When to elect the reduced R & D credit (under sec. 280C).

• Author: Touger, Steven
• Position: Research and development

Taxpayers eligible for the research and development (R&D) credit can elect to take either:

1. a 20% credit and add the credit amount back to taxable income; or

2. a 13% credit without any addback (Sec. 280C(c)(3)).

This is an irrevocable election that can only be made on the original tax return filed for the tax year.

Although some states have R&D credits, they usually do not resemble the Federal credit. However, since Federal taxable income is the starting point for computing state or local taxable income, in nearly every state the deduction added back when a full Federal credit is taken will likewise be added back for state and local purposes.

Take full credit when in 15% or 25% corporate tax bracket

A corporation will generally benefit by taking the full 20% credit (choice #1) when it is in a tax bracket lower than 34%; the tax effect of the addback will not be an additional 7% of taxes (the difference between 20% and 13% by electing the reduced credit).

Example 1: For a corporate taxpayer in the 25% Federal bracket, with an effective state and local tax rate (net of Federal benefit) of 6%:

Creditable base $50,000 Full credit x 20% Credit 10,000 Federal effect of $10,000 lost deduction ($10,000 x 25%) (2,500) State effect of $10,000 lost deduction ($10,000 x 6%) (600) Net benefit of a full credit 6,900 Creditable base 50,000 Reduced credit x 13% Federal benefit of a reduced credit 6,500 Total tax savings by taking full credit $ 400

However, if the corporation does substantial business in the Northeast states, where an effective state and local tax rate of 9% or higher is not unusual, the tax savings from taking the full credit might be mitigated or eliminated.

Take reduced credit when in 34% or higher corporate tax bracket

For Federal purposes, it generally makes no difference whether a corporation elects the full 20% credit or the 13% reduced credit when it is in the 34% or 35% bracket; the effect of the addback would approximate 7% (35% x 20%). However, taking a reduced credit would result in a state tax savings.

Example 2: For a corporate taxpayer in the 35% bracket, with an effective state and local tax rate (net of Federal benefit) of 6%:

Creditable base $50,000 Full credit x 20% Credit 10,000 Federal effect of $10,000 lost deduction ($10,000 x 35%) (3,500) State effect of $10,000 lost deduction ($10,000 x 6%) (600) Net benefit of a full credit 5,900 Federal benefit of reduced...