Lack of gross receipts does not preclude taxpayers from claiming R&D credit.

• Author: Avakian, Nick
• Position: Research and development

Since its enactment in 1981, the credit for increasing research activities (R&D credit) contained in Sec. 41 has provided an incentive for U.S. companies to conduct domestic research to develop and introduce new and improved products. The R&D credit has served as a business stimulus by retaining and creating U.S. jobs, generating intellectual property, introducing new products in the United States, and increasing the efficiency and competitiveness of U.S. companies in the world marketplace. (When this item was written, the Sec. 41 R&D credit had expired at the end of 2011, and no action had been taken to extend it; however, Congress has often retroactively reinstated the credit.)

Sec. 41(a)(1) provides an incremental tax credit for increasing research activities equal to 20% of a taxpayer's qualified research expenses (QREs) for a given tax year above a base amount, which generally requires a taxpayer to have gross receipts in one of its tax years before the credit can be claimed. Because of the complexity of the rules for calculating the credit, Congress added the alternative simplified credit (ASC) as part of the Tax Relief and Health Care Act of 2006, P.L. 109-432. Under Sec. 41(c)(5), a taxpayer may elect to take an ASC equal to 14% of the excess of QREs for the tax year over 50% of the average QREs for the three preceding tax years. If a taxpayer has no QREs in any one of the three preceding tax years, the ASC equals 6% of the QREs for the tax year for which the credit is being determined.

Prior to the ASC, it was generally assumed that start-up companies that had yet to sell any of the products they were developing could not claim the R&D credit because they did not have any gross receipts and therefore could not compute an appropriate base amount as required under Sees. 41(c)(1) and 41(c) (3)(B). The ASC provides a welcome mechanism for claiming the credit under these circumstances. However, the ASC must be claimed on an originally filed return, meaning that, if a credit was not claimed on a prior open tax year return, a taxpayer cannot amend those returns to claim the credit.

The market-based economy in the United States has been built by people who set out to put their ideas into practice and develop products well before a market existed for those products. These types of entrepreneurial activities carry tremendous risks. An example today would be a technology or software company seeking to develop the next best software platform...