Research Credit Computation Methods
The two methods used to compute the credit are the regular method that provides for the 20% credit, or the simplified method which is easier to document but results in reduced credit amounts. The simplified method is the method used by most small businesses. CAUTION: Many provisions related to the regular method are not included in this description of the research credit.
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Regular Method - Under the regular research credit method, the credit equals 20% of qualified research expenditures for a tax year over a base amount established by the taxpayer in 1984–1988 or by another method for companies that started up subsequently., This method may be best for companies that can document a low base amount.
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Simplified Method - The alternative simplified method credit equals 14% (12% for years prior to 2009) of qualified research expenses over 50% of the average annual qualified research expenses in the three immediately preceding tax years. If the taxpayer has no qualified research expenses in any of the three preceding tax years, the alternative simplified method credit may be 6% of the tax year’s qualified research expenses. This method may be the best choice for taxpayers with incomplete records from the mid-1980s, those complicated by mergers and acquisitions, or taxpayers with a high base amount from that period.
Base Amount - The base amount is a fixed-base percentage of taxpayer's average annual gross receipts from a U.S. trade or business (including any foreign sub's gross receipts), net of returns and allowances, for the 4 tax years before the credit year, and can't be less than 50% of the year's qualified research expenses. The fixed base percentage for a non-start-up company is the percentage (not exceeding 16%) that taxpayer's total qualified research expenses is of total gross receipts for tax years beginning after '83 and before '89. (Code Sec. 42(c))
Except when a taxpayer elects the alternative simplified research credit the Code assigns a fixed-base percentage of 3% in making the base amount computation for each of its first 5 tax years in which a “start-up company” has qualified research expenses. (Code Sec. 41(c)(3)(B)(ii)(I)) For the second 5 tax years, the fixed-base percentage is a specified amount of the ratio or percentage that is increased annually during this second 5-year period and is determined by dividing qualified research expenses by gross receipts.