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 qualified 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, so it 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, serves as a powerful tool to incentivize and support business innovation within the state. It operates alongside the federal research credit that is 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, not every company automatically qualifies. 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 in nature. While this seems vague, it ensures the program supports activities contributing to advancements in science, engineering, and computer science 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 type of 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 as part of 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 or more cost-saving or an improved technology used within the business. However, this wouldn’t include troubleshooting existing problems without 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 there is not a 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 make the cost of manufacturing less, and the properties of new materials that you may want to include within future products.
Experimentation
Because innovation requires a level of 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 this one of the most integral part of preserving the purpose of the credit, according to the Internal Revenue Code.
Qualified research expenses can include looking at multiple approaches to solve 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 of a product, 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’re looking to claim the significant financial benefit that 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 a bit intricate and less accessible for businesses that are 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 companies that are new, this can be challenging due to the fluctuating nature of your 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 basic research payments.
This method is best for established companies with consistent research expenses that can benefit from the 15% credit on these Massachusetts basic research payments, but the simplified credit method is often used due to the complexity of calculating the fixed base ratio.
Simplified Credit Method
This is a more user-friendly option that calculates the credit based on the average qualified research expenses over the preceding three taxable years. This straightforward approach tends to be used more often and is recommended for businesses that are new to claiming this reduction in corporate excise liability.
The base amount of the credit is a percentage of the average Qualified Research Expenses from the preceding three taxable years. The exact percentage is dependent on the company’s size and tax filing status, ranging from 6% to 10%. This approach smooths out the massive fluctuations in research expenses that are common in companies that are 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 basic research payments. If you’re unsure of the correct way to implement this formula, 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 greater impact on encouraging smaller-scale research projects while offering benefits to larger companies.
There’s an additional safeguard in place: a minimum tax threshold of $456. Regardless of the amount a company qualifies for, they must still pay at least this minimum amount. This ensures the state receives a base level of tax revenue and prevents companies from completely eliminating their tax obligations through the R&D credit.
Overall, the limitations on the credit 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 still gets paid. Regardless of the amount of credit a company qualifies for, they must still pay at least this minimum amount. This ensures the state receives a base level of tax revenue and prevents companies from completely 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. This system is further enhanced by a two-tiered approach:
- Credits exceeding the 75% limitation on tax liability above $25,000 have a standard 15-year carryforward period. This provides companies with 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. This essentially allows 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. Unlike some other tax credits, companies cannot sell or transfer their unused credit to another entity.
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, which can include anything from scientists and engineers to designers involved in the development of new products or processes.
When applying for the wage portion of qualified research expenses, some key things to consider are the role of the employee, 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 specifically from research will be able to be claimed. Similarly, supervision and management won’t generally claim their wages due to the administrative nature of their job. It’s always important to have a tax professional on hand to differentiate which wages can be claimed on your research credit.
Another important part of claiming wages is to always have proper documentation on hand in case of any discrepancies. Make sure to supplement 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 important to include supplies that you may have bought in order to facilitate your research to 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 that are directly consumed or used up during your research activities. This 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 specifically used for research, meaning that office supplies or other expenses for the business may not count unless they are used exclusively for research.
This is another expense that it is important to keep proper records for, so make sure that you stock up on invoices, purchase orders, and documentation that links 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 that is 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
- Certain 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 major 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, but 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 can qualify, the criteria for claiming expenses, and other essential details. However, it is always best to hire a tax professional to ensure you fully comply with the guidelines. They will make sure to carefully assess your R&D activities to ensure that they meet the program’s four specified criteria.
The tax credit is then claimed using the schedule RC, which is attached to your annual corporate tax return supplied by the State of Massachusetts. Carefully fill out the required information using the documentation that you’ve gathered, and the form will walk you through the steps of calculating your research credit for the year and for the past three years if necessary.
Next Steps
Massachusetts companies that are engaging in research can significantly reduce their corporate tax excise liability by taking advantage of research and development programs offered by the state. If you’re looking to fill out your schedule RC with expert help, look no further!
TaxCredits has a CPA consultation that specializes in research and development credits that will assist you in ensuring that you maximize 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 completely 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 entirely eliminating your liability.
What is the percentage of the Massachusetts R&D credit?
This entirely depends on the method of calculation that you use. Using the traditional method, you wouldn’t have a fixed percentage, which is why many opt for the simplified method. Using the simplified method, you can expect 6% for startups and C Corporations and 10% for most S Corporations.
How to 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. There is a three-year statute of limitations for filing amended tax returns to claim the credit.