Research tax credit - It’s back!
The Act includes extensions for certain expired tax provisions and has numerous implications for both individual and business taxpayers. Among important provisions for business taxpayers is the reinstatement of the research credit for two years, retroactively, for qualifying research expenses (QREs) paid or incurred from January 1, 2012, through December 31, 2013.
This marks the 15th time the research credit has been extended since its enactment in 1981. The Act does not provide any special relief to fiscal year taxpayers who previously filed a tax return claiming a credit for a tax year ending in 2012.
Fiscal year taxpayers who have already filed a tax return have the opportunity to amend their return to claim the full amount of the research credit to which they are now entitled for expenditures incurred subsequent to December 31, 2011.
The Act would make two substantive changes to the credit, effective for tax years beginning after December 31, 2011.
1. First, the law amends the rules for computing the credit when there is an acquisition of a major portion of a trade or business or a separate unit of a trade or business (e.g., an asset purchase). Prior to enactment of the Act, following an asset acquisition, the acquirer (purchasing taxpayer) included in its current year QREs the pre-acquisition QREs of the acquired entity. The base period amounts of the entity being acquired were also included in the acquirer’s (purchasing taxpayer’s) QREs at “non-prorated” or “full year” amounts as well, for consistency purposes.
Effective for asset acquisitions occurring after December 31, 2011, the Act no longer allows for full year (i.e., pre-acquisition) QREs to be included in current year QRE of the acquirer. Instead, the acquirer (purchasing taxpayer) would include a prorated amount of the acquired trade or business's QREs (and/or gross receipts) for the portion of the credit year beginning on the date of the acquisition and ending on the last day of the tax year of the acquirer (i.e., post-acquisition time period). The base amounts also is to be pro-rated accordingly (i.e., representing the base period impact related to the post- acquisition time period). In the event the acquirer has a different tax year than the acquired entity, the tax years of the acquirer entity are used to compute the proration, and for base period purposes, the earlier tax years of the acquirer are to be used.
Calendar year Corporation A buys a trade or business of Corporation B on September 1, 2012. Corporation B’s trade or business generates QREs throughout 2012. In computing Corporation A's research credit for 2012, using the Alternative Simplified Credit (ASC), Corporation A includes the prorated QREs of the trade or business for the post acquisition period of 2012 only (122/365 days) in its current year QREs. In computing Corporation A's base amount for 2012, it includes the same proration (122/365) of the QREs paid or incurred by the trade or business during each of the three preceding calendar years (i.e., Corporation A's 2009, 2010, and 2011 tax years).
In computing A's research credit for first post acquisition year, tax year 2013, Corporation A includes the full amount of the QREs paid or incurred by the trade or business during calendar years 2010, 2011, and 2012, including the QREs paid or incurred during January through August 2012.
A reciprocal rule would allow the disposing taxpayer (i.e., Corporation B, in this example), to similarly reduce its QREs and gross receipts for its base period if it provides the acquiring taxpayer the information necessary to adjust the acquiring taxpayer's base amount.
Taxpayers need to provide a “Section 41(f) letter” to the acquiring company and retain a copy of this letter in their files to support the reduction to its base period.
2. Second, prior to the passage of the Act, the allocation of the group credit among the members of a controlled group would be made according to each member’s proportionate share of QRE or credit amount. The determination was made based upon whether the controlled group credit exceeded the sum of the credit amount of each of the controlled group members. The Act includes a provision that states that the controlled group credit allocation must be made strictly in proportion to the QREs of each member for the credit year.
This modification therefore eliminates the need to compute stand-alone entity credit calculations for each member of the controlled group, often times requiring each member to calculate the credit under more than one credit method.
What if taxpayer had a fiscal year-end during 2012 and already filed / claimed the research credit?
In the event a taxpayer with a tax year that ended during calendar year 2012 had to forgo a portion of its research credit due to the extension being enacted subsequent to the tax filing deadline, an amended return can be filed to claim the research tax credit benefit for that portion of the research credit attributable to the time period for which the research credit had lapsed.
There are important issues to consider regarding both the calculation of the benefit and the filing of an amended return. And while the IRS has altered its prior position designating the research credit as a “Tier One” issue when claimed on an amended return for examination purposes, consideration needs to be given so that the proper level of documentation of qualified activities and related expenditures exist.
KPMG observation (planning)
The research credit extension is for two years, thereby providing more certainty in planning R&D related investments.
Taxpayers awaiting a reinstatement of the credit since its expiration on December 31, 2011, may now have the opportunity to fund research projects/investments that otherwise might not have been possible.
Further, taxpayers need to make certain that they have a process in place to substantiate qualified research activities and their related expenditures for both the 2011 and 2012 tax years—keeping in mind that the IRS views records kept contemporaneously as more credible in supporting a taxpayer’s research credits.
For assistance with the R&D credit process, contact a KPMG research credit professional who can assist with the required analysis and documentation associated with research credit claims currently, prior year amendments, and establishing “go-forward” processes. KPMG also recently developed an on-line tool that uses technology to gather the necessary documentation (technical and financial) while bringing efficiency to the process.
For more information, contact a KPMG Research Credit Services tax professional:
Kathleen Milone, (author of this report)
David Culp, Washington National Tax
Chris Kachinsky, East Coast Leader
Adam Boyar, West Coast Leader