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Federal election for reduced R & D credit can be state tax planning opportunity.

Taxpayers should consider making the federal election to take a reduced research and development (R&D) credit solely to reduce their state income tax liabilities. Under federal rules, a corporation allowed an R&D credit is required to reduce its expenses, and thus increase its income, by the amount of the credit (e.g., a $100 credit also increases taxable income by $100). With the maximum corporate tax rate of 34%, the effective credit can be as much as $66.

However, Sec. 280C(c)(3) allows an election to fully deduct R&D expenses, provided that the credit is reduced by the product of the credit multiplied by the maximum tax rate. (Electing this "reduced R&D" credit for federal income tax purposes is usually motivated by alternative minimum tax concerns.) For many taxpayers, taking the "reduced R&D credit" can leave them with the same net federal tax result as the "full R&D credit." (Foreign tax credit implications also need to be considered.) For a taxpayer with a $100 R&D credit assuming no other federal tax implications), a reduced credit election would result in the same effective credit of $66 ($100 - ($100 x 0.34)).

However, since most states do not provide for an addback of disallowed R&D expenses, there may be state tax benefits to electing the reduced credit. Additionally, the reduced credit election for federal purposes may not have any impact on a state's separate R&D credit provisions. Thus, the taxpayer may obtain a "full state R&D" credit while also receiving the benefit of the related R&D expense deduction.

Accordingly, a number of corporate taxpayers have elected the reduced R&D credit solely to achieve additional state tax benefits.

From Stephen T. Ryan, CPA, Chicago, Ill.
COPYRIGHT 1992 American Institute of CPA's
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Author:Ryan, Stephen T.
Publication:The Tax Adviser
Date:Feb 1, 1992
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