Pennsylvania recently enacted significant changes to its research and development credit that permit businesses that could not previously take advantage of the credit to convert the credit to cash. These changes are particularly important to small and medium-sized businesses and to start-ups that may not have been able to use the credit in the past.
Since 1997, Pennsylvania has granted a tax credit for businesses that incur expenses for qualified research and development activities that are performed within Pennsylvania. The amount of the credit is equal to 10 percent of the increase in the business’s research and development activities over a base period.
The tax credit may be applied against the corporate net income tax and the capital/stock franchise tax. Additionally, if the business is an S corporation or partnership, the credit flows through to the owners so that the individual shareholders or partners in the S corporation or in the partnership may apply the credit against their personal income tax liability.
In prior years, the aggregate amount of research and development credits that could be claimed by all businesses in Pennsylvania was $15 million. Of that amount, $3 million was set aside for small business. The credit could not exceed more than 50 percent of a tax liability, but unused credits could be carried forward and applied against future tax liability for 15 years.
An application for the credit has to be made by Sept. 15 of the following tax year. For example, an application for a credit arising from activities in 2004 must be made no later than Sept. 15, 2005.
In 2003, Gov. Edward Rendell proposed changes broadening the benefits of the research and development credits. In December 2003, the law was amended to provide the following significant changes that particularly benefit small businesses, as well as those businesses that were not in a position to use the credit.
Start-up businesses are a beneficiary of these changes because they often do not have a sufficient tax liability to use the credits.
* The amount of credits for a year, beginning in 2004, has been increased from $15 million to $30 million, of which $6 million will be allocated exclusively for small business.
* The 50 percent limitation on the use of the credits has been repealed effective in 2005. Accordingly, taxpayers will be able to apply the full amount of the credit to any one qualified tax liability.
Many start-up businesses were unable to take advantage of the research and development credit because they had yet to generate a significant Pennsylvania tax liability. To provide an incentive for research and development activities and as an aid to start-ups, taxpayers may now sell any portion of a research and development credit that was awarded after Dec. 31, 2002.
There are two important rules that a potential buyer of a credit should keep in mind. First, a buyer can only apply a credit against 75 percent of its tax liability for the tax year. Second, the buyer must use the credit in the tax year in which it is bought. It can not be carried back, forward or refunded.
Jeffrey S. Blum is a shareholder with Buchanan Ingersoll PC, and has 30 years of experience handling Pennsylvania state and local tax controversies, real estate tax appeals and state and local tax planning matters. Reach him at (412) 562-8940 or [email protected]