Good news: After keeping taxpayers on tenterhooks for virtually all of 2014, Congress enacted the Tax Increase Prevention Act (TIPA) late in December.
TIPA extends, retroactive to Jan. 1, 2014, a host of tax provisions that had expired, including the research and development (R&D) tax credit, which is crucial for many manufacturers.
However, the law restored the tax credit only until Dec. 31, 2014. This means manufacturers can claim the credit only on their 2014 tax returns. Congress may consider extending the credit for 2015 and perhaps beyond.
History of the Credit
The R&D credit was introduced in the 1980s as an incentive for manufacturers and others to engage in research. But it was temporary and each subsequent extension has also been temporary, generally lasting only a year or two. TIPA marks the 16th extension.
Since its inception, the R&D credit has been modified several times. On 2014 returns, the credit is equal to the sum of:
- Twenty percent of the excess of qualified research expenses for the year over a base amount (or an alternative simplified credit of 14 percent of the amount by which qualified expenses exceed 50 percent of the average for the three preceding tax years);
- The university basic research credit (in other words 20 percent of the basic research payments); and
- Twenty percent of the qualified energy research expenses undertaken by an energy research consortium.
The base amount is a fixed-base percentage (not to exceed 16 percent) of the average annual receipts, net of returns and allowances, for the four years preceding the year the credit is claimed. It cannot be less than 50 percent of the annual qualified research expenses.
In other words, the minimum credit is equal to 10 percent of qualified research expenses (50 percent rule times the 20 percent credit).
The extended research credit is only available when:
- Expenses qualify as a “research and experimentation expenditure” under Section 174 of the tax code (see right-hand box);
- Costs 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; and
- 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.
Some critics have complained about the temporary nature of the research credit. Although previous proposed legislation would make it permanent, the credit has remained a year-to-year proposition thus far.
Modifications to the Credit
Previously, when one firm acquired another, the research credit allowable to the acquiring firm for any tax year ending after the acquisition was computed by increasing its qualified research expenses by the amount of qualified research expenses of the acquisition “target.”
It also increased its gross receipts by the gross receipts of the predecessor attributable to the portion of the business acquired. Over the years, IRS provided varying interpretations of how to calculate the research credit for a consolidated group’s mid-year acquisition of a target.
For tax years beginning after 2011, in addition to the acquiring firm’s own qualified research expenses paid or incurred during the “measurement period,” the company takes into account certain of the predecessor’s expenses. Gross receipts for the measurement period are also increased by certain gross receipts of the target.
The measurement period is, for the tax year of acquiring firm for which the research credit is determined, any period preceding the tax year which is taken into account for purposes of determining the credit for the year. No expiration date is provided for these changes, but they are tied to the applicability of the research credit.
Lessons to be learned: First, maximize the tax benefits for your firm’s research by claiming the appropriate credit amount on your 2014 tax return. Second, implement a plan of action for 2015 that is sensible regardless whether the credit is reinstated again.