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Extension and Modification of Federal Research Credit

President Bush signed The Emergency Economic Stabilization Act of 2008 on October 3rd, 2008. This Act contains extensions of numerous business tax provisions. Among those extensions is the incremental research credit. The research credit for increasing research activities was previously extended to only include taxable years ending through December 31, 2007. The new Act continues to add to the research credit’s resilience by extending it two additional years through December 31, 2009.

Under the general rule a taxpayer determines their credit by first calculating a base period amount. The base amount is equal to the average of gross receipts for the four preceding tax years multiplied by the taxpayer’s fixed-base percentage. The fixed-base percentage is the ratio that its total qualified research expenditures for 1984 through 1988 is to total gross receipts for that period. Please note the fixed-base percentage is capped at 16%. Also note that start-up companies use a fixed-base percentage of 3% for its first five years.

After calculating a base period amount, the taxpayer then determines the credit by taking the sum of: 20% of a company’s qualified research expenses for the tax year over its base amount; 20% of the excess of its qualified research payments made during the year over the average annual payments made during the base period; and 20% of all payments made during the year to an energy research consortium. Note that qualified expenses used to calculate the credit are not deductible. However, a taxpayer may elect to use a reduced percentage, 13%, of the above payments and still deduct the qualified expenses on its tax return. This election is irrevocable and must be made on a timely field tax return including applicable extensions.

As an option to the above regular credit calculation, taxpayers can make an election to use The Alternative Incremental Credit. Under this option the taxpayer uses a reduced rate over a lower fixed base percentage to calculate the research credit. However, the new Act terminates this election option for taxable years beginning after December 31, 2008. Therefore, the 2008 tax year is the last year this option is available.

Another option to the regular credit calculation is the Alternative Simplified Credit added previously by the Tax Relief and Health Care Act of 2006. A taxpayer may elect to use this method whereby the taxpayer claims a credit equal to 12% of the increase of current year qualified research expenses over 50% of the average of the same expenses for the previous three years. The new Act increases this percentage to 14% for taxable years ending after December 31, 2008. If a taxpayer does not have qualified expenses for any of the three preceding years, then the credit is determined by taking 6% of the current year’s qualified expenses. This option should always be looked at by taxpayers, especially those taxpayers who have issues with the base amount either limiting or eliminating the incremental credit calculated under the general rule. This provision was not changed by the new Act. It is important to note that once a taxpayer elects to use this method, they must continue to do so unless revoked with IRS consent.

For more information, contact: 

James J. Cunningham, CPA, Tax Shareholder, at 412.281.2533 or jcunningham@alpern.com; Dennis W. Grady, Jr., Esq., Senior Tax Manager, at 412.281.2501 or dgrady@alpern.com.