Massachusetts R&D Tax Credit: Eligibility, Benefits, Claiming

Massachusetts, a state rife with research and a hub for groundbreaking advancements, is seeking to reward businesses that conduct qualified research. This program offers a significant financial incentive through tax credits to ensure that research is more accessible for businesses and corporations by giving credits for skilled services.

Claiming the Massachusetts research credit doesn’t have to be complicated! Here, we will look at the qualified research expenses you can claim on your research credit, eligibility criteria, ways to calculate your federal credit, and more!

What are the Massachusetts R&D Tax Credits?

The state of Massachusetts recognizes the importance of research activity conducted by businesses within the state and wants to reward them for their innovation. Providing a tax break for businesses that invest in qualified research activity translates into real financial advantages for companies, allowing them to deduct a portion of their qualified expenses from their corporate excise liability.

The Massachusetts R&D Tax Credit Program, under 830 CMR 63.38M.1, is a powerful tool to incentivize and support business innovation within the state. It operates alongside the federal research credit established by Section 41 of the Internal Revenue Code, offering a complementary layer of financial benefits.

Does Massachusetts have an R&D Credit?

The specific program that this research credit falls under is regulation 830 CMR 63.38M.1. This incentivizes businesses to write off expenses, including wages paid to qualified employees, contract research expenses, and general expenses for your research facility.

This program was created in the 1980s to mirror some of the popular federal credit programs of the time. This state version was meant to benefit companies that settled within Massachusetts.

Eligibility Criteria for Massachusetts Businesses

While the R&D Tax Credit program offers enticing financial benefits, only some companies automatically qualify. There is a four-part test to ensure that the activities fall within the bounds of what the research credit covers.

Technological in Nature

This research credit requires activities that are covered to be technological. While this seems vague, it ensures the program supports activities contributing to science, engineering, and computer science advancements over time.

The core principles of this criteria include that it must have a reliance on scientific or technological knowledge, meaning the application of an already proven knowledge or process wouldn’t qualify to give you a reduction in your corporate excise liability. It also must be innovative, meaning that doing routine things wouldn’t fall under this credit. Specifically, designing a new battery or software program would fall under this program, but routine quality control testing wouldn’t.

Permitted Purpose

This Massachusetts research credit also includes permitted purposes for reducing corporate excise tax liability. Permitted purpose means that your research must focus on improvement rather than simply being able to write off routine business practices.

This component can be a new or existing product innovation. This process is used in manufacturing to make the process faster, more cost-saving, or an improved technology used within the business. However, this would only include troubleshooting existing problems while focusing on broader improvement or research for marketing purposes.

Eliminating Uncertainty

This criterion focuses on the uncertainty surrounding developing or improving a business component through your research and development activities. Your qualified research expenses should be to eliminate this uncertainty by addressing genuine technological or scientific challenges.

This means that your research credit can be used to address technical challenges, information gaps, or other challenges for which there is no current solution within your area. This can include the best approach to achieve a specific outcome for businesses in your field, the feasibility of different design processes that may reduce the cost of manufacturing, and the properties of new materials that you may want to include in future products.

Experimentation

Because innovation requires experimentation, this criterion ensures that the tax credit supports activities that involve a trial-and-error approach to solving pressing technical issues. Experimentation is also a key part of the scientific process, making it one of the most integral parts of preserving the purpose of the credit, according to the Internal Revenue Code.

Qualified research expenses can include examining multiple approaches to solving a technical issue, gathering data from each trial or test to evaluate effectiveness, or learning from failed attempts. For example, building and testing different prototypes of a new product to determine the optimal design, conducting simulations, running trials, and experimenting with algorithms.

If you’re wondering whether or not your activities count as experimentation, consulting with a tax adviser can help you identify which tax credits you’re eligible for.

Calculating the Massachusetts R&D Tax Credit

Calculating the actual amount can seem daunting if you want to claim the significant financial benefit these tax credits offer. Here is a breakdown of the different methods involved:

Regular Method

This method relies on a fixed base amount determined using data from the company’s early years and the 1980s. It can be intricate and less accessible for businesses looking to reduce their corporate excise liability for the first time.

The core of this calculation is a fixed base ratio, which is a percentage determined using a combination of the company’s qualified research expenses from its early years and a fixed percentage tied to research expenses to gross receipts for a five-year period. For new companies, this can be challenging due to the fluctuating nature of their qualified research expenses.

Once you have this ratio, the credit is calculated by taking your qualified expenses for the current year, subtracting this base amount, multiplying it by 10%, and then adding 15% of your Massachusetts essential research payments.

This method is best for established companies with consistent research expenses that can benefit from the 15% credit on these Massachusetts essential research payments. Still, the simplified credit method is often used due to the complexity of calculating the fixed base ratio.

Simplified Credit Method

This more user-friendly option calculates the credit based on the average qualified research expenses over the preceding three taxable years. This straightforward approach is often used and recommended for businesses new to claiming this reduction in corporate excise liability.

The base credit amount is a percentage of the average Qualified Research Expenses from the preceding three taxable years. Depending on the company’s size and tax filing status, the exact percentage ranges from 6% to 10%. This approach smooths out the massive fluctuations in research expenses common in companies beginning to invest in research.

This method is then calculated by taking your excess research expenses and multiplying them by your credit percentage, adding 5% of your essential research payments. If you need help implementing this formula correctly, consult with a tax advisor as soon as possible.

Massachusetts R and D Tax Credit Limitations

The Massachusetts R&D tax credit provides a valuable incentive for companies conducting qualified research and development activities within the state. However, there are limitations to ensuring the credit doesn’t eliminate a company’s tax burden.

The first limitation applies to a tiered system to the credit amount. Companies can claim the credit for 100% of their first $25,000 in corporate excise tax liability. This offers significant relief for smaller companies or those with lower tax bills.

The credit’s effectiveness is reduced for any amount exceeding $25,000. Companies can only offset 75% of their remaining tax liability with the credit. This ensures the credit has a more significant impact on encouraging smaller-scale research projects while offering benefits to larger companies.

An additional safeguard is a minimum tax threshold of $456. Regardless of the amount a company qualifies for, it must still pay at least this minimum amount. This ensures the state receives a base level of tax revenue and prevents companies from eliminating their tax obligations through the R&D credit.

Overall, the credit’s limitations create a balanced system that incentivizes research and development while maintaining tax collection for the state.

Selling & Carryforwarding the Massachusetts R&D Tax Credit

There’s a two-pronged approach to limiting the credit amount itself. Companies can only offset a specific percentage of their corporate excise tax liability. They can claim 100% of the credit for the first $25,000, offering significant relief for smaller companies or those with lower tax bills. The effectiveness of the credit is reduced for any amount exceeding $25,000, with companies only able to offset 75% of their remaining tax liability.

A minimum tax threshold of $456 safeguards against the credit, eliminating a company’s tax burden and ensuring that the state tax is still paid. Regardless of the amount of credit a company qualifies for, it must still pay at least this minimum amount. This ensures the state receives a base level of tax revenue and prevents companies from eliminating their tax obligations through the R&D credit.

Companies don’t lose out on any unused credit they generate. A carryforward system allows them to be applied to future tax liabilities, maximizing the benefit of their R&D activities. A two-tiered approach further enhances this system:

• Credits exceeding the 75% limitation on tax liability above $25,000 have a standard 15-year carryforward period. This provides companies ample time to utilize the credit in subsequent tax years.
• Credits that are not allowed because they would reduce the tax liability below the $456 minimum threshold receive an even more generous benefit. These credits can be carried forward indefinitely, essentially allowing companies to use them whenever they have sufficient tax liability to absorb the credit without violating the minimum tax requirement.

It’s important to note that the state tax credit is not transferable. Companies cannot sell or transfer unused credits to another entity, unlike other tax credits.

Massachusetts Qualifying Research Expidentures

If you’re looking for what counts as qualified research expenses under this act, there are three main categories that they can fall into:

Wages

This program allows you to deduct a portion of wages paid to employees involved in R&D activities, including scientists, engineers, and designers who develop new products or processes.

When applying for the wage portion of qualified research expenses, some key things to consider are the employee’s role, supervision, management, and documentation.

If an employee’s time is split between research and other nonqualifying activities, only the portion of their wages that came explicitly from research can be claimed. Similarly, supervision and management will only sometimes claim their wages due to the administrative nature of their job. Having a tax professional on hand is always important to differentiate which wages can be claimed on your research credit.

Another vital part of claiming wages is always having proper documentation in case of discrepancies. Complement your current records with project descriptions, lab notebooks, or other documentation that strengthens the connection between wages paid and research activities.

Supplies

This tax credit falls under more than just brainpower! Having physical supplies is necessary for almost every lab. When looking at in-house research expenses, it’s essential to include supplies you may have bought to facilitate your research and get the most reduction in your corporate excise tax liability possible.

The program specifies that it allows deductions for a portion of the cost of supplies directly consumed or used during research activities. These can include items such as laboratory materials, prototyping materials, software licensing, and technical supplies.

The supplies must be directly used up or consumed during the activity, meaning long-lasting materials such as machinery wouldn’t count under this definition. These materials must also be used explicitly for research, meaning that office supplies or other expenses for the business may only count if they are used exclusively for research.

This is another expense for which proper records are important, so make sure that you stock up on invoices, purchase orders, and documentation linking the supplies to specific projects within your research.

Contracted Research

Contracted research expenses are a category within qualified activities that allow companies to claim credit for a portion of the cost associated with outsourcing your research to qualified institutions. Leveraging this category correctly requires you to research the institutions that you’re outsourcing to, but they generally fall under three categories:

• Universities and colleges with active research programs
• Independent research institutions with a focus on scientific or technological advancement
• Specific government research labs.

The program allows you to claim a portion, generally, 65% of the payments made to these qualified research institutions for R&D activities conducted on your behalf. Ensuring that you have a written agreement with the institution, ownership of any research results, and documentation of the research being done by the institution will allow you to claim this credit without any significant problems.

How to Claim Massachusetts R&D Tax Credits?

The Massachusetts R&D Tax Credit program offers these financial benefits for companies engaged in qualified research activities. Still, there is a well-defined process that you need to follow to claim your credit accurately.

The Massachusetts R&D tax credit program guidelines explain which activities qualify, the criteria for claiming expenses, and other essential details. However, hiring a tax professional to ensure you fully comply with the guidelines is always best. They will carefully assess your R&D activities to ensure they meet the program’s four specified criteria.

The tax credit is then claimed using the schedule RC attached to your annual corporate tax return supplied by the State of Massachusetts. Carefully fill out the required information using the documentation you’ve gathered, and the form will walk you through the steps of calculating your research credit for the year and the past three years if necessary.

Next Steps

Massachusetts companies engaged in research can significantly reduce their corporate tax excise liability by taking advantage of the state’s research and development programs. If you want to fill out your schedule RC with expert help, look no further!

TaxCredits has a CPA consultation that specializes in research and development credits. This consultation will assist you in maximizing your claim while fueling innovation in your sector.

FAQs

What is the tax exemption for R&D in Massachusetts?

While the R&D tax credit doesn’t technically fall under a traditional tax exemption, it does reduce your overall liability to incentivize research and development activities. A tax exemption eliminates the tax liability of a specific expense or income, meaning you would pay no taxes on those expenses. A tax credit operates differently by allowing you to deduct a portion of your qualified expenses from your overall taxable income, reducing but not eliminating your liability.

What is the percentage of the Massachusetts R&D credit?

This entirely depends on the calculation methods you use. The traditional method doesn’t give a fixed percentage, which is why many opt for the simplified procedure. Using the simplified method, you can expect 6% for startups and C Corporations and 10% for most S Corporations.

How do you file for R&D tax credits in Massachusetts?

After consulting with a CPA, you can file for research and development credits to be added to your overall taxes. After following the instructions for the form, you can file it with your taxes, as it will be attached to your annual Massachusetts corporate tax return. A three-year statute of limitations exists for filing amended tax returns to claim the credit.