Businesses that incur expenses for research activities in Pennsylvania can receive credits which offset their business taxes, personal taxes of owners, or even be sold for cash.
Who can apply
Any taxpayer who conducts research and development activities in Pennsylvania can apply for the credit. Pennsylvania follows the federal definitions of qualifying research expenses under Internal Revenue Code Section 41 and the related regulations. These rules can be very complex and a detailed discussion wouldn’t fit in a blog post. But, the typical types of expenses which qualify are:
- Wages paid to your employees for qualified research services
- Cost of supplies used directly in research activities
- 65% of amounts you pay to others for contracted research services
Manufacturers represented 55% of taxpayers receiving the credit in 2013. Among service providers, the largest group of credit recipients was designers of computer systems.
Check your federal tax return. If it includes Form 6765, Credit for Increasing Research Activities, then you may qualify for the Pennsylvania credit.
The credit is for increasing research activities. The calculation compares your current year R&D expenses to the average R&D expenses over the previous four years.
- You need R&D expenses in at least one of the previous four years in order to get the credit. If this is your first year with R&D expenses, you don’t qualify for the credit in the current year.
- If your R&D expenses have decreased – i.e. your current year expense is less than the prior years’ average – you don’t qualify for the credit in the current year
When to apply
Applications must be filed by September 15th for R&D expenses incurred in the tax year ending in the preceding year. So, unlike many filings, the due date is the same regardless of your fiscal year end.
For example, the 2014 application is due by Sep. 15, 2014. Calendar year taxpayers will report their 2013 R&D expenses on the 2014 application. A taxpayer with a June fiscal year will report their expenses for the fiscal year ending June 30, 2013 on the 2014 application. Their expenses for the year ending June 30, 2014 won’t be reported until the 2015 application.
How to apply
Apply for the credit using Form REV-545. Be sure to read the instructions carefully and include all necessary attachments with the application.
How it works
Calculating the credit
The credit is fairly easy to calculate assuming that you’ve applied for the federal R&D credit on Form 6765.
- Take your current year qualified research expenses from Form 6765
- Divide that amount by two
- Determine your average research expenses from the previous four years
- Compare steps 2 and 3. Take the larger number, and subtract it from the amount in step 1
- Take the result in step 4 and multiply it by:
- 0.2 for a small company (less than $5 million total assets at beginning or end of year)
- 0.1 for a large company
- The result is your tentative credit. However, your credit might be limited by the amount of the credit pool.
The credit pool
Each year, the state sets aside an amount of R&D credits to award. The current amount is $55 million. Businesses file their applications by Sep. 15. Over the next three months, the state reviews and approves the applications and totals the amount requested. If the amount requested exceeds the amount set aside, then credits are awarded on a pro rata basis. For example, if $110 million of valid applications were filed (double the set-aside amount of $55 million), then each applicant would receive 50% of the amount they requested on their application. The state sends letters with the amount of credit awarded on Dec. 15. There is no way to be sure of the amount that will be awarded, but recent years have been around the 50% mark.
Small companies
But it’s not quite that simple. In order to encourage small start-up businesses, the state carves out $11 million just for small businesses. A small business for this purpose is one with less than $5 million of total assets at the beginning or end of the current tax year. For the past three years, small business applications have been below the $11 million set aside for them. So, small businesses have been receiving 100% of the amounts properly claimed in recent years.
Applicable taxes
Credit award letters are sent on Dec 15. The 2014 credit is first applied on the applicant’s RCT-101 tax return toward their capital stock/franchise tax (CSFT) liability and their corporate net income (CNI) tax liability. If there is credit remaining, there are several options:
- Carry forward the credit for up to 15 years for use against the CSFT and CNI
- S corporations and partnerships can pass the credit through to their owners for use against their personal income tax (PIT) liabilities
- The credit can be sold for cash
Selling the credit
Since some businesses, particularly start-ups, may have significant research expenses but little or no tax liability, the state allows unused credits to be sold to other taxpayers. This is frequently done through a broker. The purchaser typically pays about 92 cents on the dollar for the credits, and the broker takes a 5% cut for matching the parties up and handling the paperwork. So, a $10,000 credit would net about $8,700 for the seller. Sales of the credit are administered by the state’s Department of Community & Economic Development (DCED).
Buying the credit
Taxpayers with CSFT and/or CNI liabilities can save some money by buying R&D credits at a discount, which is generally about 8%. A purchaser must be careful not to buy too large an amount of credits. Purchased credits can only be used in the taxable year in which purchased. They cannot be carried forward, carried back, refunded, or re-sold. They can only be used to offset 75% of the qualified tax liability for the year.
Links
REV-545 2014 Research & Development Tax Credit Application
Federal Form 6765, Credit for Increasing Research Activities
Department of Community & Economic Development (DCED)
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