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IRS Research Tax Credit Renewed Retroactively for 2008 and Also Extended Through 2009Federal Taxes Weekly Alert October 31, 2008 One of the tax provisions that were enacted as part of the Emergency Economic Stabilization Act of 2008 (Act) retroactively revives and extends the research credit. The Act also terminates the alternative incremental research credit (AIRC) and increases the alternative simplified research credit. In addition, it makes a technical correction relating to how the research credit is computed for any tax year with respect to which the research credit applies to a number of days that is less than the total number of days in the tax year. General background. A taxpayer is entitled to a research credit, which is generally equal to 20% of the amount by which the taxpayer's qualified research expenses exceed a specific base amount unless the taxpayer elects the alternative incremental research credit (AIRC), or the alternative simplified credit (ASC). Additional components of the research credit include the separately computed "university basic research credit" equal to 20% of the basic research payments to qualified research organizations less the "qualified organization base period amount" and a separately computed "energy research consortium credit" based on amounts paid or incurred to an energy research consortium. Unlike the other components of the research credit, the energy research consortium credit applies for all qualified expenditures, not just those in excess of a base amount. Under pre-Act law, the research credit, including the university basic research credit and the energy research consortium credit, was scheduled to expire and was not available for any otherwise qualifying research expenses paid or incurred after Dec. 31, 2007. Qualified clinical drug testing expenses are eligible for the orphan drug credit. Expenses eligible for this credit are defined, with certain modifications, by reference to the Code Sec. 41 definition of expenses qualifying for the research credit. For this purpose, under pre-Act law, Code Sec. 41 was considered to remain in effect for periods after Dec. 31, 2007. Research Credit Revived and Extended The Act revives and extends the research credit for two years by striking the Dec. 31, 2007 expiration date of the research credit (including the university basic research credit and the energy research consortium credit) and replacing that date with Dec. 31, 2009. (Code Sec. 41(h)(1)(B)) RIA observation: The extension applies to amounts paid or incurred after Dec. 31, 2007 and before Jan. 1, 2010. The research credit won't apply to amounts paid or incurred after Dec. 31, 2009. An earlier termination date applies to the AIRC, as explained below. The Act also makes a conforming change to the orphan drug credit by providing that, for purposes of the orphan drug credit, Code Sec. 41 (the research tax credit) is considered to remain in effect for periods after Dec. 31, 2009. (Code Sec. 45C(b)(1)(D)) Elective Alternative Incremental Research Credit Terminated Taxpayers are allowed to elect an alternative incremental research credit (AIRC) in lieu of the regular research credit. If a taxpayer elects to be subject to this alternative regime, the taxpayer is assigned to a three-tiered fixed-base percentage (that is lower than the fixed base percentage otherwise applicable) and the credit rate likewise is reduced. Under the AIRC, a credit rate of: ... 3% applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1% but do not exceed a base amount computed by using a fixed base percentage of 1.5%; ... 4% applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1.5% but do not exceed a base amount computed by using a fixed base percentage of 2%; ... 5% applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of 2%. Under pre-Act law, the research credit, including the AIRC, was scheduled to expire and was not available for any otherwise qualifying research expenses paid or incurred after Dec. 31, 2007. AIRC terminated. Under the Act, no election of the AIRC applies to tax years beginning after Dec. 31, 2008. (Code Sec. 41(h)(2)) RIA observation: Thus, even though the regular research credit has been extended to apply to amounts paid or incurred through Dec. 31, 2009, the AIRC isn't available for tax years beginning after Dec. 31, 2008. RIA observation: Termination of the AIRC is not limited to new elections. Taxpayers who had elected the AIRC in an earlier year will no longer be able to claim the AIRC for tax years beginning after Dec. 31, 2008. These taxpayers must therefore decide whether to use the regular research credit under Code Sec. 41(a)(1) or the alternative simplified method under Code Sec. 41(c)(5). Alternative Simplified Research Credit Increased Taxpayers may elect an alternative simplified research credit (ASC) in lieu of the regular research credit. Under pre-Act law, the ASC was equal to 12% of the excess of the qualified research expenses (QREs) for the tax year over 50% of the average QREs for the three tax years preceding the tax year for which the credit is being determined. ASC rate increased. The Act increases the ASC rate to 14%. However, it expressly retains the 12% rate for tax years ending before Jan. 1, 2009. (Code Sec. 41(c)(5)(A)) RIA observation: Thus the ASC rate is raised from 12% to 14% for tax years ending after Dec. 31, 2008. RIA illustration (1): X, a calendar year taxpayer, has $500,000 of QREs for its 2009 tax year. For the preceding three tax years, X's QREs were $40,000, $50,000, and $90,000, an average of $60,000 per year. X can elect an ASC of $65,800 (.14 × ($500,000 – $30,000, which is 50% of $60,000)). RIA illustration (2): Y, a calendar year taxpayer, has $500,000 of QREs for its 2008 tax year. For the preceding three tax years, Y's QREs were $40,000, $50,000, and $90,000, an average of $60,000 per year. X can elect an ASC of $56,400 (.12 × ($500,000 – $30,000, which is 50% of $60,000)).
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