What Costs Qualify for the R&D Credit?
The costs eligible for the R&D credit are called QREs (Qualified Research Expenses) and are defined as the sum of in-house research expenses and contract research expenses. In-house research expenses generally include wages paid to employees on a qualified project, and any amounts paid or incurred as supplies used in the conduct of qualified research. Contract research expenses are 65% of any amount paid to third party for conducting qualified services on behalf of the taxpayer.
Computation of the R&D Credit
To calculate the R&D credit, the taxpayer must determine its QREs (see above) in excess of a ‘base amount’ for each year. The term ‘base amount’ is defined by multiplying the ‘fixed-base percentage’ by the average annual gross receipts of the taxpayer for the prior four taxable years.
This fixed-base percentage is a formula in which the numerator is the aggregate qualified research expenses of the taxpayer for taxable years beginning in 1984 through 1988. The denominator of the fixed-base percentage is the aggregate gross receipts of the taxpayer for the 1984-1988 period.
The Alternative Simplified Credit (ASC)
The ASC approach enacted in 2006 makes this calculation a bit easier with respect to the ‘base amount’ – rather than utilizing information from 1984-1988, a taxpayer can now elect on an originally filed return to utilize the ASC to calculate its R&D credit.
The Alternative Simplified Credit equals 12 percent of the excess of current-year QREs over 50 percent of the taxpayer’s average QREs for the prior three years. For start-up taxpayers, the credit would equal 6 percent of current-year QREs.
This ASC calculation may be greatly beneficial to companies who have gone through changes in business models or economic changes in the industry where their proportional spending on R&D relative to gross receipts/sales has not kept pace in recent years.
The ASC also permits companies to claim the R&D credit who may have had trouble documenting the historical 1984-1988 base period due to the passage of time and/or record retention issues. In fact, there have been recent proposals in Congress to not only make the R&D credit permanent, but to eliminate the historical 84-88 base period in favor of the easier to apply ASC approach.
Contact us today to learn more about how we can assist in securing you R&D Tax Credits.