State Tax Credits for Research and Experimentation

By Billings, B. Anthony; Houston, Melvin | The CPA Journal, June 2002 | Go to article overview

State Tax Credits for Research and Experimentation


Billings, B. Anthony, Houston, Melvin, The CPA Journal


Incentives for staying in the laboratory

In Brief

limo Shows State-by-State Benfits

Companies seeking to locate or relocate their research and experimentation (R&E) facilities can frequently benefit from state business incentives such as state R&E credits. In addition to summarizing the R&E credits offered by the states, the authors compare the effective rates of these credits based on the differences in the statutory rates, the definition of creditable research, and the limitations imposed in the credit formulae used to compute the credit. Using sales and research and development expenditures from the Ford Motor Company's published financial statements, they simulate the effective rate of R&E credit for the 32 states that have some form of R&E tax credit.

No keep pace with technology, U.S. companies must make significant investments in research and experimentation (R&E). Both the federal and state governments support a broad range of R&E initiatives, both directly and indirectly.

The most direct support, which involves government funding of basic and applied R&E, is often tied to objectives such as national defense or future economic growth. Indirect support is offered through a variety of policies, including a federal R&E tax credit, which encourages firms to spend more on research.

Most state governments have also enacted tax credits to encourage firms to conduct research within their state. Although the statutory rate to compute the credit varies from state to state, most states structure their credits after the federal tax credit for R&E expenses. The Exhibit identifies the 32 states with some form of tax credit for qualified R&E expenditures. The majority of these states base the amount of the credit on the increase in qualified R&E expenditures over a three- or five-year base period. The states' statutory rates range between 5% and 6.5% of qualified R&E costs for a majority of states. Generally, those states with lower credit rates are more liberal in the items that are eligible for the credit. Most of the states offering R&E credits allow unused credits to carry over to future years.

Between 1998 and 2000, 32 states offered R&E credits at rates ranging from 3% to 20 %. However, the effective rates of credit for the 32 states presented in the Exhibit range from a low of zero to a high of 100% of its statutory rate. Moreover, a number of states reduce the credit's attractiveness through restrictions, such as the requirement to locate in designated enterprise zones and the inability to carry unused R&E credit back or forward to other taxable years.

Federal Definition of Eligible Expenditures

The United States first offered an R&E tax credit in 1981: a 20% percent credit for expenditures made in an experimental or laboratory sense (Public Law 97-34). Qualified expenses included in-house, contract, or basic research; for example, wages for research employees, research supplies, lease payments for property used in research, and 65% of contract research costs. Such expenditures are eligible for either a basic research credit or an incremental credit. To obtain the credit, R&E costs must be technological in nature, potentially useful in the development of a new or improved business component, or elements of experimentation for a functional process.

The development or improvement of an experimental model, plant process, or formula qualifies for the credit, but expenditures for the refinement or production of a product do not quality for the credit. Expenses for testing, efficiency surveys, and consumer surveys on existing products are also disqualified. Furthermore, R&E conducted outside of the United States does not qualify for the federal R&E tax credit.

States' definitions of eligible expenditures. Nearly all of the 32 states included in the Exhibit adopted the federal definition of qualified expenses under IRC section 41, which distinguishes between in-house and contract-related R&E expenditures but does not restrict the credit to expenditures incurred in designated enterprise zones. …

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