With the passage of the Tax Relief and Reconciliation Act of 2006, a new method of calculating the R&D credit is available for R&D expenses incurred after December 31, 2006. This new method, which is called the Alternative Simplified Credit, is equal to 12 percent of the qualified research expenses for the taxable year in excess of 50 percent of the average qualified research expenses for the 3 prior taxable years.
This method may result in a greater credit for those taxpayers who have been limited under the Regular Method due to the amount of their gross receipts or the inability to calculate the fixed-based percentage, which is based on the R&D expenses to gross receipts from the taxable years 1984-1988. If this new method is elected, the taxpayer must continue to use this method unless it gets consent from the IRS to change back to the regular method. Overview of the Research and Development Credit Internal Revenue Code (IRC) Section 41 enables a taxpayer to claim a tax credit for qualified research expenses paid or incurred by the taxpayer during the taxable year in carrying on any trade or business. The availability of this tax credit hinges upon the definition of qualified research expenses as defined by IRC Section 41 and the regulations under IRC Section 174. Indiana income tax law also permits an Indiana tax credit for qualified research expenses. Qualified Research Activities Expenditures qualifying for the tax credit are referred to as qualified research expenses (QRE) and are defined solely by IRC Sections 41 and 174. Federal income tax law's definition of a QRE is often different than accounting or engineering definitions of research and development expenses. Under IRC Sections 41 and 174 there are essentially two tests which must be met in order for an expenditure to constitute a QRE: Purpose Test and Elimination of Uncertainty Test. Purpose Test 1. General Purpose-Technological Information Test The research must be performed for the purpose of discovering information which is technological in nature; i.e., it must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. Discovery is defined as gaining information new to the taxpayer which is not freely available to the general public. Research is not qualified research if its purpose relates to style, taste, cosmetic, or seasonal factors. 2. Specific Purpose-New or Improved Business Component The research must be undertaken to discover information intended to be useful in the development of a new or improved business component. Business component is a product, process, technique, formula, invention, or software item. Substantially all of the research must constitute elements of experimentation (trial and error testing) relating to new or improved function, reliability, or quality. The improvement need not be significant. Elimination of Uncertainty Test The expenditures must eliminate uncertainty concerning the development or improvement of a business component. The required uncertainty exists if the information available to the taxpayer does not establish either:
The elimination of uncertainty is done through a process of experimentation involving more than one alternative at the outset of the project. It appears unnecessary that there be uncertainty as to whether the product or improvement can be designed at all. It is sufficient merely that the specific design be uncertain at the outset. Qualified Research Expenses Expenditures which qualify for the research credit (QRE) as defined above are the total of in-houses research expenses and contract research expenses. In-House Research Expenses (IHRE) 1. Wages Paid For Qualified Research Services IHRE include wages paid to employees engaged in qualified research or engaging in the direct support or supervision of qualified research activities. Wages do not include:
If at least 80% of an employee's time is spent on qualified research activities, then 100% of the employee's annual wage is eligible for the research credit. 2. Supplies Used In Qualified Research IHRE include any tangible personal property, other than land or depreciable property (including annual depreciation thereof), purchased for direct use in qualified research activities. 3. Computer Leasing IHRE include amounts to other persons for the right to use computers in the conduct of qualified research activities. Contract Research Expenses Contract Research Expenses (CRE) paid or incurred to any person, other than an employee of the taxpayer, for qualified research are qualified expenses. CRE expenses are limited to 65% of the amount paid and the taxpayer must bear the expense even if the research project is unsuccessful (risk of failure). The percentage increases to 75% of amounts paid or incurred for qualified research performed by a qualified research consortium. Expenses that do NOT qualify for the R&D Credit IRC Sections 41 and 174 and associated regulations specifically exclude expenditures on the following from eligibility for the research credit:
Please feel free to contact Baden, Gage & Schroeder at (260) 422-2551 if you need further clarification or assistance with the credit. |
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