Introduction
The Texas Research & Development (R&D) Tax Credit offers businesses an opportunity to reduce their tax liability by investing in innovation, product development, and technological advancements. This incentive helps companies lower their franchise tax or qualify for a sales tax exemption on R&D-related purchases.
This guide explains who qualifies, how to calculate the credit, and the steps to claim it.
1. What Is the Texas R&D Tax Credit?
The Texas R&D Tax Credit provides two types of tax benefits:
- Franchise Tax Credit – Businesses can offset their Texas Franchise Tax based on qualified R&D expenses.
- Sales Tax Exemption – Companies can avoid paying sales tax on qualifying R&D equipment and software purchases.
Who Qualifies for the Texas R&D Tax Credit?
Businesses that:
- Perform qualified research and development activities in Texas.
- Engage in new product development, software creation, or engineering improvements.
- Meet the requirements under Section 41 of the Internal Revenue Code (IRC) for R&D.
What Activities Qualify for the R&D Tax Credit?
To qualify, research must meet the IRS’s Four-Part Test:
- Permitted Purpose – Research must aim to develop or improve a product, process, or software.
- Elimination of Uncertainty – The research must address scientific or technical uncertainty.
- Process of Experimentation – The research must involve testing, modeling, or simulations.
- Technological in Nature – The research must rely on engineering, biology, chemistry, or computer science.
What Expenses Can Be Claimed?
- Wages paid to employees performing R&D activities.
- Supplies and materials used in research.
- Contract research expenses (if performed within Texas).
- Cloud computing and software costs related to R&D.
How to Calculate the Texas R&D Tax Credit
The Texas R&D tax credit is calculated as a percentage of qualified research expenses (QREs).
| Tax Credit Type | Credit Rate | Carryforward Period |
|---|---|---|
| Franchise Tax Credit | Up to 6.25% of eligible R&D expenses | 20 years |
| Sales Tax Exemption | 100% sales tax exemption on R&D purchases | N/A |
Example Calculation
- A company spends $1 million on qualified research expenses.
- They qualify for a 6.25% tax credit.
- Total tax savings = $62,500 off their franchise tax liability.
How to Claim the Texas R&D Tax Credit
Step 1: Identify Qualified R&D Expenses
- Review wages, supplies, and contract research costs.
- Ensure expenses align with IRS Section 41 guidelines.
Step 2: Complete the Required Forms
- Texas Franchise Tax Report (Form 05-158 or 05-169).
- Texas R&D Activities Schedule (Form AP-234) for franchise tax credit.
- Texas Sales Tax Exemption Form for sales tax benefits.
Step 3: File with the Texas Comptroller
- Submit forms online through the Texas Comptroller’s eSystems portal.
- Attach supporting financial and technical documentation.
Step 4: Maintain Records for Audit Protection
- Keep detailed documentation of R&D projects, payroll records, and expense reports.
- Maintain records for at least four years in case of an audit.
Common Mistakes to Avoid When Claiming the R&D Tax Credit
- Failing to meet the Four-Part Test – Research must be technological and experimental.
- Not keeping proper documentation – The IRS and Texas Comptroller require detailed records.
- Missing the filing deadline – The credit must be claimed on the Texas Franchise Tax Report each year.
How the Texas R&D Tax Credit Compares to the Federal R&D Credit
| Credit Type | Texas R&D Tax Credit | Federal R&D Tax Credit |
|---|---|---|
| Who Qualifies? | Texas-based R&D activities | U.S.-based R&D activities |
| Tax Reduction | Franchise Tax & Sales Tax | Federal Income Tax |
| Credit Rate | Up to 6.25% | 6% – 20% |
| Carryforward Period | 20 years | 20 years |
Should You Work with a CPA for R&D Tax Credit Claims?
A CPA can help:
- Identify all qualifying R&D expenses.
- Ensure compliance with IRS and Texas Comptroller rules.
- Maximize credits and reduce franchise tax liability.
Conclusion
The Texas R&D Tax Credit provides businesses with significant tax savings through franchise tax credits and sales tax exemptions. Companies engaged in innovation, product development, and software engineering should take full advantage of this opportunity.
For expert tax credit assistance, schedule a meeting with our CPA Anshul Goyal by clicking at https://calendly.com/anshulcpa/ now.
Frequently Asked Questions (FAQs)
1. Who qualifies for the Texas R&D Tax Credit?
Businesses engaged in product development, engineering, software innovation, and scientific research may qualify.
2. What expenses are eligible for the Texas R&D credit?
Qualified expenses include wages, materials, contract research, and software costs.
3. Can I claim both the Texas and federal R&D tax credit?
Yes, businesses can claim both credits if they meet the eligibility criteria.
4. How much can I save with the Texas R&D Tax Credit?
Businesses can reduce up to 6.25% of their franchise tax liability or receive a sales tax exemption on R&D purchases.
5. What happens if I fail to file properly?
Businesses that fail to file correctly may lose the credit and face penalties from the Texas Comptroller.