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Federal and State Research and Development Tax CreditsCGCPAJust

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Federal and State Research and Development Tax Credits

Just to make sure I understand all the specifics with the state and federal research and development/experimentation tax credits, so I submit some examples to you. I will submit each scenario as a separate question as you experts may determine that they are quite different. When googling for r & d tax credit, the first US state that comes up with specifics is arizona, so we'll use that. It specifies a 24% credit above excess QREs...

Scenario 1:
A genius research scientist form a lab (S-Corp) in Arizona (in 2013) looking for the cure to all illnesses. He is the sole owner of the S-Corp and shares control of the lab with no one. He somehow manages to get contracts with a pharmaceutical, and he will produce $1.2M in revenue over the next year. He will need $200K of lab equipment. Since he controls his own salary, he decides to take $1M in salary, to maximize the research credit (of course he'll pay a bit for this with self-employment taxes). The rest of the profits ($0M) will flow through distributed equally (because of the pass-through of the S-Corp). Assuming no other personal deductions, and rounding off numbers for simplicity, let's assume AZ flax tax rate of 4% and fed flat tax rate of %35. All tax rates are personal tax rates (since S-Corp doesn't pay corporate taxes and all credits will pass-through).
Federal Tax = 35% of $1M = $350K
AZ Tax = 4% of $1M = $40K

Computation of the Federal R&E (Research and Experimentation) tax credit
The salary and equipment all qualify as research expenditures. This makes research expenditures to be equal to $1.2M. Also note: I've read that since this is the first year and there is no historical research expenditures to form a base amount, the QRE has a flat credit rate of 6%.
Federal R&E tax credit =
0.06 * $1.2M = $72K

Arizona R&D tax credit (requires regular research credit calculation) =
Current year's QREs will be: $1.2M
Initial Fixed Base Percentage will be 3%
Lesser or FBP or 16% = 3%
Multiplied by avg. annual gross receipts = Base Amount of $36K
Greater of base amount or %50 of current QRE = $600K
Excess of current QRE = $564K
Arizona tax credit for 2013 = 24% of excess QRE = ~$135K
Arizona tax credit refund (up to 75% of excess) = ($135K - $40K) * 0.75 = $67.5K

First of all, please correct me where I may have computed some of these things wrong.
The federal tax credit makes a little sense to me, since the tax rate is so high. However the state tax credit (for any research heavy organization) will likely wipe-out all state tax liability (if I have the computation right). Furthermore, the newer Arizona tax credit refund is where I truely believe I may be misunderstanding something. Is AZ really refunding up to $67.5K? If no equipment is needed, it seems like this program will subsidize the income of this genius... Perhaps I have something wrong here...I just want to make sure I have a solid grasp of these programs.

Hi, I am a moderator for this topic. I sent your requested Professional, CGCPA a message to follow up with you here, when they are back online. If I can help further, please let me know. Thank you for your continued patience.


Customer: replied 4 years ago.

Yes, I would like to wait for an answer. Perhaps during the week, CGCPA will have time to answer.




Thank you for your continued patience.

Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

I see a few minor points in your work up:

The net income will be ($1.2M less equipment of $200k, less salary of $1M less payroll taxes ) If we assume for sake of simplicity that the payroll taxes and payroll will combine to $1M) then the net taxable income will be zero. The tax credit for R&D expenditures will be as you calculated but will carry through to the following year. To make them usable in the current year there would need to be a net income.

If you alter the amounts to achieve this then your analysis appears correct. The tax credits for R&D will pass through to the shareholder via Schedule K-1.

Customer: replied 4 years ago.

Is this true as long as there is ANY net income? Can I alter the amounts to make the net income $1? Would the rest of my analysis be correct then?


Thanks for your help!

Yes to all of the items.

Category: Tax
Satisfied Customers: 3820
Experience: over 40 years experience in tax matters
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