Texas R&D Credit Reborn: What the New Subchapter T Means for Houston Businesses Starting in 2026

For more than a decade, Texas businesses with research and development activities have been able to choose between two state tax incentives: a five percent franchise tax credit under former Subchapter M of Chapter 171 of the Tax Code, or a sales and use tax exemption for depreciable property used in qualified research under § 151.3182. Both were enacted by H.B. 800 in 2013, both were set to expire on December 31, 2026, and both required the taxpayer to choose one or the other. The choice was not always straightforward, the credit cap of fifty percent of franchise tax liability limited its value for capital-intensive operations, and the sales tax exemption created friction with vendors who did not always honor the exemption certificates correctly.

When does the new Texas R&D credit take effect?

Senate Bill 2206, signed by Governor Abbott on June 17, 2025, has rebuilt the Texas R&D incentive structure from the ground up. The legislation took effect for franchise tax reports originally due on or after January 1, 2026, which means the new regime is now operative for the report that most Texas entities will file in May 2026. The new framework is housed in Subchapter T of Chapter 171, codified at Tex. Tax Code §§ 171.9201 through 171.9211. The sales tax exemption under § 151.3182 has been repealed, and the old franchise tax credit under Subchapter M has been repealed. Existing carryforwards from the old credit are preserved and may continue to be used, but no new credits accrue under the prior regime.

What are the new Texas R&D credit rates?

The new credit rate is 8.722 percent of qualified research expenses incurred in Texas above a base amount, which is computed as fifty percent of the average qualified research expenses for the three preceding tax years. Where the taxpayer has no qualified research expenses in any of the three preceding years, the credit rate drops to 4.361 percent of current-year QREs. A taxpayer that contracts with a Texas public or private institution of higher education for qualified research earns the higher rate of 10.903 percent on the qualifying portion of the contract amount, with a corresponding 5.451 percent rate where the taxpayer has no three-year prior QRE history. The fifty percent cap on the credit relative to franchise tax liability is preserved, and unused credits carry forward for up to twenty years.

Is the new Texas R&D credit refundable?

The single most significant addition is refundability. Three categories of taxpayers are eligible for a refund of the credit to the extent it exceeds their franchise tax liability. The first is a taxable entity whose pre-credit franchise tax liability is less than one thousand dollars. The second is a taxable entity with annualized total revenue of less than the no-tax-due threshold, currently $2.47 million. The third is a qualified veteran-owned startup. Refundability is the feature that the prior Subchapter M credit lacked. Pre-revenue startups, no-tax-due entities, and similar growth-stage businesses had been functionally excluded from the credit because they had no liability against which to apply it, and the only state benefit available to them was the sales tax exemption. The new regime makes the credit a usable cash-flow tool for the businesses that often have the highest concentration of R&D spending relative to revenue.

Does the Texas credit conform to the federal R&D credit?

Subchapter T is also notable for its conformity to federal law. Qualified research expenses are now defined by reference to line 48 of federal Form 6765, the line where Texas-attributable qualified research expenses are reported. The new regime ties to the federal definitions in effect for the federal year for which the Form 6765 is filed, which means the Texas credit incorporates the federal four-part test under IRC § 41(d), the QRE definitions under § 41(b), and the federal exclusions under § 41(d)(4). The IRS audit outcome flows through to the Texas credit, statistical sampling under Rev. Proc. 2011-42 is accepted, and ASC 730 substantiation is permitted. The conformity reduces the recordkeeping burden materially, since taxpayers no longer need to maintain separate Texas-specific documentation for the same activities they document for the federal credit.

What happens if I claimed the sales tax exemption in 2025?

The transition rules deserve close attention. Section 4 of S.B. 2206 provides that the repeal of § 151.3182 does not affect tax liability accruing before the effective date. The repeal of Subchapter M does not affect unused credits a taxable entity was authorized to carry forward, which means existing carryforwards remain available within their original twenty-year window. The most important transitional rule is the prohibition on dual benefits. A taxable entity that received the sales tax exemption under § 151.3182 during the period covered by a franchise tax report cannot claim the new Subchapter T credit on that report. Combined groups are caught by the same rule. Even where a single member of the group received the exemption, the group cannot claim the credit. For the 2026 transition year, this means that businesses which obtained the sales tax exemption in calendar year 2025 will not be able to claim the new credit on their 2026 franchise tax reports. The lost-benefit math should be modeled before assuming the new regime simply layers on top of prior planning.

Which Houston industries benefit most from the new credit?

Several practical questions arise for Houston businesses preparing 2026 franchise tax reports. The first is the basic feasibility question: did the business have qualified research expenses in Texas during the report year, and how do those expenses compare to the three-year prior average? Texas has a vibrant R&D economy spanning energy services engineering, chemical and process engineering, medical devices and life sciences, custom manufacturing, aerospace, and software. Many businesses in these sectors have never claimed the Texas credit because they took the sales tax exemption instead, or because the credit math did not justify the documentation burden. The new rate, refundability, and conformity to federal definitions change the calculation.

How do higher-education partnerships boost the credit rate?

The 10.903 percent rate applies to qualified research expenses paid to a Texas public or private institution of higher education for qualified research. For a manufacturer with engineering relationships at the University of Texas, Texas A&M, Rice, or the University of Houston, restructuring research contracts to fit the higher-education rate produces a meaningful incremental benefit. The contracts must be properly documented as qualified research, the work must be performed by the institution, and the payments must satisfy the contract research definitions under federal § 41(b)(2)(B), but the additional 2.181 percentage points of rate translates into real money over a three-year planning horizon.

How does the repeal of the sales tax exemption affect equipment purchases?

The final consideration is timing of equipment purchases. The repeal of the sales tax exemption means that depreciable property used in research is no longer exempt from Texas sales and use tax. Equipment costs go up by 8.25 percent in most Houston-area jurisdictions when the exemption goes away. For businesses that timed equipment purchases to take advantage of the exemption, the planning math has changed. The franchise tax credit offsets some of the cost, but it does not eliminate the increase, and the cash-flow profile is different because the credit is realized when the franchise tax report is filed rather than at the point of purchase.

How does the federal R&D credit stack with the Texas credit?

The Texas credit complements the federal credit under IRC § 41 and stacks with it. A Houston business with $1 million of Texas QREs and a three-year prior average of zero would compute a federal credit using the alternative simplified credit method or the regular credit method, and a Texas credit of $43,610 at the 4.361 percent first-year rate. With sufficient prior history to qualify for the 8.722 percent rate, the Texas credit on the same $1 million in current-year QREs above the base would be $87,220. Layered with the federal R&D credit, the combined state and federal benefit is meaningful, and refundability under the new Texas regime makes the credit usable for early-stage and no-tax-due companies that previously had no realistic path to monetize it.

North Star Law Firm represents Houston businesses in research and development credit studies, including coordination of federal and Texas claims under the new Subchapter T framework, examinations of credit positions, and structuring of higher-education research partnerships.

Frequently asked questions

When does the new Texas R&D credit take effect?

Subchapter T of Chapter 171, Tex. Tax Code, applies to franchise tax reports originally due on or after January 1, 2026. The new credit replaces the prior Subchapter M franchise tax credit and the § 151.3182 sales and use tax exemption, both of which are repealed for periods on or after that date.

What are the new Texas R&D credit rates?

The base rate is 8.722% of qualified research expenses incurred in Texas above a base amount equal to 50% of the three-year prior QRE average. Where there is no three-year prior history, the rate is 4.361%. Qualified research expenses paid to a Texas public or private institution of higher education qualify at 10.903%, with a corresponding 5.451% rate where there is no prior history.

Is the new Texas R&D credit refundable?

Yes, for three categories of taxpayers: (1) taxable entities with pre-credit franchise tax liability of less than $1,000, (2) taxable entities with annualized total revenue less than the no-tax-due threshold, currently $2.47 million, and (3) qualified veteran-owned startups. Refundability is a major change from the prior regime, which had no refund mechanism.

What happens if I took the sales tax exemption in 2025?

Section 4(a) of S.B. 2206 prohibits a taxable entity that received the § 151.3182 sales tax exemption during the period covered by a franchise tax report from claiming the new Subchapter T credit on that report. Combined groups are caught by the same rule. Taxpayers who obtained the exemption in 2025 should evaluate whether they remain eligible for the credit on their 2026 report.

Does the Texas credit conform to the federal R&D credit?

Yes. Qualified research expenses are defined by reference to line 48 of federal Form 6765, and the regime ties to federal definitions in effect for the federal year for which the Form 6765 is filed. The federal four-part test under IRC § 41(d) governs, IRS audit outcomes flow through to the Texas credit, and statistical sampling and ASC 730 substantiation are accepted.