FEDERAL Research Tax Credit Extended and Sweetened

Once again, Congress has breathed new life into the politically popular Research Tax Credit, which expired December 31, 2005. The extension was contained in The Tax Relief and Health Care Act of 2006. The politically popular Research Tax Credit was extended retroactively for qualified expenses incurred after December 31, 2005 but before January 1, 2008.

The Research Tax Credit extension goes a step further than the old credit, adding a third method for calculating the credit and sweetening another existing option for calculating it. Now, in addition to the regular research credit and the alternative incremental research credit, taxpayers will want to examine whether they should use the new alternative simplified research credit.

Reexamine Your Eligibility
Many taxpayers who in the past may have assumed that they couldn’t utilize the research tax credit should take another look in light of the new third option for computing the credit. The regular research credit relies on research spending in the 1984-1988 time frame in order to calculate the credit. Using this base period limited the use of the credit for many taxpayers, especially high tech and pharmaceutical companies that have seen their sales increase faster than qualified research expenditures. The new method allows companies to base the credit on their incremental research spending over the prior three years. With this change, these companies may qualify for a bigger research credit using this method. In addition to growth companies, the alternative simplified research credit method could be valuable for companies that have engaged in multiple acquisitions, mergers, or divestitures in recent years or that repatriated significant amounts of dividends from foreign affiliates. The alternative simplified research credit is 12% if qualified expenses exceed 50% of the average qualified research expenses for the previous three tax years.

New Effective Rates
The new law also increases the rates of the alternative incremental research credit for taxable years beginning after December 31, 2006. For tax years beginning after December 31, 2006, the new rates on the tax credits are:

• 3% (an increase from 2.65%) for qualified research expenses exceeding 1% to 1.5% of the company’s average gross receipts for the previous four years.
• 4% (instead of 3.2%) for qualified expenses exceeding 1.5% to 2% of average gross receipts for the previous four years.
• 5% (an increase from 3.75%) to the extent qualified research expenses exceed 2% of average gross receipts for the previous four years.

Companies will need to decide which method for computing the Research Tax Credit works most effectively for them. Companies whose ability to claim the credit was limited by higher research spending in prior years will find the alternative simplified method especially appealing.

Determine Which Credit Is Appropriate
In determining whether to use the alternative simplified research credit or the alternative incremental research credit instead of the regular credit, taxpayers should examine their future sales, research spending and investment plans. Once the taxpayer elects to use either the alternative simplified research credit or the alternative incremental research credit, the selection cannot be revoked in future years without a Private Letter Ruling from the Secretary of the Treasury.

Taxpayers have not heard the last word on the Research Tax Credit. While Congress and the Bush Administration extended the credit and enabled more companies to claim it, the extension is only for two years, retroactive to the earlier expiration at the end of 2005. The Congress will consider yet another extension of the Research Tax Credit during 2008, a Presidential election year.

For more information, please contact Peter Orfanakos at porfanakos@gellerco.com.