Ohio Research and Development Investment Tax Credit

Written on Apr 04, 2018

By Kaitlin Newkirk, CPA and David Randolph, CPA

A valuable and sometimes overlooked credit for Ohio businesses is the Ohio Research and Development Investment Tax Credit. This nonrefundable credit can offset Ohio’s Commercial Activity Tax.

The permanent extension of the federal R&D tax credit (PATH Act) and Treasury’s recent issuance of final regulations under Internal Revenue Code 41 (T.D. 9786) provide incentives for businesses to carefully reconsider how they can maximize their federal research credit (see, for example, Michael Krajcer, CPA, “Recent changes to the R&D tax credit provide improved incentives for businesses,” CPA Voice, September/October 2017). Likewise, now is a good time for businesses to review their Ohio CAT tax returns to make sure they are claiming the Ohio R&D credit and maximizing the benefits it can offer. Because the Ohio credit derives from the methodology used for the federal calculation, the incremental effort to quantify and claim the Ohio credit should be minimal.

Optimizing the Ohio R&D Credit
The Ohio R&D credit is equal to 7% of the excess of (1) qualifying research expenses incurred in Ohio for the year for which the credit is being claimed over (2) the taxpayer’s average annual qualifying research expenses incurred in Ohio for the three preceding tax years (Ohio Revised Code Section 5751.51). For those, Ohio prescribes to the same definition given under Internal Revenue Code Section 41. This definition includes both contract research expenses and in-house expenses, such as qualifying wages and supplies, and the definition of internal use software provided in the (taxpayer-friendly) final regulations issued Oct. 4, 2016.

Because of the complexities involved in identifying QREs, a number of mistakes are possible. One common mistake to avoid is understating the amount of wages that qualify. Treasury Regulation section 1.41-2(d)(2) provides that if “substantially all” of the services performed by an employee consist of qualified services, then all of the employee’s wages are considered QREs for purposes of the credit. The “substantially all” test is applied year-by-year on an employee-by-employee basis; it is met if 80% or more of the employee’s total work hours are spent on “qualified research” activities.

It is important to note qualifying research expenses must occur within the State of Ohio in order to be eligible for the Ohio credit. Businesses should consider how the location(s) where they perform R&D affects their tax benefits in Ohio and elsewhere. Like Ohio, many other states offer R&D tax credits as a way to promote economic development. Multistate filers should employ a coordinated approach across all states in order to maximize overall state tax benefits.

Ohio businesses also should note the amount of contract research expenses that qualify for the Ohio credit differ favorably from the amount that qualifies for the federal credit. Only 65% (generally) of contract research expenses are considered QREs for purposes of the federal credit. In contrast, 100% of contract research expenses qualify for the Ohio credit provided the expenses occur within the State.

Claiming the Ohio Credit
Taxpayers are not required to follow a special application or approval process to claim the credit. The credit is claimed on a taxpayer’s quarterly or annual CAT return filing and may be subject to audit by the state. The following documentation must accompany the filing:

•Federal Form 6765, “Credit for Increasing Research Activities,” for the year of the Ohio credit being claimed.
•Ohio Form CAT CS, “Commercial Activity Tax Credit Schedule,” for the quarter for which the taxpayer submits the report. The completed form must include the signature of an officer or managing agent of the corporation.
•Explanation of the taxpayer’s credit calculation that provides the following details: (1) a description of the types of expenses (and amounts) that comprise the total amount of Ohio QREs for the current tax year, (2) the address of the location(s) where contract research, if any, was conducted within the state, and (3) total Ohio QREs for each of the three preceding years (used to calculate the preceding three-year average).

The Ohio R&D credit can offset all Ohio CAT other than the annual minimum tax. Any excess credit not used for the tax year in which earned carries forward for up to seven years. Taxpayers must file Form CAT CS quarterly to carryforward the available credits.

Ohio requires all businesses—regardless of federal tax year—to calculate the Ohio credit on a calendar year basis and claim the credit on the filing due in February of each year (Ohio Administrative Code Section 5703-29-22(C)(2)).

These requirements are an unwelcome burden, particularly for businesses that do not follow a calendar federal year. We echo the recommendations made by the OSCPA Ohio Tax Reform Task Force that would allow taxpayers to piggyback on the federal credit calculation and timing (“Improving Ohio’s Tax Climate,” issued June 2016, available from OSCPA at http://www.ohiocpa.com/advocacy/ohio-tax-reform-task-force).

Amending returns to claim prior year credits Ohio businesses that originally failed to claim the Ohio R&D credit can amend up to four prior tax years (Ohio Revised Code Section 5751.08). In order to claim the credit, taxpayers should file amended CAT returns electronically for each quarter, beginning in the 4th quarter of the earliest eligible year. In addition to the regular filing requirements outlined above, taxpayers must file Form CAT REF, “Application for CAT Refund,” with each amended return.

Kaitlin Newkirk, CPA, is a professor of accountancy at Xavier University and David W. Randolph, Ph.D., CPA (inactive) is an associate professor of accountancy at Xavier University.

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