Overview:
The ASC method’s credit calculation is slightly less complicated than the RRC method. Under the ASC method, the R&D credit is equal to 14% of the portion of QRE that exceeds 50% of the average QRE for the prior three tax years (the "base amount"). If the taxpayer has no QRE in any one of the prior three years, the applicable percentage is 6% instead of 14%. Once the taxpayer has three prior years of QRE, 14% may be used.
In computing the base amount, taxpayers are required to account for prior year QRE in a manner consistent with the accounting for the credit year. This applies even if a research credit was not claimed for the prior years. For example, a qualifying supply expense included in QRE for the current year will also need to be included in base period QRE to the extent that the supply was used in a similar qualifying manner. Without the consistency requirement, the base amount could potentially be distorted.
In cases where the base amount needs to be determined for years in which the R&D credit was not claimed, a reasonable calculation method should be used. The best method is to accumulate actual QREs for each of the prior years similar to the process for identifying QREs for the claim year. However, in some cases this may not be feasible due to personnel changes, loss of records, or other factors. In such cases, an estimation method such as regression analysis could be performed (using gross receipts, R&D spend, etc.) to determine a percentage to apply to current year QRE. For example, assume that a taxpayer has increased R&D spending by 20% consistently year-over-year. After computing QRE for the claim year (assume QRE of $100,000), the taxpayer could then apply this growth rate to claim year QRE in order to estimate base year QRE. Thus, base period QRE for the prior three years would be $83,333, $69,444, and $57,870 (from the most to least recent year respectively). Alternatively, if a taxpayer cannot substantiate QRE for any of the base period years, the startup percentage (6%) should be used to calculate the claim year R&D credit each year until base period QRE is substantiated.
Rules published February 27, 2014, allow companies to go back and claim R&D credits on amended returns under the alternative simplified credit (ASC) method for all open tax years. This was a game changer for company’s that previously missed out on claiming the R&D tax credit because of a lack of substantiation in the base years. The new rules ease this burden. However, they stipulate that a taxpayer may not make an ASC election for a tax year on an amended return if it already claimed a credit for that tax year using the traditional method.
For a company that has been in existence since the early 1980s, it can be challenging to calculate the fixed base percentage due to the age of the information required. Thus, the ASC may be the more appealing credit calculation method. Additionally, as previously mentioned the ASC method may produce a larger credit depending on the calculated fixed base percentage and the average annual gross receipts. It is important to evaluate the credit produced by both methods in order to maximize the available benefit.