Texas R&D Tax Credits

Texas provides a Research and Development (R&D) Credit to incentivize investment in the state. This includes qualified small businesses as well as larger more established companies. Enacted in 2014, the Texas R&D credits may be applied one of two ways:

• As a Franchise Tax Credit; or
• As a Sales and Use Tax Exemption on the purchase, rental, storage, or lease of depreciable tangible personal property used in the state of Texas.

Determining how to use the credit is part of Strike's analysis and is dependent on your specific financial position. The taxpayer can only choose one method each year.

‍Franchise Tax Credit

Texas R&D credits calculated for the current tax year are applied to the Franchise Tax Report in the subsequent tax year. Therefore, for R&D tax credits calculated based on 2022 expenses, those credits will be utilized on the 2023 Franchise Tax filing. If a Company decides to use the credits toward the Franchise Tax Credit, the credit amount equals 5% or 6.5% of the difference between:

1. the Qualified Research Expenses incurred in Texas (QRETs) during the period on which the report is based; and
2. 50% of the average amount of QRETs during the three tax periods immediately preceding the period on which the report is based.

The credit is claimed using a Long Form Franchise Tax Report (05-158-A and 05-158-B) with a Credits Summary Schedule (05-160) and a Research and Development Activities Credits Schedule (05-178). The forms can also be submitted electronically using the Texas Comptroller's portal.

Sales and Use Tax Exemption

‍If a taxpayer chooses to use the R&D credit toward sales and use tax, the credits are calculated in the same manner (5% or 6.5% of excess QREs over the prior three-year average QREs). The taxpayer must apply online for a Registration Number and complete Form 01-931 (Texas Qualified Research Sales and Use Tax Exemption Certificate). This certificate is presented when purchasing qualifying items.

The company must register with the Comptroller’s office, and the taxpayer cannot apply for the franchise tax credit in the same tax period as using the sales and use tax exemption certificate.

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2022 Amendments - Changes in Texas R&D Claims 

Carryforward Rules

‍Recent changes to the Texas state R&D requirements [34 Tex. Admin. Code Section 3.599 (Section 3.599)] have restricted a combined group’s ability to carryforward tax credits if the combined group changes members. However, this is a positive change. Previously, the Comptroller considered a combined group as a new taxable entity if there was any change in membership, and consequently wouldn’t allow credits to carryforward. Now, each member of the original group reported on the franchise tax report can carryforward tax credits individually.

Internal-use Software and Prototype Research Activities

The 2022 Amendments roll back the definition of Internal-use Software (IUS) to the pre-November 2016 federal definition. Now the Comptroller defines IUS as "computer software developed by, or for the benefit of, the taxable entity primarily for internal use by the taxable entity.” 

The change also defines what IUS is not. Any software “sold, leased, licensed, or otherwise marketed for separately stated consideration to unrelated third parties” can’t be considered part of the qualified research activities.

The amendments also affect pilot models and prototypes. They will not follow the updated federal regulations.

With these more stringent requirements, research and development credits may be more difficult to qualify for in Texas. Having a specialty tax firm that understands the intricacies of Texas tax law will help you claim the credits you’re owed.

Learn more about Texas R&D Tax Credit law from the Texas Comptroller!

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R&D Tax Credit Available:

Yes

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Eligible Entities:

C-Corporation, S-Corporations, LLCs, Partnerships

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Deadline for Tax Filing:

Franchise Tax Form due May 15th (or extended to November 15th)

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Data Required to Compute Credit:

Claim Period Texas Qualified R&D Expenses (QREs)

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What Information is needed?

Texas QREs for Prior 3 Years

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Credit Carryforward:

20 Years

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The Texas tax credit equals:

• 5% of the excess amount of QRETs in the current reporting period over the base amount (half of the average of the three preceding taxable years QRETs). If there are no qualified research expenses in one or more of the three preceding tax years, the credit equals 2.5% of all qualified research expenses incurred in the current year.
• If a company contracts with colleges or universities to conduct R&D activities in Texas, the credit for the report period equals 6.25% of excess amount of QRETs in the current period over the base amount (half of the average of the three preceding taxable years QRETs). If there are no QRETs in the prior 3-year period on which the report is based, the credit equals 3.125% of all qualified research expenses incurred in the current period.
• Only 50% of the franchise tax credit due for a single period can be offset, however the Texas R&D credit can be carried forward for 20 years, if needed.

Specific State Tax Items to Note:

• Depreciable tangible personal property is defined as: 1) property that has a useful life of more than one year and 2) is subject to depreciation under either generally accepted accounting principles (GAAP) or Internal Revenue Code Sections 167 or 168. For federal income tax purposes, a depreciation deduction is a reasonable allowance for the exhaustion, wear and tear, and, obsolescence of certain business-related or income-producing property. For the purpose of the sales tax exemption, the depreciable item must be directly used in qualified research activities (QRAs).
• Registrants claiming the sales tax exemption must file an Annual Information Report (AIR) with the Comptroller's office on or before March 31st each calendar year in which they claimed the sales tax exemption to avoid cancellation of the registration. The AIR allows registrants to renew their registration number and report required information about the amount of qualified research they performed in Texas, the number of employees engaged in research and development (R&D) in Texas, and data regarding sales tax revenue.
• A retailer is not required to accept any sales tax exemption certificate. The purchaser can request a refund of the tax directly from the Comptroller if the retailer gives the purchaser Form 00-985, Assignment of Right to Refund.