Overview of 2005 developments on the research credit.

• Author: Arkin, Steven D.

The scope and interpretation of the research credit (Sec. 41) were shaped by several significant developments during 2005. The credit was expanded by the Energy Policy Act of 2005 (EPA) (P.L. 109-58). Important guidance on computing the credit and allocating it among control group members appeared in temporary regulations (TD 9205). Also, these regulations simplified electing in and out of the alternative incremental research credit (AIRC) regime.

At the start of 2006, Congress was poised to enact another one-year extension of the research credit (which otherwise expired on Dec. 31, 2005) as part of the budget reconciliation process, and to expand further the options for computing it.

EPA

Among a variety of tax provisions enacted to promote energy production and conservation, the EPA expanded the Sec. 41 research credit in two respects. First, it added new Sec. 41(b) (3) (D), which allows taxpayers to claim 100% (rather than only 65% as under old law) as a "contract research expense" when they pay a small business, university or Federal laboratory for energy research conducted on the payor's behalf. Second, the EPA also added new Sec. 41(a)(3), which allows taxpayers to claim a separate 20% credit for payments they make to an "energy research consortium," regardless of whether the base amount computed for regular credit (i.e., for Sec. 41(a)(1)) purposes is exceeded. Both provisions are effective for expenses paid or incurred after Aug. 8, 2005.

Although the term "energy research" is not defined by statute, the EPA's legislative history indicates that the research must relate to production, supply or conservation of energy, such as efforts to develop hydrogen fuel cell vehicles or efforts to improve the energy-efficiency of lighting. Thus, the new research credit provisions apply to a wide variety of businesses (e.g., consumer product manufacturers), not merely to those commonly thought of as comprising the "energy industry."

Of the two research credit provisions contained in the EPA, new Sec. 41(a)(3) offers taxpayers the most potential benefit, while also raising more interpretive questions. Initially, it appeared that a taxpayer could claim the same payment made to a research consortium as eligible for both the regular, incremental credit computed under Sec. 41(a)(1) and the new, nonincremental credit computed under Sec. 41 (a)(3). More recently, however, this opportunity to "double dip" was eliminated retroactively by tax technical corrections provisions in the Gulf...