Research and development (R&D) tax credits are available to companies that bear the financial risk of developing new or improved products or processes. And claiming them can be lucrative, since they offset a company’s tax liability, making more cash available to invest in ongoing projects. Companies that perform qualified R&D and meet certain requirements can claim a 20 percent tax credit at the federal level, and many states offer their own R&D tax credit, usually at a rate of five to 10 percent. But both federal and state levels considered, Arizona takes the cake, offering companies that perform R&D the most generous tax credit rate in the nation at 24 percent. Furthermore, it offers this benefit in the form of a refundable credit to qualifying businesses.
Why refundable matters
In some cases companies may not be able to use the full amount of the credit Arizona awards them. This could be because they’re operating at a loss or because the amount they’re awarded exceeds their Arizona tax liability. With the refundable credit option, qualifying businesses may elect to receive the excess in the form of an immediate cash payment rather than carry it forward to offset a future liability. The refundable opportunity is limited to companies with fewer than 150 full-time-equivalent employees; the nonrefundable credit has no such limit.
While Arizona places no annual cap on nonrefundable R&D credit claims, the total amount of refunded payments allowed each year is limited to $5 million, so timing is critical if your company hopes to claim the refundable credit. Funds are allocated on a first-come, first-served basis until the $5 million is exhausted. For the 2013 tax year, the refundable option was depleted by the end of February. It’s uncertain how quickly this reserve will go for the 2014 tax year.
Eligible refundable credit applicants must obtain pre-approval by submitting an application prior to filing their tax return, and a full R&D credit calculation needs to be submitted with this application. You’ll need to begin an R&D study immediately to allow for its timely completion and submission.
Who can claim the credit?
Both the refundable and nonrefundable Arizona credits are available to individuals, companies, and all types of pass-through entities, such as S corporations. You may be surprised to learn that the tax definition of R&D is quite expansive: A wide range of businesses can qualify for the credit, from companies in the food and beverage, apparel, and agriculture industries to those involved in construction, manufacturing, and energy production. Don’t let the common misconception that R&D tax credits are limited to large high-tech companies keep you from taking advantage of this lucrative opportunity.
Whether you’re interested in pursuing the refundable or nonrefundable Arizona credit, consult a team dedicated to understanding the technical requirements of the R&D credit—including Arizona’s particular requirements — to help you navigate the process.
Peter Henderson is manager and Tom Sanger is partner at Moss Adams LLP.