The final step in computing the R&E credit.

• Author: Goldbas, Michael
• Position: Research and experimentation tax credit

The Sec. 41 research and experimentation (R&E) credit presents practitioners with numerous challenges, especially as to substantiation and base amount issues. While many articles have addressed these concerns, the final step in the computation of the research credit has received little attention. This step is set forth in Sec. 280C and is intended to eliminate the potential windfall from claiming a current Sec. 174 deduction for research expenditures and a Sec. 41 research credit for the same expenses.

While Form 6765, Credit for Increasing Research Activities, navigates the practitioner through the Sec. 280C adjustment, recent IRS pronouncements indicate that tax advisers need to pay greater attention to this somewhat obscure provision. This item examines these rules and explores some easily overlooked issues.

Sec. 280C's Affect on the Research Credit Calculation

Under Sec. 174, taxpayers can elect to deduct all qualified R&E expenses currently or to amortize them ratably over a period of not less than 60 months. This can be done without the Service's consent, if the expenditures are currently deducted when first incurred. In addition, taxpayers can claim a Sec. 41 credit for incremental "qualified research expenses" (QREs). For purposes of this credit, these expenses are a subset of qualifying Sec. 174 expenses. This is evident from the definition of "qualified research" in Sec. 41(d), which provides that the expenses incurred in the activity must first qualify under Sec. 174 and also pass a (1) business component test (See. 41(d)(1)(B) (ii)) and (2) process-of-experimentation test (See. 41(d)(1)(C)). Further, the activities cannot fall within the scope of eight Sec. 41(d)(4) ineligible activities. Expenses that qualify under Sec. 41 are more limited than under Sec. 174. For example, 100% of contractor fees incurred to perform research qualify under Sec. 174, but only 65% of otherwise qualifying expenses are includible under Sec. 41(b)(3)(A).

Sec. 280C(c)(1) and (2) require taxpayers to reduce R&E deductions by the Sec. 41(a) research credit, when computed at the 20% statutory rate; this is often referred to as the 280C "addback" to taxable income. Taxpayers may, however, elect under Sec. 280C(c) (3) to take the Sec. 41 credit at a 13% rate in lieu of reducing deductions and computing the credit amount at 20%. The election must be made on a timely filed Form 6765 by writing at line 16, "Sec. 280C."

Example 1--nonelective Sec. 280C...