R&D Tax Credit Survives Latest Round of Tax Legislation

The research credit is like the cat with nine lives…except it’s more. This credit, which technically expired after 2013, was just reinstated by the Tax Increase Prevention Act (TIPA) retroactive to January 1, 2014. By last count, it’s the 16^th time the temporary credit has been revived.

But this latest extension is also short-lived. Along with the other TIPA extensions, the research credit was wiped off the books again on December 31, 2014. It will take another act of Congress to bring it back to life for 2015.

Let’s look at the basic rules affecting business entities on their 2014 returns. Generally, the credit is equal to 20 percent of the excess of qualified research expenses for the year exceeding a base amount. Alternatively, a business can elect to use a simplified credit based on 14 percent of the amount by which qualified expenses exceed 50 percent of the average for the three previous tax years. The base amount is a fixed-base percentage — not to exceed 16 percent) — of average annual receipts for the four years prior to the year of claiming the credit. It can’t amount to less than 50 percent of the annual qualified research expenses.

Therefore, the minimum credit equals 10 percent of qualified research expenses (50 percent x the 20 percent credit). This can be a valuable tax incentive for competitive companies in industries where it’s important to be on the cutting edge.

The research credit is only available, however, for qualified expenses. To qualify, the following requirements must be met:

The expense must qualify as a “research and experimentation expenditure” under Section 174 of the Internal Revenue Code. Such expenses include in-house wages and supplies attributable to qualified research; certain time-sharing costs for computer use in qualified research; and 65 percent of contract research expenses (i.e., amounts paid to outside contractors in the U.S. for conducting qualified research).

The expense must relate to research undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component.

Substantially all of the activities of the research constitute elements of a process of experimentation that relates to a new or improved function, performance, reliability or quality.

Unfortunately, you can’t have your cake and eat it, too. Any Section 174 deduction must be reduced if you claim the research credit for the same expenses.

What are the prospects for another reincarnation of the research credit? Although there have been calls to authorize this tax break permanently, or just let it die once and for all, it’s more likely that Congress will approve yet another temporary extension once it gets around to it.