The recently enacted Emergency Economic Stabilization Act of 2008 includes the long-awaited extension of the IRC § 41 research credit. The credit had expired at the end of 2007, but the act extends it to apply to amounts incurred after Dec. 31, 2007, and before Jan. 1, 2010.
Under section 41, taxpayers can receive credit for a portion of their expenditures on certain types of qualified research. Expenditures eligible for the section 41 credit are generally limited to research or experimental expenditures eligible for expense treatment under section 174. In addition, section 41(d) contains three other requirements: (1) the research must be for the purpose of discovering information technological in nature; (2) substantially all of the research activities must constitute an experimentation process; and (3) the experimentation must relate to a qualified purpose. Research for “a qualified purpose” relates to a new or improved function, performance, reliability, or quality of a business component.
The Emergency Economic Stabilization Act made a couple of changes to the research credit: The credit rate under the alternative simplified credit (ASC) method is increased from 12% to 14%, but only for tax years ending after Dec. 31, 2008. Also the alternative incremental research credit (AIRC) is eliminated for tax years beginning after Dec. 31, 2008.
The ASC simplifies the calculation of the research credit by using only the taxpayer’s average qualified research expenditures (QREs) incurred over the prior three-year period, with no inclusion of gross receipts in any portion of the calculation. In addition, the ASC includes a special provision that allows taxpayers to take the credit even if they do not have QREs in all three of the preceding tax years.
The ASC is calculated by multiplying the total amount of current-year QREs that exceed 50% of the average QREs of the three prior tax years by (now) 14%. For taxpayers that did not have QREs in any of the three prior tax years, the credit is calculated using 6% of current-year QREs.
Given the current state of the economy, this retroactive extension potentially creates both cash benefits and earnings-per-share benefits for taxpayers. Taxpayers will need to consider the financial statement effect of the research credit’s availability for 2008. Taxpayers will also need to consider the effect of the retroactive extension on their estimated tax payments for the 2008 tax year. Fiscal year taxpayers that have already filed their 2007 tax year returns will need to consider filing amended returns to claim research credits related to the period for which the credit had expired.
Taxpayers that are not currently reporting research credits under the ASC method will need to analyze the effect of the ASC rate increase beginning with tax years ending after Dec. 31, 2008. Fiscal year taxpayers whose 2007 tax year has already closed and who are therefore already in their fiscal year ending after Dec. 31, 2008, are currently subject to the new 14% ASC rate. Also, taxpayers that are currently using the AIRC method will need to evaluate whether to use the regular credit or ASC for tax years beginning after Dec. 31, 2008.
For a detailed discussion of the issues in this area, see “Research Credit Extended,” by Anthony J. Mondoro Jr., CPA, and David Hudson, Esq., LL.M., in the January 2009 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also look for articles on the following topics in the January 2009 issue of The Tax Adviser:
- What CPAs should know about tax fraud.
- Filing season update.
- Recent corporate tax developments.
The Tax Adviser is the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 1-800-513-3037 or e-mail firstname.lastname@example.org for a subscription to the magazine or to become a member of the Tax Section.