The federal research and development (R&D) credit isn’t the only potential tax break for taxpayers that increase their research activities in Florida. Qualified businesses also might be eligible for the state R&D credit. While the definitions and many other provisions in the federal and state credits closely align, the availability of Florida’s credit is much more limited. It’s also administered very differently than the federal credit. Read on to find out what you need to know.
What is the Florida R&D credit?
Like the federal credit (also known as the Section 41 tax credit), Florida’s credit is intended to encourage businesses to conduct more R&D work. The state generally allows a business doing “qualified research” to apply a percentage of its qualifying research expenses (QREs) against its state income or franchise tax liability.(While Florida doesn’t have an individual income tax, it does have a corporate income tax.)
What are QREs?
Florida has adopted the federal definition for QREs. Under that definition, QREs are the sum of in-house research expenses — generally, wages for qualified services, the cost of supplies (for example, tools, molds, and raw materials), and rental costs for computers used in qualified research — and contract research expenses incurred in the state.
For contract research expenses, you can include 65 percent of any amount paid or incurred to a third party for qualified research. If the research is performed by a qualified research consortium, you can claim 75 percent of the expenses. Research consortiums are generally 1) tax-exempt and 2) organized and operated primarily to conduct scientific research.
Do I qualify for the credit?
The Florida credit is more limited than the federal credit. It’s only available to C corporations that 1) have QREs in the state and 2) claim and are allowed the federal R&D credit against federal income tax.
In addition, the Florida credit is limited to businesses in the following target industries:
- Aviation and Aerospace
- Cloud Information Technology
- Homeland Security and Defense
- Information Technology
- Life Sciences
- Marine Sciences
- Materials Science
Partnerships, limited liability companies taxed as partnerships, and disregarded single-member limited liability companies can’t apply for the credit. However, each corporate partner of a partnership can apply separately for the Florida credit based on the corporation’s separate research expenses — including allocated partnership research expenses — if the corporate partner is also a qualified target industry business.
A corporate partner must attach a copy of Form 1065, Schedule K-1, “Partner’s Share of Income, Deductions, Credit, etc.” to its Florida tax return when claiming credit based on allocated partnership QREs.
What is qualified research?
Florida applies the IRS’s four-part test for qualified research activities:
1. The research is performed to eliminate technical uncertainty about the development or improvement of a product or process, including computer software, techniques, formulas, and inventions (the Section 174 test),
2. The research is undertaken to discover information that’s technological in nature. That is, it relies on physical, biological, engineering, or computer science principles. (the technological information test),
3. The research is intended for use in developing a new or improved business product or process (the business component test), and
4. Substantially all (generally, at least 80 percent) of the research activities are elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality (the process of experimentation test).
Such research can qualify for the credit even if it ultimately fails to produce your desired results.
What types of activities are excluded?
The R&D credit isn’t allowed for expenses related to:
- General administration
- Research conducted after commercial production of the product or process has begun
- Research adapting an existing product or process to a particular customer’s need
- Duplication of an existing product or process (in whole or in part)
- Surveys or studies, including:
- Efficiency studies
- Activities related to management function or technique
- Market research, testing, or development
- Routine data collection
- Routine quality control testing or inspection
- Research relating to certain internal-use computer software
- Research conducted outside the United States, Puerto Rico, or a U.S. possession
- Research in the social sciences, arts, or humanities
- Research funded by another person or governmental entity
How much is the credit worth?
The Florida tax credit generally equals 10 percent of the excess of QREs over the base amount (see below). The federal R&D credit, by contrast, generally equals 20 percent of the excess.
It’s important to realize, though, that you won’t necessarily be able to claim that full 10 percent because of how Florida administers its system. The state limits the total amount of R&D tax credits awarded annually, so you may receive only a portion of your actual tax credit (see below).
Note: Your credit for any tax year can’t exceed 50 percent of your net corporate income tax liability after all other credits have been applied.
What is the “base amount”?
The base amount is the average of your QREs in Florida for the four previous taxable years.
The maximum tax credit for a business that hasn’t been in existence for at least four taxable years immediately preceding the taxable year is reduced by 25% for each taxable year for which the business, or a predecessor corporation, didn’t exist.
Does Florida provide the “alternative simplified credit” (ASC) option that’s available under federal tax law?
Is the Florida R&D credit refundable?
No, but you can carry forward unused credits for up to five years. Unused federal credits, on the other hand, can be carried forward for 20 years or back one year.
How do I claim the credit?
The total amount of Florida R&D credits that may be granted each year is $9 million. Unlike the federal credit, which you can simply claim on your tax return, you first must apply to the Florida Department of Revenue (DOR) for an allocation of the state credit, using Form F-1196, “Allocation for Research and Development Tax Credit for Florida Corporate Income/Franchise Tax.”
When you apply, you must include a letter from the Department of Economic Opportunity (DEO) certifying that your business is an eligible qualified target industry business. If the department has declined to issue such a letter, you can instead submit documentation that you’ve protested the department’s decision. The DOR will consider your application and reserve an amount of credit for you as if you had a certification letter. However, you’ll only receive an allocation if you prevail on your appeal of the DEO decision.
The application is due on or after March 20 and before March 27 for the QREs incurred within the preceding calendar year. For example, the application process for an allocation of credit for R&D expenses incurred in the 2022 calendar year begins on March 20, 2023. If the total credits for all applicants exceed $9 million, the credits are allocated on a prorated basis.
If you’re required to file returns and make payments by electronic means, you also must apply for a credit allocation online through the DEO website.
Note: DEO certification letters expire three years after the date of issue. Taxpayers must be re-certified if they want to continue applying for credit allocations after the expiration date.
If you’re eligible for the credit, you’ll receive a letter from the DOR informing you of the amount of your allocation and the tax year that you can claim the credit on your Form F-1120, “Florida Corporate Income Tax Return.” When you file your return, you’ll also need to attach:
- IRS Form 6765, “Credit for Increasing Research Activities” and
- IRS Form 3800, “General Business Credit.”
Note: You must add the amount taken as a Florida R&D credit to your taxable income before calculating your corporate income/franchise tax.
What if I overstate the amount of credit I’m eligible for in my allocation application?
The percentage of the original allocation you receive will be applied to the lesser amount of credit you should have requested.
For example, say you requested an allocation of $800,000 and were allocated $368,000 for a credit. If it turns out your QREs amount was smaller than originally computed, and you should have applied for an allocation of only $400,000, you’re only entitled to an allocation of $184,000:
$184,000 = $400,000 x $368,000/$800,000
What if I understate my credit allocation request?
Unfortunately, you’re out of luck — you can’t claim more credit than originally allocated because of the annual cap.
How should I document my credit?
Florida requires taxpayers claiming the R&D credit to retain documentation that substantiates the credit, including records or other evidence of:
- The amount of Florida QREs incurred for in-house research and contract research expenses,
- That they qualified for the federal R&D credit, and
- That the federal credit was claimed.
You must also retain:
- A copy of the certifying letter from the DEO,
- A copy of the DOR letter granting the credit, and
- A schedule reconciling all credit carryovers.
What if the IRS adjusts the amount of my QREs?
If the amount is reduced due to an IRS audit or examination, you must recalculate your Florida credit. You’ll need to file amended tax returns for all affected years and pay the difference between your initial credit taken and the recalculated credit amount, with interest.