IRS Addresses Election, Calculation of Alternative Simplified Research Credit

Pharma and Life Sciences Tax News - Vol 7, No. 9

The IRS issued temporary regulations on election and calculation of the alternative simplified research credit (ASC) under section 41(c)(5), which became effective generally for tax years ending after 2006. Under the ASC, the credit generally equals 12 percent of so much of the taxpayer's qualified research expenditures (QREs) for the calculation tax year as exceeds 50 percent of the average QREs for the three preceding tax years.

The new regulations provide important guidance regarding ASC elections and revocations, as well as calculating the credit for short tax years or for tax years during which the credit lapses. All section 41 credit provisions terminated for amounts paid after 2007; bills to restore the credit retroactively are pending in Congress

New Regulations

The temporary regulations generally provide the same rules related to elections and revocations as those provided for the alternative incremental research credit (AIRC) in Reg. sec. 1.41-8.

An ASC election applies to the tax year for which made and all succeeding tax years unless revoked with IRS consent (as described below).

The ASC election is made by completing the applicable portion of Form 6765, Credit for Increasing Research Activities, and attaching the completed form to the taxpayer's timely filed (including extensions) original return for the tax year to which the election applies.

For a controlled group of corporations, all the members of which are not included on a single consolidated return, an election or revocation must be made by the designated member and is binding on all the members of the group for the credit year to which the election or revocation relates. If the designated member fails to timely make or revoke an election, each member of the group must compute the group credit using the method used to compute the group credit for the immediately preceding credit year.

The regulations provide that a taxpayer is deemed to have requested, and to have been granted, IRS consent to revoke an ASC election if the taxpayer completes the portion of Form 6765 relating to the credit determined under the Regular Credit or the AIRC and attaches the completed form to the taxpayer’s timely filed (including extensions) original return for the year to which the revocation applies. As is the case with a revocation of an AIRC election under Reg. sec. 1.41-8, an ASC election under section 41(c)(5) may not be made or revoked on an amended return.

Observation : Significantly, even though the ASC is a dramatically different method of calculating the credit and was the subject of little transitional guidance, the temporary regulations provide that an extension of time to make or revoke an election under section 41(c)(5) (and similarly, under section 41(c)(4)) will not be granted under Reg. sec. 301.9100-3.

The temporary regulations include several special rules :

  • Unless a taxpayer has QREs in each of the three tax years preceding the tax year for which the credit is being determined, the credit equals the percentage of the QREs for the credit determination tax year provided by section 41(c)(5)(B)(ii) -- that is, 6 percent rather than 12 percent (both rates assume no timely section 280C(c)(3) election is made).
  • A consistency requirement provides that QREs for the three tax years preceding the credit year must be determined on a basis consistent with the definition of QREs for the credit year, without regard to the law in effect for the three tax years preceding the credit year.
  • If one or more of the three tax years preceding the credit year is a short tax year, the QREs for that year are deemed to be equal to the QREs actually paid or incurred in that year multiplied by 12 and divided by the number of months in that year. If a credit year is a short tax year, the average QREs for the three tax years preceding the credit year are modified by multiplying that amount by the number of months in the short tax year and dividing the result by 12.

  • Taxpayers need to analyze the availability and advisability of calculating the credit under the three possible methods -- the regular research credit, the AIRC, and the ASC -- because the method selected must be used on the taxpayer’s original timely filed return (including extensions) and is binding for future periods unless revoked by choosing a different method on a timely filed original return (including extensions) for a subsequent tax year. Taxpayers also should consider whether to make a section 280C(c)(3) election on each year’s timely filed original return (including extensions), as that election or non-election is binding for that tax year.
  • The rules for identifying the designated member -- the member of a controlled group that decides which of the three methods of credit calculation the entire controlled group will be using for each credit determination year -- must be carefully considered and applied.
  • Given the IRS’s current approach of vigorously examining base period items under the regular research credit method of section 41(c)(1)-(3), taxpayers should be sure that they comply with the ASC consistency requirement regarding the way QREs are calculated in credit determination years as well as the preceding three years.
  • Also reflecting the recently released Audit Techniques Guide, the preamble to the regulations notes that "the IRS may deny the credit for failure to provide sufficient records substantiating the claimed credit for any method used in determining the research credit."