November 1, 2011

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Before you File

Reap the Rewards of Increased R&D Tax Incentives

MK Mortensen, Joe Stoddard

November 1, 2011

Utah is making a big push to attract high-paying jobs and business investment by expanding its tax incentives for research and development (R&D). Many Utah companies that take advantage of R&D tax incentives noticed a significant increase in the amount of cash benefit received on their recent 2010 tax filings. That’s because the R&D tax credit enhancements enacted by Utah in 2008 ramped up to a historical high for 2010 tax filings.

R&D tax credits are important for encouraging the competitive efforts of companies across the U.S. economy. According to a recent Treasury report, Investing in U.S. Competitiveness: the Benefits of Enhancing the Research and Experimentation Tax Credit, R&D tax incentives increase company research spending on a dollar-for-dollar basis—with even larger potential returns in the long run. Treasury found that this increased spending can be directly tied to high-wage job creation as approximately 70 percent of research costs that qualify for R&D credits are for labor costs.

The federal R&D tax credit is a 20 percent credit on qualified R&D expenses that exceed a base amount (often resulting in a maximum 6.5 percent benefit). Many states, including Utah, offer state credits in addition to the federal credit. These state credits play an important role in states’ ability to compete for and attract new investments and jobs. R&D credits directly reduce a company’s income tax liability and can be claimed in addition to tax deductions taken for R&D expenses.

Companies in many industries can benefit from R&D tax credits. These credits are often available for companies that have undertaken any of the following types of initiatives:

  • Developed new or improved products
  • Developed prototypes or new patents
  • Enhanced their production process
  • Utilized technical or engineering personnel
  • Built a new manufacturing facility
  • Automated their process or added sophisticated software

Utah’s Growing Incentives

Before the state enhanced its research credit in 2008, Utah offered a 6 percent incremental R&D credit that closely mirrored the federal R&D tax credit rules. Under this regime, a maximum credit benefit of 3 percent of qualified R&D expenses was awarded.

Starting in 2008, the traditional incremental credit percentage was reduced to 5 percent and a second credit was established—the Utah Research Expenses Credit. This additional credit is based on a flat percentage of qualified expenses without regard to a base amount. The credit rate was phased in over three years, beginning at 5 percent in 2008 and reaching 9.2 percent in 2010.

The new credit represents a significant expansion of Utah’s R&D tax credit incentives because it rewards all R&D spending (not just incremental spending). Since companies can claim both credits for the same expenses, Utah companies can now receive as much as an 11.7 percent Utah tax refund for their qualified R&D expenses—almost four times the incentives available prior to 2008. When coupled with the federal incentives, some Utah companies receive almost 20 cents of tax benefit for every dollar spent on R&D.

Utah also provides a separate 6 percent credit for investments in R&D equipment and software (effectively refunding the sales tax paid on these types of purchases).

States Battle for R&D Investment

Unlike the federal and incremental Utah credits, Utah’s 9.2 percent Research Expenses Credit cannot be carried forward if it is not used in the year generated—making it a “use it or lose it” incentive.

While Utah now offers one of the most attractive R&D incentives of any of the states, the limitations on the ability to monetize the majority of the credit for companies without a Utah tax liability makes some other states’ credit regimes more attractive for certain companies in startup mode or currently operating at a loss. For example, Minnesota recently enhanced its state R&D credit and now offers a “refundable” credit providing immediate refunds in the year generated, even if no Minnesota tax liability is owed in that year.

While Utah has shown that it’s serious about attracting R&D investments from well-established and profitable companies, refundable credits offer the most enticing and immediate rewards for startup and pre-revenue companies that are making significant investments in R&D. As other states enhance their R&D incentives to compete for R&D investment and high-paying jobs, Utah policymakers should consider additional enhancements to the credit regime to maintain Utah as a top choice for startup ventures investing in innovation.

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