There are 2 ways to calculate the tax credit:

The Regular Research Credit or The Alternative Simplified Credit.

Regular research credit: The RRC is an incremental credit that equals 20% of a taxpayer’s current-year

Qualified Research Expenditures (QREs) that exceed a base amount, which is determined by applying the taxpayer’s historical percentage of gross receipts spent on QREs (the fixed-base percentage) to the four most recent years’ average gross receipts. The fixed-base percentage may not exceed 16%, and the base amount may not be less than half of the current-year QREs.

Alternative simplified credit: Since 2007, taxpayers have been able to elect the ASC, which equals 14% of the QREs for the year that exceeds 50% of the average QREs for the three previous years. If the taxpayer has no QREs in any one of the three preceding tax years, the ASC rate equals 6% of the QREs for the year.

Ways to Capture Costs for R&E Tax Credit

There are two main approaches to capturing costs – the project (also referred to as “job cost”) approach and the cost center (also referred to as “departmental”) approach. The IRS provided a briefing paper to provide guidance on the two approaches, which are illustrated below.

The Project Approach

The project (which may also be referred to as the “job cost”) approach is based on the matching principle of accounting.

The project approach directly matches costs with the activities that gave rise to them. As all costs associated with an activity are gathered together by the accounting system, qualified activities can be readily determined and matched to the costs associated with them.

The Cost Center Approach

The cost center (which may also be referred to as the “departmental”) approach is a logical grouping of activities that often follows the organizational structure of the company.

The cost center approach tracks costs based on where within the company structure the cost was incurred. A cost center may contain:

  • The activities on a single business component (in which case this approach does not differ significantly from the Project method),
  • The activities on numerous business components (which may be related to one another), or
  • The activities associated with only a portion of a particular business component.

Although there is not necessarily a direct relationship between particular costs and activities within a cost center system (so that taxpayers applying this approach instead of the project approach face the burden of establishing that the activities undertaken within each of the cost centers are qualified research), each cost center does represent a limited pool of costs and activities that are related to one another in some way.

In those situations where the costs charged to the cost center represent activities on more than one business component, a taxpayer employing the cost center approach will face the additional burden of segregating costs that do not qualify.  If the research credit computed under a cost center approach is audited and the examiner determines that non-qualified activities were charged to a cost center that the Taxpayer had considered to be composed entirely of qualified costs and activities, the Taxpayer will face the challenge of allocating costs among the activities within the cost center.

In those situations where the costs charged to the cost center represent only a portion of the activities related to a particular business component, a taxpayer employing the cost center approach may face the additional burden of associating the activities of several cost centers with the business component in order to demonstrate that the activities are qualified research.

The additional burden the taxpayer faces in computing the Research Credit under this approach partially offsets the savings that can be realized from the simplicity of implementing and administering it.

The Hybrid Approach

The hybrid approach to cost capturing is an amalgamation of the Project and Cost Center approaches.

This method may be presented as a cost center approach since the costs are accumulated from departments within the company.  It is also common for taxpayers using the hybrid approach to assert that they do not have a project accounting system in place and that this necessitated the adoption of a cost capturing approach based on the use of cost centers.  The hybrid approach adopts those portions of each approach for which records are most easily obtained.

The costs captured under the hybrid approach are generally based on the opinions of company managers delivered years after the fact.

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Learn More about the US R&E Program & How EVAMAX can help Maximize benefits through the program

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