Are R&D Tax Credits Available in Texas?

Yes. Beginning with tax returns filed after January 1st, 2014 (for tax years ended in 2013), Taxpayers in Texas state can claim the Research Development (R&D) Tax Credit to offset a portion of their franchise tax or use it towards a sales and use tax exemption on the purchase or lease of depreciable tangible personal property used in qualified research in Texas. Some highlights of the Texas Research and Development Tax Credit include:

  • Qualified Research Expenses (QREs) have the same meaning as in IRC § 41, except that such expenses must be for research conducted within Texas.
  • The credit amount is 5% of the excess amount of qualified research expenses in the current period over the base amount (50% of the average of the previous three years).
  • The allowable Franchise Tax Credit in any one period, including carryforward amounts, cannot exceed 50% of the franchise tax due for the period.
  • Unused credits can be carried forward for up-to 20 consecutive report years.
  • The sales and use tax exemption is effective for activities beginning after January 1st, 2014.
  • Any entity (including combined group) creating or claiming a research and development activities credit in Texas must file a Texas franchise tax report.
  • Any amount spent with a public or private institution of higher education will be able to generate a 25% higher Texas R&D tax credit. This will increase the percentage of the credit eligible for the Texas R&D tax credit from 5% to 6.25%.
  • NEW: On October 15, Texas promulgated significant amendments to the Texas research and development activities franchise tax credit. The main highlights from the amendments are noted below:
    • The internal use software (IUS) exclusion in Texas does not apply to software used in an activity that constitutes qualified research, or in a production process that meets the requirements of the 4-Part Test. Texas now defines IUS as it was defined federally before final internal use software regulations were released in November of 2016.
    • Any item of tangible personal property where the taxpayer would not have paid Texas sales and use tax due to the manufacturing exemption or the sale for resale exemption is excluded from qualified research. This treatment requires taxpayers to choose either a sales and use tax exemption or a research and development supplies credit.
    • Although Texas incorporates IRC Section 41 into its R&D credit rule, the burden of proof does not align with the federal standard. The final rule provides that while case law on various issues is persuasive, however, it is not binding on the Texas Comptroller.
    • If a combined group changes (e.g., loses a member), the credit carryforward will be attributed to each member of the combined group that was included on the report of the report year that the carryforward relates. Each member of the combined group that has a carryforward attributed to it (including the member that leaves), may use the carryforward on future franchise tax reports. The combined group with a membership change may only carryforward the R&D credit on future franchise tax reports if the member(s) who were attributed a carryforward remain part of the combined group on the last day of the accounting period on which the report is based.

What are the Potential Benefits of this Tax Credit?

There are several benefits to realizing the R&D tax credit. These benefits can include the following:

  • Receive up to 12-16 cents of federal and state R&D tax credits for every qualified dollar
  • Create a dollar-for-dollar reduction in your federal and state income tax liability
  • Increase earnings-per-share
  • Reduce your effective tax rate
  • Improve cash flow
  • Carry forward the credit up to 20 years
  • Perform look back studies to recognize unclaimed credits for open tax years (generally 3 or 4 years)
  • Utilize the federal R&D tax credit against payroll tax (applicable to certain startup companies)

Texas R&D Tax Credit Case Study

An Austin-based software developer began operations in 2006. The Company has steadily increased its research expenditures primarily through the addition of both experienced and inexperienced developers. The client has been claiming the federal R&D Tax Credit since 2009 and the Texas R&D Tax Credit beginning for tax year ended December 31, 2013.

FEDERAL
TEXAS
Year
Total QREs
Credit
Total QREs
Credit
2014
$750,000
$75,000
$750,000
$24,583
2013
650,000
65,000
650,000
22,500
2012
500,000
50,000
500,000
NA
2011
400,000
40,000
400,000
NA
Total $2,300,000 $230,000 $2,300,000 $47,083

You can read more about this Texas tax credit case study here.