States’ Tax Credits for Company-Financed Research
A Current Comparison

By B. Anthony Billings

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FEBRUARY 2007 - Most state governments offer a variety of tax incentives to stimulate research and experimentation (R&E, used interchangeably with research and development, R&D) within state borders. Companies seeking to locate or relocate their R&E facilities can benefit from knowing what business incentives, such as state R&E credits, particular states offer. This article uses sales and R&D expenditures from the 3M Company’s published financial statements to simulate the effective rates of R&E credit for states that have some form of R&E tax incentive.

The statutory rate of credit offered by the 40 states that have such a credit ranges from 0.75% to 22.5% of qualified costs. To compare the states in more detail, they are separated into three groups, with states having the same or similar provisions included in the same group. The groups are discussed below.

Group 1: Federal Definition States

Arizona permits a credit of 20% on the first $2.5 million in incremental research costs and 11% on incremental research expenses in excess of $2.5 million. (The federal credit under IRC section 41, which had expired, was ultimately extended by the Tax Relief and Health Care Act, signed into law by President Bush on December 20, 2006.) The incremental credit is limited to $2.5 million in any taxable year, and any excess is carried forward over the succeeding 15 taxable years but is subject to annual limits on the carryover benefit. (If the excess is over $2.5 million, the credit is equal to $500,000 plus 11% of the amount of expenses over $2.5 million.) In addition to the incremental credit, Arizona allows a credit for construction materials incorporated in R&E facilities and an additional credit of 10% on research conducted at Arizona state universities, which is capped at $5 million per corporate donor.

California allows a nonrefundable credit equal to 24% of basic research costs along with 15% of the excess of qualified research expenses over the computed base-period spending. Taxpayers are allowed to use an alternative method for computing the incremental credit. Basic research is defined as payments by a taxpayer to fund basic or applied research aimed at advancements in science or engineering or at improvements in the effectiveness of commercial products, excluding basic research in the social sciences, arts, or humanities. Unused credits can be carried forward until they have been fully utilized.

Hawaii’s credit mirrors the IRC section 41 federal credit and has a statutory rate of 20% of incremental spending, but it does not have the restrictions and limitations imposed by Arizona and California. Moreover, the Hawaiian credit is refundable and can be used against corporate or personal income taxes. As of July 1, 2004, only certain qualified high-technology businesses are eligible for the research activities credit.

Idaho allows a credit of 5% on the excess of qualified research payments conducted in Idaho over a computed base amount. The base amount is defined the same as in IRC sections 41(c) and 41(h), except that average annual gross receipts must be calculated using sales or receipts attributable to Idaho sources. All unused credits may be carried forward for a period not to exceed 14 taxable years.

Indiana allows a nonrefundable credit of 10% on qualified research expenses in excess of the taxpayer’s base period spending. Beginning in 2008, the rate of credit increases to 15% on the first $1 million in incremental research expenses plus 10% of incremental research expenses in excess of $1 million. Unused credits can be carried forward for 10 taxable years. Businesses engaged in the production of civil or military jet propulsion systems may elect to calculate the credit as a percentage determined by the Indiana Economic Development Corporation. However, the resulting amount cannot exceed 10% multiplied by Indiana-qualified research expenses for the taxable year, reduced by 50% of the taxpayer’s average Indiana-qualified research expenses over the three prior taxable years.

Iowa allows a 6.5% refundable credit on the excess of qualified research expenses during the tax year over a computed base amount of expenditures using the state’s apportioned share of research expenses. The taxpayer may, however, elect to compute the credit in a manner consistent with the calculation of the alternative incremental credit under IRC section 41(c)(4), and this election is not binding in succeeding tax years. Taxpayers also are eligible for a nonrefundable credit of up to $225,000 on sponsored research in an educational institution in the state, limited to $600,000 over a five-year period.

Louisiana allows a credit equal to either 8% of Louisiana’s apportioned share of incremental research expenditures as determined under IRC section 41, if the taxpayer employs 500 or more Louisiana residents, or 20% of Louisiana’s apportioned share, if the taxpayer employs fewer than 500 Louisiana residents. The state also awards qualified medical concerns an income tax credit to promote R&D, but that credit is limited to the cost of machinery and scientific equipment used by the medical concern on premises. The annual amount granted is capped at 30% of the corporation’s income, franchise, and state sales and use taxes collected during the preceding fiscal year. Louisiana also offers a credit on donations for biomedical and biotechnological R&D in higher educational institutions in the state. Only donations in excess of $200,000 are eligible for this credit, which is equal to 35% of the donated amount. The state also offers a tax exemption on qualified concerns engaged in research, development, manufacturing, support, or service located in a university R&D park, or operated in association with a public and regionally accredited university in the state.

Massachusetts allows a nonrefundable credit equal to the sum of 10% of any excess qualified research expenses for the taxable year over the computed base amount, plus 15% of the basic research payments determined under IRC section 41. The credit applies to wages, supplies, computer-use fees, and 65% of contract research payments in the state. Although this credit is subject to a limit of $25,000 in each taxable year, any excess can be carried forward for 15 taxable years. Expenses for services rendered or for tangible R&D property used both within and without Massachusetts must be prorated according to the ratio of the number of days the service provider or the property was used in Massachusetts to the total number of days the service provider or property was employed in research.

Minnesota allows a nonrefundable credit against the state’s franchise (income) tax equal to 5% of the first $2 million of the excess of qualified research expenses for the year over a computed base amount of research expenses; the credit is 2.5% on all such expenses in excess of $2 million. Items used or consumed for R&D (along with quality control, testing, and design) activities that are considered part of the production process are exempt from the sales and use tax. The calculated base-period amount is determined consistent with the federal definition under IRC section 41 using Minnesota-sourced items. Unused tax credits have a 15-year carryforward period.

Montana allows a nonrefundable credit of 5% on the excess of qualified research expenses during the year, over a computed base amount of research expenses and on basic research payments. The calculated base-period amount is determined consistent with the federal definition under IRC section 41 using Montana-sourced items. Excess credits may be carried back two tax years or carried forward over 15 tax years.

New Jersey allows a nonrefundable credit of 10% on incremental research expenses in addition to a 10% credit on basic research payments. Incremental spending is determined based on the federal definition under IRC section 41 using New Jersey–sourced items. Qualified research activities are limited to scientific experimentation or engineering activities designed to aid in the development of a new or improved product, process, technique, formula, invention, or computer software program that is held for sale, lease, or license or used by the taxpayer in a trade or business. The amount of credit applied during a taxable year may not exceed 50% of a company’s tax liability otherwise due. Unused credits may be carried forward over the succeeding seven taxable years.

North Dakota allows a nonrefundable credit equal to 8% on the first $1.5 million of qualified research expenses in excess of the computed base amount, along with an additional 4% of qualified research expenses over the $1.5 million in excess of the computed base amount. The credit cannot exceed the entity’s tax liability in the state. Unused credits may be carried back three taxable years or forward 15 taxable years.

Oregon allows a credit equal to 5% of qualified research expenses as defined under IRC section 41, except that the research must be conducted in the state. The credit amount is limited to $2 million per year. An alternative credit equal to 5% of qualified research expenditures in excess of 10% of Oregon sales is also allowed. The alternative credit is limited to $10,000 multiplied by the number of percentage points by which qualified research expenses exceed 10% of Oregon sales; the credit may not exceed $2 million. In no case can the taxpayer claim both credits. Unused credits can be carried forward for five years.

Rhode Island offers a nonrefundable credit equal to 22.5% of the first $25,000 in incremental research expenses and 16.9% above $25,000. The definition of qualified research expenses, along with incremental spending, is consistent with the federal definition under IRC section 41. Rhode Island also offers a property tax credit equal to 10% on property used in a research facility. The maximum credit claimed during any year cannot exceed 50% of an entity’s tax liability due for the year. Excess credits can be carried forward for a maximum of seven taxable years.

Texas allows a nonrefundable credit equal to 5% on the sum of the excess of qualified research expenses incurred in Texas over the computed base amount and basic research payments as determined under IRC section 41(e)(1)(A). The credit is limited annually to 50% of the company’s total franchise-tax liability before any other credits. Moreover, taxpayers may elect to compute the credit consistent with the alternative incremental credit under IRC section 41(c)(4), provided that a federal election was made. Unused credit may be carried forward for up to 20 taxable years.

Utah allows a nonrefundable credit of 6% on incremental research expenses incurred in the state. Qualified research expenses include payments to qualified organizations for basic research as provided in IRC section 41(e). Companies can also obtain a credit of 6% on machinery used in research. The definition of incremental spending is defined consistent with the federal definition in IRC section 41; however, taxpayers are not eligible for the alternative credit under IRC section 41(c)(4). Excess credits may be carried forward for 14 taxable years.

Wisconsin allows a nonrefundable credit equal to 5% of the amount paid or incurred during the tax year to construct, expand, or equip new research facilities in the state, and on incremental research expenses as defined under IRC section 41. For purposes of the incremental credit, both the definition of qualified research expenses and the computed base mirror the IRC section 41 definition. A taxpayer may elect the alternative incremental credit computation under IRC section 41(c)(4). Unused credits may be carried forward for up to 15 taxable years.

Group 2: Unique Base-Period States

Colorado allows a 3% credit on the excess of qualified expenses over the average of expenditures for the two prior taxable years in an enterprise zone. No more than one-fourth of the allowable credit may be taken in any one tax year, and the remaining amount is credited in the succeeding three taxable years.

Delaware allows a credit equal to either 10% on the excess of the firm’s qualified research costs in the state over the average of qualified R&D over the immediately preceding four taxable years, or 50% of Delaware’s apportioned share of the taxpayer’s federal R&D tax credit computed under the alternative incremental credit method under IRC section 41(c)(4). The otherwise available credit cannot exceed 50% of a company’s qualified tax liability in any taxable year. Approved and unused credits may be carried forward for 15 taxable years.

Illinois allows a nonrefundable credit equal to 6.5% on the excess of qualified research costs over the average amount of qualifying expenditures for the three prior taxable years. Qualified research expenses include in-house costs and contract research payments for research done by a third party. Unused credits in excess of the tax liability can be carried forward for five taxable years.

Maine allows a nonrefundable credit equal to 5% of the excess qualified research expenses over the average qualified expenses for the three prior taxable years, along with 7.5% of basic research payments as defined under IRC section 41 (e)(1)(A). Eligible taxpayers can also receive credits up to 100% of the first $25,000 of tax due before the allowance of any credits, plus 75% of taxes in excess of $25,000. Unused credits can be carried forward over the next 15 taxable years.

Nebraska, beginning in 2006, offers a credit equal to 3% on R&E expenses, as defined in IRC section 174, in excess of the computed base amount. The base amount is the average R&E expenditures incurred in the state for the two tax years immediately preceding the first year the credit is claimed.

Ohio allows a nonrefundable credit equal to 7% of qualified research expenses over the average of qualified expenses for the three prior taxable years. Unused credits may be carried forward for seven taxable years. Ohio also allows a nonrefundable credit, not to exceed $150,000, equal to a taxpayer’s qualified R&D loan payments made during the calendar year immediately prior to the tax period in which the credit is claimed, and a nonrefundable credit equal to 25% of the investments made in small, Ohio-based companies engaged in R&D.

Pennsylvania allows a nonrefundable credit of 10% on the excess of the current year’s qualified R&D costs over the prior year’s research expenses. Beginning July 1, 2006, the credit increases to 20% for small businesses. To receive the credit, companies must submit an application to the state’s Department for Qualified Research and Development Expenses showing the amount of expenses incurred. Pennsylvania allows a maximum of $40 million in credits for all taxpayers, and at least $8 million of the total is allocated to qualified small businesses. Qualified expenses mirror the IRC section 41(d) definition. Excess credits may be carried forward for up to 15 taxable years.

Group 3: Unique Credit-Formula States

Arkansas permits eligible businesses to claim an income tax credit equal to 10% of qualified in-house research expenses conducted in the state. The maximum amount of credit for each qualified business is $10,000 per year; unused credits can be carried forward for three years. Targeted businesses can also earn transferable credits equal to 33% of approved expenditures for in-house research.

Connecticut’s statutory rate of credit increases with the amount of R&D conducted in the state. The tentative credit is 1% for expenses equal to or less than $50 million, but if R&E expenses exceed $200 million, the tentative credit is $5.5 million plus 6% of the excess over $200 million. No more than one-third of the amount of the credit available in any given year may be credited in that year. Unused credits can be refunded or carried forward for up to 15 taxable years.
Florida’s Innovation Incentive Program rewards businesses expanding or locating in the state that are likely to be a catalyst for technological growth, including R&D, or that will significantly affect the local economy. Applications for the program are subject to the governor’s approval.

Georgia allows a 10% credit on qualified research expenses in excess of a computed base amount. The computed base amount is determined by multiplying the company’s Georgia taxable income by either the average of the company’s aggregate qualified research expenses attributable to Georgia taxable income for the preceding three taxable years, or 30%, whichever is less. The credit taken in any taxable year cannot exceed 50% of the company’s remaining Georgia net income-tax liability after all other credits have been applied. Unused credits can be carried forward for 10 taxable years.

Kansas provides incentives for businesses engaged in bioscience in the state, including research or production related to bioscience products or processes for specific commercial or public purposes. The state allows companies to seek payments of up to $1 million from the Kansas Bioscience Authority on up to 50% of net operating losses (NOL) incurred in the state during the taxable year.

Kentucky offers a nonrefundable credit equal to 5% of the cost of constructing, remodeling, equipping, or expanding facilities for qualified research, as defined in IRC section 41. The credit may be claimed against personal or corporate income taxes, and unused credits may be carried forward 10 years.

Maryland has both a basic credit and an incremental credit. The basic credit is equal to 3% of qualified expenses. If the total amount of credit claimed by all businesses in the state exceeds $3 million, however, the credit is prorated among eligible companies, but excess funds from the incremental credit may be used to enhance the $3 million amount. (The total amount of credit approved by the Maryland Department of Business and Economic Development for any taxable year may not exceed $6 million.) The incremental credit is equal to 10% of research expenses in excess of average qualified R&D expenses over the Maryland base amount of R&D expenses. Approved unused credits may be carried forward for seven taxable years.

Michigan allows eligible pharmaceutical companies a credit equal to 6.5% of incremental research expenses incurred in the state. Unused credits may be carried forward for up to seven taxable years and are limited to the taxpayer’s Single Business Tax (SBT). (Note that the SBT was repealed on August 9, 2006, by the legislature and will expire at the end of 2007.) Start-up businesses with at least 25% of business expenses on qualified R&D expenses and without business income for two consecutive tax years may claim a credit equal to their SBT liability. From 2006 to 2015, Michigan allows a refundable credit equal to 3.9% of compensation paid to employees performing R&D for a two-mode hybrid system to propel a motor vehicle. The credit is limited to $3 million per year for each taxpayer. In addition, qualified high-technology businesses may claim a refundable credit for the creation of qualified new jobs in the state. Taxpayers also may claim a credit for R&D activities conducted in either an alternative-energy zone or a pharmaceutical-renaissance zone. The credit amount is limited to the incremental SBT liability attributable to the expansion or relocation to the amount of personal income tax attributable to new jobs created. [The Michigan Economic Growth Authority (MEGA) offers various other tax credits for targeted activities related to economic growth and job creation.]

Mississippi allows a nonrefundable credit for businesses that create jobs requiring R&D skills from professionals such as chemists and engineers. The credit is equal to $1,000 for each net new full-time employee for the first five years and is limited in aggregate to 50% of the taxpayer’s state corporate income tax liability in a taxable year. Unused credits can be carried forward for up to five years.

New Mexico allows a nonrefundable tax credit to organizations meeting the qualified R&D small-business designation. This credit is effective from July 1, 2005, through June 2009. The credit is equal to the annual sum of all state gross receipts taxes, compensation taxes, and personal income tax withholding due to the state or payable by the taxpayer. A qualified R&D small business is defined as a business entity that employed no more than 25 employees on a full-time–equivalent basis and had total revenues of no more than $5 million in any prior fiscal year.

New York offers a credit of 4% on R&D expenses and a credit of 7% on property used in conducting R&D. The state also allows qualified emerging-technology companies a refundable credit on certain R&D property, research expenses, and high-tech training expenditures. The credit may be claimed for four consecutive years by an eligible taxpayer but may not exceed $250,000 annually.

North Carolina allows a 3% nonrefundable credit on qualified research expenses incurred in the state by small businesses. The credit applies only to the North Carolina–apportioned share of the expenses. A taxpayer having North Carolina university research expenses is allowed a credit up to 15% of the expenses. The amount of research credits is capped at 50% of the taxpayer’s tax liability reduced by other credits allowed. Unused credits may be carried forward for 15 taxable years.

Oklahoma, for tax years beginning after 2005, allows an income tax credit for businesses with a net increase in the number of full-time–equivalent employees engaged in computer services, data processing, or R&D in the state. The credit is equal to $500 for each new employee, and is limited to a maximum of 50 new employees. Oklahoma also offers a credit on donations to an independent biomedical research institute.

South Carolina offers a tax credit of 5% on qualified research expenses incurred in the state. Qualified research expenses are consistent with IRC section 41. The annual credit is capped at 50% of a taxpayer’s state tax liability net of all other applied credits. Unused credits may be carried forward for 10 years.

Washington allows business and occupation tax credits for research expenses in excess of 0.92% of taxable income. The credit is computed by multiplying qualified research expenses by the greater of the taxpayer’s average tax rate or statutory rates ranging from 0.75% to 1.50% (depending upon the calendar year when the credit is being claimed). To qualify, a company’s employees must perform qualified research activities in an R&D project and must complete an annual survey by March 31 following the year in which the credit was taken.

West Virginia permits a refundable credit for businesses engaged in strategic research and development projects. The credit is equal to the greater of 3% of annual combined qualified research expenses or 10% of the excess of annual qualified research and investment expenses over the average of those expenditures over the three prior years. Qualified research are defined as the sum of 100% of in-house and 65% of contract research expenses. The credit amount can be used to offset up to 100% of the taxpayer’s franchise tax, corporate income tax, and personal income tax (for flow-through business profits only), in the aforementioned order. West Virginia also allows an economic opportunity tax credit for job creation in high-tech research zones or parks.

Effective Rates of Credit

A thorough comparison of the benefits of states’ R&D tax credits can be performed by looking at the financial data from a sample company. Using data from published annual reports of 3M, the authors estimated the tax credit that 3M could have claimed for calendar years 2002–2004. The credit amounts were used to develop average effective rates for each of the 41 states with a tax incentive for research. For the purpose of computation, sales and R&D expenditures were extracted from 1994 through 2004. It was assumed that 3M earned all of its revenues and conducted all of its R&D activities in each of the states, and that these activities were all in-house research expenses. The estimated rates of credit shown in the Exhibit were adjusted for the maximum amounts allowed by the state in each year. (The rates are based on the full amount of otherwise-qualified expenditures and ignore any possible IRC section 280C reduction in deductible R&D in the computation of taxable income for state income tax purposes.)

Even though the statutory R&D credit rates range from 0.75% to 22.5%, in these examples most states’ effective rates would be much lower. Hawaii was found to have the highest effective rates, while Arkansas, Georgia, and Michigan had the lowest effective rates. Although 13 states offer statutory rates of at least 10%, the limitations and other restrictions imposed in computing the credit will reduce the benefits well below the statutory rates.


B. Anthony Billings, PhD, is a professor of accounting at Wayne State University, Detroit, Mich.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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