of the controlled group.
Despite the extension of the law, the research credit still retains elements of complexity and misunderstanding. Unfortunately, many small and medium size companies, including product manufacturers, software companies, and service companies with new application and analytics activities continue to interpret efforts to develop new products or improve legacy products as a cost of doing business. As a result, these businesses may be overlooking potential tax benefits.
Any firm with leading edge technology is likely to have qualified research and eligible costs. Companies in the chemical, electronics, manufacturing, medical technology, pharmaceutical, and software industry sectors are candidates for the credit.
A State of Mind
In addition to the federal research credit, approximately 35 states have enacted some form of research credit. R&D activities may also enable a company to qualify for other incentives, such as investment credits, jobs credits, and sales and use tax exemptions.
As an example, for clients doing R&D activities in the state of Texas there’s some good news. On June 14, 2013, the state of Texas reintroduced the Research and Development Tax Credit (Bill HB 800) effective for expenses paid or incurred between January 1, 2014 and December 31, 2026. The new law allows taxpayers to take either the credit or a sales tax exemption for purchased property used in R&D activity.
Modeled on the federal law, HB 800 provides a tax credit equal to 5 percent of the excess of i) the qualified research expenses (QREs) incurred in the state of Texas for the reporting tax period; over ii) 50 percent of the average amount of QREs in the state of Texas during the three tax periods preceding the reporting period.
If a taxpayer has no QREs in one or more of the three tax periods preceding the reporting period, the credit for the reporting period equals 2.5 percent of the QREs during that period.
Any unused credits can be carried forward 20 years. The credit is not transferable and must be reported with the tax report for the reporting period.
The new law also provides a sales tax exemption for certain depreciable tangible personal property used directly in R&D activities. This sales tax exemption is also effective January 1, 2014.