July/August 2007 |
Extra credit The research and development (R&D) credit has been around for more than 20 years. And despite continual efforts by supporters to make the credit permanent, the tax break remains a temporary one. Nevertheless, each time the credit has expired, Congress has renewed it. Most recently, the R&D credit expired at the end of 2005. But the Tax Relief and Health Care Act of 2006 (TRHCA) extended the credit for another two years, through the end of 2007. The act does more than simply revive the credit, though. It also increases the credit for some companies and establishes an alternative, simplified credit that may make these benefits available to businesses that had trouble qualifying in the past. Reviewing the prerequisites If your company invests in new product development, process improvement or software development, it pays to determine whether you’re eligible for the R&D credit. Organizations in a broad range of industries — including manufacturing, distribution, construction, health care, technology, finance, agriculture and retail — have been able to take advantage of this tax break. To qualify for the credit, your R&D activities must pass these four tests:
Several types of activities are ineligible. They include research conducted after commercial production begins; research used to adapt or reproduce existing business components; and research related to style, taste, cosmetic or seasonal design factors. Doing the math Once you’ve identified your qualifying research activities, you can determine the related expenses that qualify for the credit. Qualified research expenditures (QREs) generally include supplies, W-2 wages for employees conducting research, and 65% of consultants’ fees. The “traditional” R&D credit is equal to 20% of the amount by which your QREs exceed a base period amount. That amount is calculated by determining your ratio of QREs to gross receipts from 1984 to 1988 and multiplying it by your average gross receipts (AGR) for the previous four tax years (that is, for 2007 you’d use your AGR for 2003 through 2006). Regardless of that result, your base period amount can’t be less than 50% of your QREs in the current year. There are special rules for companies that didn’t exist from 1984 to 1988 or that lacked sufficient QREs or gross receipts during that period. Or businesses can elect to use an alternative incremental credit that doesn’t require data from the 1984 to 1988 base period. The TRHCA increases the rates used in this approach. For 2007, the incremental credit is equal to:
The most significant change is the new alternative simplified credit. In the past, the gross receipts requirement was an obstacle for many companies. If your gross receipts grew rapidly, for instance, you may have had trouble qualifying for the R&D credit. The simplified credit eliminates gross receipts from the equation. Beginning this year, you can claim a credit equal to 12% of the amount by which your current-year QREs exceed 50% of your average QREs for the previous three years. If you had no QREs during those years, the credit is 6% of the current year’s QREs. Finishing your homework The TRHCA extends the R&D credit retroactively to the beginning of 2006. If you’ve qualified for this credit in the past or if you believe you may qualify now, review last year’s expenses and be sure you’re getting the credit you deserve. Also, work with your |