Enhanced research credit for 2007.

• Author: Arkin, Steven D.

In one of its last actions before adjournment, Congress voted to extend the research tax credit so that qualified research and development (R&D) expenses incurred in 2006 and 2007 are eligible for the credit. This legislation was signed into law on Dec. 20, 2006, as part of the Tax Relief and Health Care Act of 2006. The legislation not only extends for two years the research credit provisions previously in effect through 2005, but also expands the Sec. 41 regime in two important respects:

* The current-law alternative incremental research credit (AIRC) rates of 2.65%, 3.2% and 3.75% are increased to 3%, 4% and 5%, respectively; and

* Taxpayers have the option of computing the credit under a new alternative simplified credit (ASC) regime, which in most cases will provide a 12% credit on about half of the company's current qualified research spending. The new ASC is determined without regard to the "regular" base amount calculation that otherwise takes into account gross receipts and research spending during a historic base period (generally, 1984 to 1988).

Effective Date

These two "expansions" of the research credit are effective prospectively only, for tax years ending after 2006. Consequently, for tax years ending before 2007, taxpayers have the option (as under the old law) of claiming either the regular 20% credit or the AIRC with a top rate of 3.75%.

For tax years ending after 2006 (i.e., either calendar-year 2007 or fiscal years that include a portion of 2007), taxpayers have three options: they can claim a regular 20% credit, use the AIRC with a top rate of 5% or claim the new ASC (12% rate). Calendar-year taxpayers can simply use whichever of the three computation methods generates the largest expected benefit for calendar-year 2007. For fiscal-year taxpayers, however, the computation will be more complex; a special transition rule effectively allows such taxpayers to claim the enhanced AIRC with a top rate of 5% or the new ASC, but only for the portion of the fiscal year that falls within 2007.

New ASC

A taxpayer that elects the ASC option for a tax year ending after 2006 can claim a credit of 12% of its current-year qualified research expenses (QREs) that exceed 50% of its average QREs for the three preceding tax years. In effect, a taxpayer with relatively constant qualified research spending in recent years will be able to claim an ASC credit of approximately 6% of total QREs. As with the other credit options, the ASC is subject to the Sec. 280C(c) "cutback" rule, which generally reduces the value of the credit by 35%.

State tax implications: While many states "piggyback" on the Federal research credit provisions, no state has yet adopted the additional ASC option. However, California and other states may consider adding a similar ASC option to their tax credit regimes. Because California and other states do not bind taxpayers to the method used for computing a research credit on their Federal returns, it may be possible to adopt the ASC for state purposes, while claiming the "regular" credit on the Federal return (or vice versa).

Who will benefit?: Many...