States Revamp R&D Tax Credit Programs: Key Changes in Iowa, Texas, and Missouri

In addition to the federal R&D Tax Credit, many states also offer R&D tax incentives for work conducted within their borders. Over time, these states have modified the criteria for their respective R&D Tax Credit programs to optimize the incentive for certain taxpayer bases. Certain states recently released program updates with some of the most targeted criteria.

Iowa R&D Tax Credit Changes: New Limitations and Phase-Out of Supplies Expenses

Starting in tax year 2023, Iowa has implemented limitations on the Qualified Research Expenditures (QREs) that are includable in the state R&D Credit calculation. Supplies expenses will be phased out of the Iowa credit calculation over the next five years, with a 20% reduction in the allowable amount each year until the complete phase-out occurs for the tax year 2027.  Additionally, cloud computing expenses cannot be included as Iowa QREs, and the “substantially all” rule is no longer applicable. At the federal level, the “substantially all” rule allows taxpayers to include 100% of an employee’s wages as QREs if that employee spends 80% or more of their time performing qualified research activities.

Iowa is also phasing out the refundable amount of the credit. It requires the use of the Alternative Simplified Credit (ASC) computation if that method was utilized for the federal credit. Finally, there is a strict limitation that amended claims for more significant R&D Credit amounts must be filed within six months of the original return due date, including extensions. This all comes on top of 2017 legislation that specified taxpayers claiming the R&D Credit in Iowa must be engaged in manufacturing, life sciences, software engineering, or aviation & aerospace industries and explicitly prohibits taxpayers engaged in a host of other industries.

Texas R&D Tax Credit Regulations: Key Differences from Federal Guidelines

Texas has released new regulations that differ from the federal guidelines regarding qualified research expenses (QREs). These state regulations limit the types of QREs that can be claimed and impose restrictions on specific industries and activities. The regulations place more emphasis on what constitutes an experimental versus a non-experimental process. The regulations express skepticism towards activities characterized by trial-and-error methods.

Furthermore, additional restrictions exist on which supply expenses can be included as QREs. Most materials used in the development of manufactured products or in making improvements to manufacturing processes are specifically excluded. According to the regulations’ preamble, the Texas Comptroller notes that the intent is that supplies used in qualified research “are not resold.”

For specific industries, it is imperative to note that the Texas regulations exclude designs and services provided to a customer as eligible business components. This significantly limits the ability of architectural-engineering services and design-build firms to claim the Texas credit. Additionally, the regulations address software development activities by stipulating that qualifying business components must be developed for commercial sale, lease, or licensing to outside parties. The rules also indicate that many activities classified as “moderate-risk” by the IRS are “unlikely to qualify” under Texas guidelines.

Missouri R&D Tax Credit Reinstatement: New Opportunities for Businesses

Beginning for tax years starting on or after January 1, 2023, Missouri has reintroduced a state R&D Tax Credit program that had previously expired in 2005. This is an application-based credit with an allocated budget of $10 million, half of which is earmarked for small businesses, minority-owned businesses, and women-owned businesses. There is a prioritization of claims based on submission date, providing new opportunities and additional incentives for companies to invest in R&D within Missouri.

As tax legislation continues to evolve at federal and state levels, McGuire Sponsel’s team of experts will monitor these changes to provide the highest quality service to clients. It is crucial to thoroughly consider the differences in criteria and requirements across various jurisdictions to maximize R&D Credit claims in a manner that can withstand rigorous scrutiny.

Contact our R&D Tax Credit Services team with inquiries about state or federal R&D Tax Credit qualifications.