The Research Tax Credit

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Internal Revenue Code (”Code”) § 41 provides taxpayers with a tax credit for increasing research and experimentation (”R&E”) activities. The Code § 41 R&E tax credit is equal to twenty percent of the increase in the taxpayer’s R&E expenses from the year in which the tax credit is claimed and the “base amount.” The base amount is the average of the taxpayer’s gross receipts for the four years prior to the year in which the R&E tax credit is claimed, multiplied by the taxpayer’s fixed-base percentage. The fixed-base percentage is the percentage that R&E spending was of gross receipts for the base period.

Research Tax Credit Base Period

The research tax credit base period consists of years 1984 through 1988, unless the taxpayer is deemed to be a start-up company for purposes of Code § 41. A taxpayer is deemed to be a start-up company for purposes of Code § 41 if the first tax year in which the taxpayer had both gross receipts and qualified research expenses (”QREs”) occurred after 1983 or, for the period beginning after December 31, 1983, and ending before January 1, 1989, the taxpayer had fewer than three tax years in which the taxpayer had both gross receipts and QREs.

If the taxpayer is deemed to be a start-up company, the taxpayer must use the special base period rules set out in Code § 41(c)(3)(ii) for calculating its Code § 41 tax credits. These rules provide a mechanical formula for determining what years make up the taxpayer’s base amount and what its fixed-base percentage is.

Qualified Research Expenses

Qualified research expenses can include wage costs, supply costs, contractor costs and certain computer rental expenses that the taxpayer paid or incurred for qualified services in carrying on the taxpayer’s trade or business. The two key terms are “qualified services” and “qualified research.”

Qualified Services

The term “qualified services” involves directly engaging in qualified research or engaging in the direct supervision or direct support of research activities that constitute qualified research. The term “direct supervision” means the immediate supervision of qualified research and the term “direct support” means services in the direct support of either persons engaging in actual conduct of qualified research or persons who are directly supervising persons engaging in the actual conduct of qualified research.