R&D Tax Credit Calculation

The Credit For Increasing Research Activities, or Research & Development Tax Credit, as it is more often called, can be calculated using two methodologies – the regular credit calculation, and the alternative simplified credit. At its essence, the R&D credit is an incremental measure of the increase in current-year qualifying R&D activities relative to a prior period. Before we dive into the specifics of the separate methods, let us discuss the essential variables of the R&D tax credit calculation itself. The common inputs to both calculation methods include the Qualified Research Expenses (QREs) of both the current tax year and a historical base period. The Regular and Simplified calculation methods award this incremental increase in R&D activity in the amount of 20% and 14%, respectively. The two methodologies often yield different credit amounts, depending on the interrelationship between the variables over time. A taxpayer is permitted to calculate both methods and utilize the one that is most beneficial.

How to calculate the Research and Development Tax Credit?

The regular credit methodology calculates a Research & Development Tax Credit that equals 20% of the incremental difference between the current year QREs less a Base Amount. The Base Amount is a function of a Fixed Base Percentage and the average gross receipts of the prior 4 years. Depending on the taxpayer’s financial history, the Base Amount can date as far back as the 1980s. There are two Base Amount calculations, one requires the taxpayer to have QREs and Gross Receipts in at least three of the years between 1984 and 1988. The other Base Amount calculation draws from a more recent period, tailored to a taxpayer’s founding year and financial record availability.

The second method for how to calculate the R&D tax credit is known as the Alternative Simplified Credit (ASC), and it differs from the regular credit calculation in that it uses a Base Amount calculated from more recent years. In addition, the ASC method does not take into account gross receipts. The ASC method allows taxpayers to enjoy a credit in the amount of 14% of the incremental amount that the current year QREs exceed 50% of the average QREs of the previous three years. The ASC methodology is great for newer companies that either did not exist, or do not have financial records from a more distant historical period, as required by the regular credit calculation. In addition, companies whose Gross Receipts-to-Qualified Research Expenses is skewed (e.g. their R&D methods have been made more efficient and streamlined, and  therefore have declined relative to total sales) may opt for the ASC method to more accurately reflect their ongoing R&D efforts.

Although the name of the R&D credit is technically the Credit for Increasing Research Activities, a credit can often be generated even if R&D spend remains flat year-over-year because of a built-in safeguard in the R&D credit calculation methodology. Additionally, it is worth mentioning that there are a number of limitations that apply to the credit calculation, which should be carefully considered when claiming R&D credits. One such limitation is the Fixed Base Percentage limitation, which states that the fixed base percentage may not exceed 16%, nor be less than 50% of current year’s QREs. In addition, the start-up provision of the R&D credit can be used to offset payroll taxes for certain companies within their first five years of revenue generation. However, this provision is limited to $250,000 of payroll taxes. Click here to see R&D tax credit calculation examples from some of our clients.

How is the R&D Tax Credit Calculated?

As you can see, the R&D tax credit is a highly complex and nuanced niche of the tax code. As such, it is advisable to involve a R&D specialist when assessing and calculating R&D credits. Endeavor Advisors can provide a gratis quote of your credit value and costs associated with securing R&D credits for your company.

This page was last updated by Steven Jefferies