The “Tax Relief and Health Care Act of 2006” (the “Act”) was passed by the House and Senate on December 8 and 9, respectively, and signed into law by President Bush on December 20. The Act contains energy tax credit provisions, provisions to expand health savings accounts, and a host of other targeted tax incentives. Additionally, the Act extends certain provisions which would otherwise expire, including the research tax credit, the deduction for state and local sales taxes, and the college tuition deduction. This advisory focuses on the provisions in the Act affecting the research tax credit.
Section 104 of the Act extends the research tax credit two years, i.e., for amounts paid or incurred in 2006 and 2007. The Act also enhances the research tax credit for portions of tax years that are in 2007 by (1) increasing the rates of the alternative incremental credit; and (2) creating a new alternative simplified credit that does not use a gross receipts factor.
Thus, for 2006 and 2007 a taxpayer will continue to be entitled to a research tax credit equal to 20 percent of the amount by which the taxpayer’s qualified research expenses for the taxable year exceed its base amount for that year. The taxpayer may instead elect to take (i) the alternative incremental credit, which is based on a stated percentage of qualified research expenses that exceed the taxpayer’s average gross receipts over the preceding four years, or (ii) for 2007, the alternative simplified credit.
The Act also increases the rates of the alternative incremental credit for 2007 as follows: (1) a credit rate of 3 percent (rather than 2.65 percent) applies to the extent that a taxpayer’s qualified research expenses exceed 1 percent of the taxpayer’s average gross receipts over the preceding four years (the “base amount”) but do not exceed 1.5 percent of the base amount; (2) a credit rate of 4 percent (rather than 3.2 percent) applies to the extent that a taxpayer’s research expenses exceed 1.5 percent of the base amount but do not exceed 2 percent of the base amount; and (3) a credit rate of 5 percent (rather than 3.75 percent) applies to the extent that a taxpayer’s research expenses exceed 2 percent of the base amount.
Under the alternative simplified credit method for 2007, the credit is 12 percent of the qualified research expenses that exceed 50 percent of the average qualified research expenses for the 3 preceding taxable years. If the taxpayer has no qualified research expenses in any one of the preceding three years, the credit is 6 percent of the current qualified research expenses. An election to use the simplified credit method applies to the year of the election and all succeeding taxable years (assuming a research credit is available in succeeding years), unless revoked with the consent of the IRS.
If you have any questions about the contents of this Advisory, please contact Howard J. Barnet (212-238-8606, barnet@clm.com).