My pass-through entity applied for the R&D tax credit and told me my share, but the Department cut my claimed credit down -- can I still claim the full amount I was told to expect?

Plain-English summary

A taxpayer owned an interest in a pass-through entity (PTE) that applied for, and was granted, Virginia's Research and Development Expenses Tax Credit for the 2016 and 2017 taxable years. The taxpayer claimed his share of the credit on his individual returns based on the amount the PTE had originally requested. Under review, the Department reduced the credit to reflect a smaller, PRORATED amount, and issued assessments for the difference.

Virginia's R&D credit is refundable, but it's also capped -- there's an annual statewide limit on the total amount of credit the Department can approve. When total eligible credit requests for a year exceed that cap (as happened in both 2016 and 2017), the Department doesn't deny anyone outright; instead, it grants every approved applicant a pro rata (proportional) share of what they requested. To claim the credit, a taxpayer (or the PTE on its owners' behalf) files an Application for the Research and Development Expenses Tax Credit (Form RDC); the Department then notifies eligible applicants of the actual amount they may claim, which the taxpayer must use on their return -- not the amount originally requested.

Here, because the PTE's total requested credit exceeded the annual cap in both years, it was granted a smaller, prorated credit. The taxpayer, however, claimed his share based on the full amount the PTE had originally applied for, not the reduced amount actually granted. The Tax Commissioner held the Department correctly adjusted the taxpayer's returns to reflect only the prorated credit amount and upheld the assessments.

What this means for you

Individuals who receive a share of an R&D credit through a pass-through entity

Claim only the amount of credit the Department actually NOTIFIES you (or your PTE) that you're entitled to -- not the larger amount the PTE originally applied for on Form RDC. If total statewide requests exceed the annual cap for that credit year, everyone's approved credit is prorated down, and there's no path to claim the un-granted difference.

Pass-through entities applying for the R&D credit on behalf of their owners

Wait for the Department's notification of the actual (possibly prorated) credit amount before advising your owners what to claim -- don't assume the amount requested on Form RDC is the amount that will ultimately be available, since the annual cap can force a reduction across the board.

Taxpayers who receive an assessment reducing a previously claimed R&D credit

An assessment that simply corrects your claimed credit down to the amount the Department actually granted (after proration) is difficult to overturn on appeal -- the credit's own governing statute and the Department's R&D credit guidelines make proration the norm whenever requests exceed the cap, not an exception.

Common questions

Q: Why did the Department reduce the R&D credit I claimed on my individual return?
A: Because the total amount of approved R&D credit requests for that year exceeded Virginia's annual statewide cap, so every applicant -- including the pass-through entity you own an interest in -- received only a prorated (reduced) share of the amount originally requested, and you can only claim that reduced amount.

Q: Is Virginia's R&D credit unlimited, or is there a cap?
A: There's an annual cap. If the total amount of credit requested by all eligible taxpayers for the year exceeds that cap, the Department grants each approved applicant a pro rata share of their request rather than the full amount.

Q: How do I know how much R&D credit I'm actually entitled to claim?
A: The Department notifies eligible taxpayers (or the pass-through entity that applied) of the actual amount of credit granted after any proration; that notified amount -- not the amount originally requested on Form RDC -- is what you must use on your Virginia income tax return.

Citations and references

• Public Document 20-120 (7/7/2020) ("R&D credit guidelines") -- the Department's guidelines explaining that when total eligible R&D credit requests exceed the annual cap, each taxpayer is granted a pro rata amount as determined by the Department

Subject

Credit : Research & Development - Prorated credit/annual cap

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-106

Original ruling text

August 10, 2021

Re: § 58.1-1821 Appeal: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayer”) for the taxable years ended December 31, 2016, and 2017. I apologize for the delay in responding to your request.

FACTS

The Taxpayer maintained an ownership interest in a pass-through entity (PTE) during the 2016 and 2017 taxable years. Both years, the PTE applied for and was granted the Research and Development Expenses Tax Credit (“R&D credit”). Accordingly, the Taxpayer claimed his share of the R&D credits on his 2016 and 2017 Virginia individual income tax returns. Under review, the Department reduced the Taxpayer’s credits based on the prorated amount granted by the Department and issued assessments. The Taxpayer appealed, contending that he is entitled to the amount of the credits originally claimed.

DETERMINATION

The R&D credit is a refundable individual and corporate income tax credit for conducting qualified research and development in Virginia. See Virginia Code § 58.1-439.12:08. If the total eligible credit requests exceed the annual cap, each taxpayer is granted a pro rata amount of credit as determined by the Department. See Public Document (P.D.) 20-120 (7/7/2020) (“R&D credit guidelines”).

To claim the R&D credit, a taxpayer must submit an Application for the Research and Development Expenses Tax Credit, Form RDC, and any supporting documentation to the Department in the year following the credit year. The Department subsequently notifies all eligible taxpayers of the amount of credit that they may claim. Upon receiving notification of the credit amount from the Department, a taxpayer must claim the credit on the appropriate Virginia income tax return.

In this case, the Department’s records indicate that the Taxpayer claimed R&D credits on his individual income tax returns for the 2016 and 2017 taxable years based upon the amount of credit applied for by the PTE. However, since the total amount of approved R&D credit requests exceeded the annual cap for both taxable years, the PTE was granted a prorated amount of credit that was less than the amount requested.

The Department, therefore, correctly adjusted the Taxpayer’s individual income tax returns to reflect the prorated amount of R&D credit granted by the Department. Accordingly, the assessments for the 2016 and 2017 taxable years are upheld.

The Taxpayer will receive updated bills, which will include accrued interest to date. The balance due for 2017 reflects a lien payment that was already applied to that assessment. The Taxpayer should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia sections and public document cited are available online at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3412-C

Related Documents

20-120