The Research and Development (R&D) tax credit is a federal tax incentive that rewards taxpayers for increasing investment in US-based research activities. The R&D tax credit is available to businesses that develop new, improved or technologically advanced products, processes, principles, methodologies or materials. In addition to this, the R&D tax credit may also be available to companies that invest time, money and resources toward improving their products and processes. The R&D tax credit was introduced in 1981 to encourage businesses to invest in innovation. It is calculated based on the wages of the employees performing the qualifying activities, making it the most valuable and permanent tax incentive available to US companies. Companies may claim the R&D tax credit for both current and prior tax years, so documenting their R&D activities can help them increase eligibility in both situations. Also, it may be claimed at the federal and state levels. This blog on the Ohio R&D Tax Credit is part of a blog series covering different states to help taxpayers understand the different elements necessary for claiming the R&D tax credit in their jurisdictions.
Ohio R&D Tax Credit
In 2008, the state of Ohio’s R&D Investment Tax Credit was established for qualified research expenses (QRE) to encourage this state’s companies to increase investments in R&D activities. The tax credit can be taken to offset the Commercial Activity Tax (CAT) liability, thus enabling innovative businesses to continue working on long-term R&D projects.
Ohio’s R&D Investment Tax Credit is a non-refundable tax credit that equals 7% of the amount of qualified expenses in excess of the taxpayer’s average investment over the three preceding taxable years. To qualify, the taxpaying company must invest in QREs as defined in Section 41 of the Internal Revenue Code (IRC). Eligible costs may include employee wages, consumable supplies and contract research expenses. Also, any unused portion of Ohio’s R&D Investment Tax Credit may be carried forward for up to seven years.
To qualify for Ohio’s R&D Investment Tax Credit, research activity must meet the IRS four-part test requirements, including the following criteria:
- New or improved products, processes or software;
- Technological in nature;
- Elimination of uncertainty; and
- Process of experimentation.
There is no special application or approval process for Ohio’s R&D Investment Tax Credit. Using the federal definition to determine QREs, businesses should calculate their credit based on 7% of the excess of their current year expenditures over their average expenditures on R&D for the three prior tax years.
Reporting CAT Activity
Reporting Ohio’s R&D Investment Tax Credit generally occurs on a quarterly basis with all CAT activity. Because of this, a company must either report quarterly activity contemporaneously or must complete the CAT Credit Report in the following way:
- In whichever quarter Ohio’s R&D Investment Tax Credit is to be filed, the CAT Credit Report should be completed with zero credit earned during the credit reporting period and with all credit for the year being reported as credit claim during the reporting period; and
- A supporting schedule should be attached to the CAT Credit Report, which in turn should be attached to the quarterly CAT return.
Taking Advantage of Invaluable R&D Tax Credits
Since its introduction, the R&D tax credit has been one of the most significant incentives used by American business owners given that it provides an immediate source of cash, creates a significant reduction of current and future years’ federal and state tax liabilities and can be carried forward up to 20 years. Furthermore, it is an actual dollar-for-dollar credit against taxes owed or taxes paid and in addition to the federal R&D tax credit, there are many state R&D tax credits available, such as Ohio’s R&D Investment Tax Credit. Yet, many businesses may still be unaware that R&D tax credit eligibility extends beyond product development to include activities such as the latest manufacturing methods, software development and quality improvements. Even start-up companies may be able to utilize the R&D tax credit against their payroll tax for up to five years.
To prevent overlooking this source of money due to a lack of the time, resources or expertise needed to identify and manage R&D tax credit claims, businesses can outsource the entire process and rely on proper software solutions. This way, they can streamline capturing of the R&D tax credit in the most accurate and IRS–defensible way with a customized mix of technology and experts specializing in tax credits.