Claiming the Franchise Tax Credit for R&D Activities in Texas
On June 14, 2013, House Bill 800 was signed reinstating Texas R&D tax credits through 2026. In order to achieve a benefit from R&D in Texas, the taxpayer makes one of two elections ; the franchise tax credit for R&D expenditures or the sales and use tax exemption on the purchase or lease of depreciable, tangible personal property used in qualified research in Texas.
Focusing on the Franchise Tax Credit…
The Franchise Tax Credit went into effect on January 1, 2014 and expires on December 21, 2026, but any unused credits granted prior to the expiration date can be carried forward for 20 years.
What is qualified research?
The Texas Franchise Tax Credit adopts the federal guidelines for qualified research and qualified research expenses which can be found in Section 41 (d) and Section 174 respectfully of the Internal Revenue Code.
The research must satisfy four main criteria, known as the 4-part test:
- Permitted Purpose: The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component.
- Elimination of Uncertainty: The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development, or the appropriateness of the business component’s design.
- Process of Experimentation: The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or method of achieving that result is uncertain at the beginning of the taxpayer’s research activities.
- Technological in Nature: The process of experimentation used to discover information must fundamentally rely on principles of hard science such as physical or biological sciences, chemistry, engineering or computer science.
What are qualified research expenses?
Qualified research expenses are the sum of in-house research expenses and contract research expenses.
In-house expenses consist of wages paid to employees conducting R&D, any amount paid for supplies used in qualified research and any amount paid to another person to use computers for qualified research.
Contract expenses are 65% of any amount paid to third-parties to conduct qualified R&D.
What is the credit rate?
The rates used to calculate the credit hinge on whether or not the taxpayer worked through a university and how many years the credit is being claimed:
- Less than 3 years of QRE and did NOT work through a university = 2.5%
- Less than 3 years of QRE and did work through a university = 3.125%
- 3 years of QRE and did NOT work through a university = 5%
- 3 years of QRE and did work through a university = 6.25%
The credit is applied against the Franchise tax due, but cannot exceed 50% of the tax liability. Any excess beyond the previous 50% threshold can be carried forward for 20 years. The credit cannot be transferred unless all assets associated with it are transferred in the same transaction.
How do I file the Franchise Tax Credit?
Each of the following forms must be filed to claim the Franchise Tax Credit;
- Form 05-178, Research and Development Activities Credit Summary;
- Form 05-160, Credits Summary Schedule; and
- Form 05-158-A and 05-158-B, Long Form.
For more information on claiming the Franchise Tax Credit please contact a Texas R&D Tax Credit Solutions specialist.