How the Texas R&D Tax Credit Will Work and What it Means for Texas Businesses

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According to SourceHOV | Tax, reinstating the state R&D tax credit is a win for Texas businesses, but it's important to understand the nuances.

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R&D activities bring in high-paying jobs and higher skilled employees, and innovation creates a stronger economic value to communities.

SourceHOV | Tax recently reported that the House and the Senate signed HB 800 reintroducing the research and development tax credit for Texas businesses. But what does the bill really mean to Texas state businesses? Below is a synopsis of HB 800 and some of the nuances behind it.

The intent of HB 800

Texas’s economic activity accounts for more than 8% of US economic activity, but only 5% of R&D spend in the US. R&D activities bring in high-paying jobs and higher skilled employees, and innovation creates a stronger economic value to communities. Passing HB 800, is an effort by the state to be more economically competitive, reduce the tax burden on R&D expenditures, promote high-paying jobs and incentivize innovation in the state’s manufacturing sector.

The bill, which will only apply to research activities and related expenditures incurred within Texas, will allow businesses the option of taking either a sales tax exemption or a franchise tax credit related to qualified activities.

Sales Tax Exemption

The bill will provide for a sales and use tax exemption on certain property used in research and development activities. Specifically, the sale, storage, or use of depreciable tangible personal property directly used in qualified research is exempted from sales and use tax if the property is sold, leased or rented to, or stored or used by a person who is engaged in qualified research.

Depreciable tangible personal property is property that has a useful life exceeding one year and is subject to depreciation under GAAP or Section 167/168 of the Internal Revenue Code.

As noted above, if a company elects to exempt property from sales and use tax under this provision, they are precluded from taking the franchise tax credit discussed below.

Franchise Tax Credit

When enacted the bill would allow companies performing qualified activities within the state of Texas to claim a credit against the cost of these activities. The credit follows the same definitions for qualified research expenses as the federal credit except that those activities must be performed within the state of Texas.

The credit is also calculated similar to the federal alternative simplified credit in that a company generates a credit on the amount of research expenses over a base amount, with the base amount being 50% of the average of the three prior years’ research expenses.

The credit amounts are 5% for companies who have research expenses in the three prior years and 2.5% for companies that do not have research expenses in each of the three prior years. There is also a credit for research expenses paid to a higher education institution for the performance of research. These credit percentages are 6.25% if a company has three prior years of research expenses and 3.125% if they do not.

The total credit claimed for any year may not exceed 50% of the amount of franchise tax due. Any unused credits may carry forward for 20 consecutive years.

A few last points to keep in mind

While Texas failed to make these incentives permanent, they are available through December 31, 2026. With the expected passage of this bill, the time to evaluate how it will impact your company is right around the corner. The franchise tax credit has to be applied for on or with the tax report for which the credit is claimed. Therefore, an assessment of the benefits of the sales and use tax exemption versus the franchise tax credit will need to be made.

The Texas state R&D tax credit provides a great opportunity to businesses to continue to grow and stay at the forefront of innovation. This program is valuable, but does require the assistance of experts to properly assess the benefits of each incentive to maximize the value to your company.

SourceHOV |Tax is a national leader in Research & Development tax credit consulting services. For more than 30 years, SourceHOV | Tax has helped companies properly identify and sustain tax incentive strategies for its clients, including R&D tax credits, cost segregation studies, 179D tax deductions and LIFO inventory accounting. For more information, please call 800-806-7626 or refer to our R&D white paper.

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Laura Kushner
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