This article was updated August 14, 2020.
Arizona is one of the only states that offers a true refundable R&D tax credit. Being refundable refers to the taxpayer not needing any state tax liability to monetize the credit—the state simply sends the taxpayer a tax refund reflecting the credit amount.
The credit is allocated on a first-come-first-serve basis with applications available in early January. Though the state authorizes up to $5 million in refundable credits each year, credits depleted rapidly in the past after the credit application was made available.
Beginning in calendar year 2019, Arizona began capping its refundable tax credit for R&D activities performed in the state at $100,000 per recipient. By capping the refund amount, the state has created an opportunity for more companies to claim the credit. Despite the expanded opportunity for more applicants to claim the credit, the process is still highly competitive and complex, so it’s critical to have an essential business advisor who has extensive experience with the filing process.
The Arizona refundable R&D credit is especially beneficial when used in conjunction with the federal R&D credit that allows certain companies to use up to $250,000 of their credit to offset payroll taxes. While not a true refundable credit, it allows companies with losses to monetize the credit by using it to offset payroll taxes that are incurred regardless of profitability.
Between these two incentives, most eligible companies could see their credits amount to 19% of their qualified development costs for the year.
R&D Credit Overview
Arizona allows companies to elect to treat 75% of the state R&D credit as refundable, forfeiting 25%, or carry forward the credit for up to 15 years until it’s utilized.
Companies that wish to apply for the Arizona Refundable R&D Credit must have fewer than 150 full-time equivalent employees.
For companies to be eligible for the federal R&D credit payroll offset, they need to meet two criteria. They must:
- Not have had any gross receipts prior to five years ago
- Have less than $5 million in gross receipts in the current tax year
In addition, the companies must be conducting development activities that meets the following four requirements:
- Technological in nature. Experimentation processes must rely on physical, biological, or computer sciences or engineering.
- Qualified purpose. Research must intend to create a new or improved product or process that increases performance, reliability, or quality.
- Technical uncertainty. Activities must aim to overcome technical uncertainty concerning capability, method, or appropriate design of a new product or process.
- Process of experimentation. Activities must include developing hypotheses, designing and conducting tests, and evaluating alternatives.
Business can include several cost categories when applying for the credit including the following:
- Employee wages for those who spend time performing R&D, including supervision or direct support of activities
- Supplies and materials used in the conduct of qualified research
- Contract research for hired consultants, outside testing facilities, equipment designers and manufacturers, and more
- Contracts for cloud services and use of leased computer servers
Filing for the credit requires multiple steps—the business must register with the Arizona Commerce Authority (ACA) and file for a certificate of qualification. This requires completing an application for the certificate, providing estimated tax liabilities without the R&D credit, and completing the R&D credit calculation on Arizona application forms.
We can assist with the credit application process by stepping into the role of business representative. By doing so, we’ll relieve the burden of the complex requirements so you can feel confident the application steps are properly completed.
The credit application process requires a significant amount of complex documentation, so it’s important to make sure all documents are properly accounted for and organized. Applicants often incorrectly complete or omit required documentation, disqualifying their application and allowing credits to be claimed by other applicants before they have the opportunity to make corrections.
Even with opportunity for more companies to claim the credit this year, the application process will remain extremely competitive and the first-come-first-serve policy is strictly enforced by submission timestamps.
We’re Here to Help
To learn more about how your business can benefit from the Arizona refundable R&D credit or for help with starting the application process, contact your Moss Adams professional.