The research credit and deduction for passthrough entities.

• Author: Anderson, Kevin D.

Small and mid-size companies are eligible for a research tax credit (RTC) of up to 20% of the amount by which their qualified research expenses (QREs) in a tax year exceed their statutorily determined base amount for that year (Sec. 41). According to recent data, however, most RTCs have been claimed by large corporations (U.S. Government Accountability Office, The Research Tax Credit's Design and Administration Can Be Improved (GAO-10-136), p. 13 (Nov. 2009), www.gao.govinew.items/d10136. pdf). Tax commentators have observed that small to mid-size companies (usually passthrough entities, such as partnerships and S corporations) may be overlooking the RTC because they are not aware that they are engaged in eligible RTC activities, do not think their activities are qualified, or do not believe they can meet the various administrative and documentation requirements for claiming the RTC. Despite these reservations, many kinds of product, process, and software development projects undertaken by passthrough entities across the country may be eligible for the credit, and this item outlines some key points that passthrough entities should keep in mind when considering whether to claim RTCs.

Although the RTC in its current form expired at the end of 2011, it continues to remain relevant for credits that could not have been used in any of a taxpayer's last 15 tax years (including by reason of having net losses or being subject to the alternative minimum tax (AMT)), given that these credits can be carried forward and used against current regular tax liabilities under Sec. 39(a). (The carryforward period was changed from 15 to 20 years for credits generated in tax years beginning after 1997 by the Taxpayer Relief Act of 1997, P.L. 105-34. Therefore, RTCs generated after 1997 may be carried forward 20 years.) In addition, most commentators believe the RTC will be renewed retroactively because it has been renewed 14 times since it was first introduced in 1981, continues to enjoy widespread congressional support as a robust vehicle for creating jobs, and is a critical driver of U.S. technological progress and economic growth.

Key Points for Passthrough Entities Claiming the RTC

Individuals' limitation under Sec. 41(g): In general, for individuals who are partners in a partnership, shareholders in an S corporation, or beneficiaries of a trust or estate, the allowable passedthrough RTC cannot exceed the amount of tax attributable to that portion of the...