Virginia’s R&D tax credit has recently undergone some statutory changes which alter how these credits are calculated and how they are funded.

The state actually has two different R&D credits for taxpayers conducting R&D. With these new changes, some businesses will benefit while others will be negatively impacted. Either way, the new funding change also expands the tax planning opportunities around the credit, so it is important for taxpayers to understand how they will be impacted.

April 11, 2024, Virginia signed a new law that modifies credit caps and calculation processes for the state’s R&D tax credits in an effort to prioritize benefits for smaller companies.

Virginia R&D Credit Regimes

The state offers two different credits:

• The Research and Development Expenses Tax Credit (RDC) – a refundable credit
• The Major Research and Development Expenses Tax Credit (MRD) – a nonrefundable credit

Taxpayers must submit an application each year to the state. The state reviews all applications and allocates set pools of money to qualified applicants based on the yearly aggregate credit cap. This means that any qualifying company may not even receive the full benefit of their credit if many other companies are also applying.

Historically, the primary differences between these credits revolved around the total qualified research expenses (QREs) the taxpayer paid or incurred during the tax year.

• MRD: Companies that spent over $5 million on qualified R&D expenses could apply to receive the nonrefundable MRD tax credit and offset a maximum of 75% of their taxable income. The MRD credit percentage was equivalent to 10% of the company’s QREs and any unused credits could be carried forward for up to 10 years.
• RDC: Companies that spent $5 million or less on qualified R&D activities could apply for the RDC, a refundable incentive that was equivalent to 15% of the first $300,000 incurred in the tax year, up to an annual limit of $45,000. Any amount excess of that limit was paid to the taxpayer as a refund.

New Legislation

For tax years beginning on or after January 1, 2023, but before January 1, 2025, both R&D tax credits can now be applied against the corporate income tax, individual income tax, or bank franchise tax. 

For the RDC Credit, the aggregate credit cap has risen from $7.77 million to $15.77 million. 

For the MRD Credit, the credit rate changed from 10% to a step-rate style. The first $1 million is calculated with a 10% rate while the following $2-5 million uses 5%. In addition, a new application amount cap of $300,000 has been applied where previously there was no cap at all. The MRD aggregate credit cap has reduced from $24 million to $16 million.

Impacts

Taxpayers claiming the RDC credit have no changes to the underlying mechanics of the calculation. However, the credit pool has doubled which means that taxpayers who apply through this category will likely see a significantly higher credit than in prior years, up to (or even over) the $45,000 cap.

For taxpayers historically claiming the MRD credit in significant excess of $300,000, the new application cap will immediately cut the size of their applications. And then the 33 percent reduction in the overall credit pool will further limit their benefit. 

Those who apply for the MRD near or below $300,000 will only be affected by the reduced aggregate credit cap.

Companies should consider both methods, if eligible for either, and prepare their tax returns and applications accordingly. One noteworthy feature of Virginia’s R&D tax credit regime is that although the MRD credit has a $5 million QRE requirement, there is no corresponding qualified research expenditures (QRE) requirement for the RDC credit. Thus, although the law prevents taxpayers from claiming both credits, a taxpayer that qualifies for the MRD credit could elect to apply under either regime.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.