The federal government provides taxpayers with a significant income tax credit for increasing research spending. This research tax credit benefits taxpayers who design and manufacture tangible or intangible products, provide technical consulting services, or develop products for their own use.
The research tax credit is often thought of as one tax credit. The research tax credit is actually four distinct tax credits. These tax credits include the basic research tax credit, regular research tax credit, alternative simplified tax credit (“ASC”), and energy research tax credit. For tax years ending prior to 2008, the research tax credit also included an alternative incremental research credit (“AIRC”).
The taxpayer may claim either the regular tax credit, the alternative incremental tax credit (for tax years ending before 2008), or the alternative simplified credit. In addition, the taxpayer may also claim the basic research credit and the credit for energy research. The requirements for each credit vary; however, in the main, the requirement that the taxpayer have qualified research activities and qualified research expenses (“QREs”) remains constant.
Research is qualified if it satisfies a four-part test. These tests provide broad rules for determining what activities can qualify. In addition to these tests, there are a number of limitation rules that specifically exclude various activities. Expenses associated with qualified research may be QREs. QREs can include wages paid to employees and supply costs, contractor costs, and computer rental costs. As with qualified research activities, there are a number of limitation rules that specifically exclude various expenses.
The taxpayer’s QREs and gross receipts are used to compute the amount of its research tax credit. The mechanical computation rules compare (1) the taxpayer’s QREs and gross receipts for its base period tax years to (2) the taxpayer’s QREs for its current year tax period and its gross receipts for the four tax years immediately preceding the current tax year. This increase in QRE spending between the base period tax years and the current tax year is multiplied by 20 percent to produce the taxpayer’s research tax credit for the current tax year. Put in an example with numbers.
There are also several rules that address how to compute the research tax credit in special circumstances. For example, there are rules for computing the research tax credit for companies that acquire or dispose of businesses and when members of corporate groups and flow through entities are involved.
In addition to these rules, there are several limitations placed on the research tax credit. There is a limit on the amount of business tax credits, which includes the research tax credit, in which taxpayers can benefit from in any one tax period. The amount of the research tax credit is also limited by the amount of the taxpayer’s federal income tax liability. Unused research tax credits can be carried back one year and carried forward for twenty years. In addition, the alternative minimum tax can limit the amount of research tax credits available to taxpayers. Taxpayers who satisfy these requirements may be able to reap the significant financial benefits of research tax credits.
- History of the research tax credit
- Regular research tax credit
- Alternative incremental research credit
- Alternative simplified credit
- Basic research tax credit
- Credit for energy research
Last Updated: 2/7/2017