State research credits.

• Author: Gantman, Andrew
• Position: California

Congress recently extended the federal research credit under Sec. 41 for amounts paid or incurred before January 1, 2010, and certain states also provide credits for qualified expenditures. However, many states impose additional requirements on the computation of the state credits (e.g., activities must be conducted in the state or computations of base amounts differ) that are easily overlooked hut can have substantial impact. Accordingly, it makes sense to revisit how these state rules might affect clients.

Note: At the time of this writing, more than half the states provide some sort of tax credit for expenses paid or incurred with respect to a taxpayer's qualified research activities. Because a review of each state's provisions is beyond the scope of this item, it will focus on some of the more interesting California provisions under CA Rev. & Tax. Code 523609. In addition, the federal and California research credit provisions also provide benefits for amounts paid for "basic research," but those are also outside the scope of this item.

Background

The federal research credit was originally enacted in 1981 and was intended in large part to spur domestic innovation. It took the form of a nonrefundable credit against income tax available to taxpayers for certain qualified expenditures that exceeded a defined base amount (Sec. 41(c)).

In computing the credit for both federal and California purposes, it is important to remember that there are various methods to consider, depending on whether the company had sufficient activity in the 1984-88 time period, whether the taxpayer wants to elect the alternative simplified method or the alternative incremental method, whether the taxpayer is a member of a group of businesses that must aggregate their activities, and so on.

However, for the sake of this discussion, the standard method of computing the credit is as follows (for both federal and California) for businesses that are not startups:

1. Take the total of the taxpayer's qualified research expenditures for tax years beginning after December 31, 1983, and before January 1, 1989.

2. Divide that total by total gross receipts for those same years. The resulting percentage is the fixed-base percentage, which, per Sec. 41(c)(3)(C), cannot be greater than 16%.

3. Take the average gross receipts for the four years preceding the current year and multiply that amount by the fixed-base percentage (Sec. 41(c)(1)). The result is the tentative base amount.

4. ...