Research and Development Tax Credits in the Lone Star State

Texas implements regulations for the exemption of Sales and Use taxes on research and development (R&D) and introduces rules for franchise tax credits.

Texas offers a Research and Development (R&D) Credit to encourage investments in the state, extending benefits to both qualified small businesses and larger, well-established companies. Enacted in 2014, businesses can apply for Texas Research and Development credits in one of two methods:

As an exemption from Sales and Use Tax, it applies to the acquisition, rental, storage, or lease of depreciable tangible personal property utilized within the state of Texas.
A franchise tax credit determined by eligible research expenditures.

An individual cannot simultaneously utilize both the sales tax exemption and the franchise tax credit for an identical timeframe. Choosing the sales tax exemption or franchise tax credit isn’t permanent; it can be changed later if needed.

FRANCHISE TAX CREDIT

Research and Development credits in Texas, calculated for the Current tax year, are implemented in the Franchise Tax Report in the following year. Consequently, R&D tax credits determined from 2022 expenses will be employed in the 2023 Franchise Tax filing. Should a company choose to apply the credits to the Franchise Tax Credit, the credit amount equals 5% or 6.5% of the difference between:

The eligible research expenditures accrued in Texas (QRETs) during the period upon which the report is founded; and
50% of the average sum of QRETs over the three tax periods directly preceding the period upon which the report is founded.

If a taxable entity lacks qualified research expenses in Texas for one or more of the three prior tax periods, the credit for that period equals 2.5% of the qualified research expenses in Texas during that specific period.

Factors to be taken into account when seeking credit:

The credit is capped at 50% of the franchise tax amount before the application of any other applicable tax credits. This credit is eligible for carryforward for 20 consecutive reports. The order of consideration for credits is as follows:

R&D credit carryforward generated before January 1, 2008.
R&D credit carryforward under H.B. 800.
Current-year R&D credit.

The R&D credit can’t be transferred unless all assets of the taxable entity are conveyed in a single transaction. The R&D credit can’t be transferred unless all assets of the taxable entity are conveyed in a single transaction. Also, the taxpayer needs to include the credit application in the tax report for the relevant claiming period.

The credit is requested through a Long Form Franchise Tax Report (forms 05-158-A and 05-158-B) along with a credit summary, Schedule (form 05-160), and a Research and Development Activities Credits Schedule (form 05-178). Alternatively, the forms can be electronically submitted through the Texas Comptroller’s portal.

SALES AND USE TAX EXEMPTION

The sales/use tax exemption, which commenced on January 1, 2014, is set to conclude on December 31, 2026. This exemption applies to depreciable property used exclusively in “qualified research” by an actively involved individual, but it’s unavailable if the taxpayer (or another group member) claims an R&D credit on their franchise tax return for the same period.

Before availing the exemption on qualifying purchases, taxpayers must register with the Comptroller’s office. Registration can be done through the Comptroller’s online registration system or by submitting Form AP-234. Texas Registration for Qualified R&D Sales Tax Exemption. Following registration, the Comptroller will issue a Texas Qualified Research Registration Number (“Registration Number”) to the taxpayer. To claim the exemption, taxpayers must provide the retailer with a Texas Q&R Sales and Use Tax Exemption Certificate (Form 01-931). An Annual Information Report must be filed with the Comptroller’s office by March 31 of the year immediately following the calendar year in which the exemption was claimed.

The calculation of credits for a taxpayer opting to use the R&D credit towards sales and use tax is performed in the same manner—specifically, as 5% or 6.5% of the excess (Qualified Research Expenses) QREs over the preceding three-year.. To initiate this process, the taxpayer needs to apply online for a Registration Number and fill out Form 01-931 (Texas Qualified Research Sales and Use Tax Exemption Certificate). Subsequently, this certificate is presented during the acquisition of qualifying items.

Steps to be taken for claiming Sales Tax Exemption:

For R&D credit claims, switching to a sales tax exemption requires specific procedural steps by the taxpayer.

(1) File an updated tax report without claiming the credit and resolve any outstanding tax, penalties, or interest dues.

(2) Request a Registration Number; and

(3) Apply to a sale and use tax refund.

Texas not only values innovation but actively encourages and rewards it through R&D Franchise Tax Credits. As businesses engage in groundbreaking R&D activities, the available tax credits catalyze progress, fostering a dynamic environment where creativity thrives.

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The information provided in this content is for general informational purposes only. You should always seek the advice of an expert before making any decisions based on the information provided. We do not warrant or guarantee the accuracy, completeness, or usefulness of the information provided. Any reliance you place on such information is strictly at your own risk. We are not responsible for any damages, losses, or expenses related to the use of this content.

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