The credit rewards increasing research, so both methods measure the current year's qualified research expenses against a base and credit only the excess. The regular credit is 20% of qualified research expenses above a base amount. The alternative simplified credit, the ASC, is 14% of qualified research expenses above 50% of the average for the previous three years. The choice is made each year on the return, and the arithmetic decides it.
What it is
| Regular credit | Alternative simplified credit | |
|---|---|---|
| Rate | 20% of QREs above the base amount | 14% of QREs above 50% of the average QREs for the three preceding years |
| Base | Fixed-base percentage multiplied by average annual gross receipts for the four preceding years, but not less than 50% of current QREs | 50% of the three-year average of QREs |
| Fixed-base percentage | Ratio of QREs to gross receipts for 1984 to 1988, capped at 16%; start-up companies use 3% for their first five years with QREs and gross receipts, then a transition formula | Not used |
| No prior QREs | Start-up rules | 6% of current QREs if there were no QREs in any one of the three preceding years |
| Data needed | Gross receipts for four prior years, historic QREs and receipts for the fixed base | QREs for three prior years only |
| Election | Default | Elected on the return; may be elected on an amended return provided no research credit was previously claimed for that year on an original or amended return (Treasury Regulation 1.41-9(b)(2)) |
Who it applies to
Every claimant chooses between the two. In practice the ASC is used by most companies because it needs only three years of QREs, while the regular credit needs gross receipts history and, for companies that existed in the 1980s, data from 1984 to 1988. The regular credit can be worth more to a company whose research spending is high relative to its gross receipts, or whose fixed-base percentage is low; it is worth computing both before deciding. Under either method the reduced credit can be elected under section 280C(c), which lowers the rate to 15.8% regular or 11.06% ASC in exchange for not reducing the research expense deduction.
How it works
Alternative simplified credit. Add the QREs for the three preceding years and divide by three. Take half of that figure. Subtract it from the current year's QREs. Multiply the excess by 14%. If the company had no QREs in any one of the three preceding years, the credit is 6% of the current year's QREs instead. For a company whose QREs are flat year on year, the excess is half of the current QREs, so the ASC works out at 7% of total QREs; for a company growing fast it approaches 14%.
Regular credit. Compute the fixed-base percentage. Multiply it by the average annual gross receipts of the four preceding years to get the base amount, subject to the floor of 50% of current QREs. Subtract the base amount from current QREs and multiply the excess by 20%. Because of the 50% floor, the regular credit can never exceed 10% of current QREs.
The 280C(c) election. Without the election, the deduction for research expenses (or the amount charged to capital under section 174) is reduced by the credit, so part of the credit's value is given back as extra taxable income. The election takes a smaller credit instead: the credit is reduced by the product of the credit and the maximum corporate tax rate, which at a 21% rate gives 15.8% and 11.06%. For a corporation at the 21% rate the two routes give the same after-tax result; the election is simpler and avoids the deduction adjustment. It must be made on a timely filed original return, including extensions.
Worked example
Illustrative example. Vantage Optics, a hypothetical company, has QREs of US$1,000,000 this year and US$700,000, US$800,000 and US$900,000 in the three preceding years. Its average annual gross receipts for the four preceding years are US$20,000,000 and its fixed-base percentage is 3%.
| Step | Alternative simplified credit | Regular credit |
|---|---|---|
| Base | Average of prior three years US$800,000; 50% = US$400,000 | 3% of US$20,000,000 = US$600,000; floor 50% of US$1,000,000 = US$500,000; base = US$600,000 |
| Excess | US$1,000,000 less US$400,000 = US$600,000 | US$1,000,000 less US$600,000 = US$400,000 |
| Credit at full rate | 14% = US$84,000 | 20% = US$80,000 |
| Credit with 280C(c) election | 11.06% = US$66,360 | 15.8% = US$63,200 |
The ASC wins by a small margin here. Were Vantage's gross receipts US$10,000,000 instead, the regular base would fall to US$500,000 (the floor) and the regular credit to US$100,000, overtaking the ASC. The lesson is to compute both; the data for the regular credit is harder to assemble, but for a research-intensive company it can be the larger number.
A start-up with no QREs in any of the three preceding years would compute the ASC at 6%: US$60,000 on US$1,000,000 of QREs, or US$47,400 with the reduced credit election.
Common questions
Can we switch methods each year? Yes, on the original return for the year. The ASC election applies to the year it is made and may be made on an amended return only if no research credit was previously claimed for that year on an original or amended return.
What counts as gross receipts? Total sales net of returns and allowances, plus other income, as defined in the regulations, which exclude certain items such as returns of capital.
Does the ASC need prior-year gross receipts? No. Only QREs for the three preceding years.
Related pages
Official sources
- 26 U.S. Code section 41(c), Base amount and alternative simplified creditLegal Information Institute, Cornell Law School
- Instructions for Form 6765, Credit for Increasing Research ActivitiesInternal Revenue Service
- 26 U.S. Code section 280C(c), Credit for increasing research activitiesLegal Information Institute, Cornell Law School
Educational content only, not tax advice. See the disclaimer.