Arizona Permits Use of Alternative Simplified Method for Tax Year 2023 Credit for Increased Research Activities

Effective for tax years ended on December 31, 2023, Arizona will permit taxpayers to compute the Credit for Increased Research Activities using either the regular method or the alternative simplified credit method. This change provides taxpayers with two methods to compute the credit, offering greater flexibility and potentially a significantly superior benefit to taxpayers than in prior tax years.

What is the Arizona Credit for Increased Research Activities?

Administered by the Arizona Department of Revenue, the research and development incentive is an Arizona income tax credit for companies that incur research and development costs in the state. The credit is allowed in an amount computed under Internal Revenue Code Section 41 with some exceptions. Since the implementation of this program in 1992, the credit has been used to encourage Arizona businesses to continue to invest in the development or improvement of technologies, products, materials, and processes.

Methods for Computing the Credit

The Regular Method

Under the regular method, taxpayers can compute the Credit for Increased Research Activities by considering the following:

  • Arizona Qualified Research Expenses (QREs): These are the expenses incurred for research activities within Arizona.
  • Base Amount: This is a benchmark figure that represents the average level of research activity in prior years.
  • Arizona Basic Research Payments: These are payments made for basic research activities conducted in Arizona.

The credit is calculated as the excess of Arizona QREs for the taxable year over the base amount and the Arizona basic research payments. If the allowable expenses do not exceed $2,500,000, the allowable credit is 24% of this amount. If the allowable expenses exceed $2,500,000, the allowable credit amount is $600,000 plus 15% of the amount of expenses over $2,500,000, subject to certain limitations. 

The Alternative Simplified Credit (ASC) Method

The ASC method offers a different approach. The credit under this method is calculated as the excess of Arizona QREs for the taxable year over the average Arizona QREs for the previous three years.

Notably, if a taxpayer has no QREs in any of the three prior taxable years, the taxpayer does not qualify for the ASC.

Small Businesses May Receive Refundable Portion of the Current Year’s Excess Credit

If a taxpayer qualifies, and receives pre-approval from the Arizona Commerce Authority, a portion of the current year’s excess regular credit may be refundable under either credit computation method. To qualify for this refund:

  • The taxpayer must employ fewer than 150 full-time employees.
  • The taxpayer must apply to the Arizona Commerce Authority (ACA) for a Certificate of Qualification to be eligible to receive a refund. 

The refundable amount is determined as the lesser of:

  • Seventy-five percent of the excess credit; or 
  • The maximum refund amount specified on the certificate, with any additional amount forfeited.

The excess credit is the current year’s credit minus the current year’s tax liability. The 75% refund is available only for the current year’s excess credit for increased research activities. To make this credit refundable, the election must be made when the taxpayer originally files its tax return to claim the current year’s credit. 

Additional Information

For detailed instructions and further information on how to compute the Credit for Increased Research Activities, taxpayers should refer to Arizona Form 308. This form provides comprehensive instructions and examples to help taxpayers accurately calculate their credits under both methods.

By providing both the regular method and the ASC method, Arizona aims to accommodate various research activity levels and financial situations, ultimately encouraging more research and development within the state. 

How BDO Can Help

BDO advises clients on state and local tax-related issues, from new regulations and audits to tax credits and incentives. At BDO, trusted tax professionals can assist companies navigate the complexities of Arizona’s new changes described above to ensure compliance and optimization of your tax credits.