State Research and Development Tax Credits: Navigating Multi-State Apportionment Rules

Description

For many small and medium sized businesses, R&D tax credits are one of the most underutilized of all tax benefits. This is particularly true for companies operating in multiple states. Tax advisers face challenges in navigating various states’ rules on qualified research expenditures, determining when state rules deviate from federal R&D tax credit treatment, and identifying sourcing rules when claiming tax benefits for R&D expenditures.

The majority of states offer tax incentives for R&D expenditures. While most states conform to federal practice in determining what activities qualify for R&D benefits and calculation of qualified research expenditures (QREs) eligible for credit, there are some significant differences. Advisers can avoid state tax by structuring research activities to occur in jurisdictions with the most favorable R&D tax benefit regime.

Beginning with the 2016 tax year, Congress made two massive changes to expand the federal benefits of R&D credits. Startup companies, defined as firms with less than $5M in annual gross receipts and no gross receipts for more than five tax years may utilize the federal credit against payroll tax liability as opposed to income tax liability. Eligible companies may also apply R&D credits to offset AMT liabilities. These initiatives make claiming the R&D credit even more attractive, and make a thorough grasp of the rules for documenting R&D activities even more critical for tax advisers.

States have slightly different methodologies for calculating credit amounts and varying approaches to providing tax benefits to startups or companies with net operating losses. So, companies operating in multiple states often miss out on this crucial tax benefit. R&D activities in a state may create or affect income apportioned to the state, such as payroll or property increasing income apportioned to a three-factor state where R&D activities occur.

Listen as our experienced panel provides a thorough and practical review of calculating, claiming and substantiating a Section 41 R&D credit.