Overview of Credit Mechanics
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      RRC (Traditional) Method

      Overview:

      The RRC allows for a 20% R&D tax credit applied to the excess of current year QRE over the base amount.  The base amount is determined by multiplying a fixed-base percentage by the average annual gross receipts of the taxpayer for the four taxable years preceding the tax year for which the credit is being calculated.  Generally, gross receipts are defined as all income derived by the taxpayer from all its activities and from all sources, with the following exceptions:

      • Returns or allowances.
      • Receipts from the sale or exchange of capital assets, defined under section 1221.
      • Repayments of loans or similar instruments.
      • Receipts from a sale or exchange not in the ordinary course of business, such as the sale of an entire trade or business or the sale of property used in a trade or business as defined under section 1221(2).
      • Amounts received with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the goods or service, and the taxpayer merely collects and remits the tax to the taxing authority.
      • Amounts received by a taxpayer in a taxable year that precedes the first taxable year in which the taxpayer derives more than $25,000 in gross receipts other than investment income.

      Gross Receipts should not be reduced by cost of goods sold. Tax exempt interest and other tax exempt income should be included in the gross receipts computation. 

      The calculation of the fixed base percentage depends on whether the taxpayer is an existing company or a start-up company.  A start-up company is defined as a taxpayer that had both gross receipts and qualified research expenses for the first time in a tax year beginning after 1983, or for fewer than three tax years beginning after 1983 and before 1989.  

      The fixed-base percentage for a start-up company is calculated as follows:

      1. For the first 5 tax years beginning after 1993 for which you have qualified research expenses, the percentage is 3%.
      2. For the 6th tax year beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for the 4th and 5th such tax years by the aggregate gross receipts for those tax years, then divide the result by 6.
      3. For the 7th tax year beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for the 5th and 6th such tax years by the aggregate gross receipts for those tax years, then divide the result by 3.
      4. For the 8th tax year beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for the 5th, 6th, and 7th such tax years by the aggregate gross receipts for those tax years, then divide the result by 2.
      5. For the 9th tax year beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for the 5th, 6th, 7th, and 8th such tax years by the aggregate gross receipts for those tax years, then divide the result by 1.5.
      6. For the 10th tax year beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for the 5th through 9th such tax years by the aggregate gross receipts for those tax years, then divide the result by 1.2.
      7. For the 11th and later tax years beginning after 1993 for which you have qualified research expenses, divide the aggregate qualified research expenses for any 5 of the 5th through 10th such tax years by the aggregate gross receipts for those tax years.

      The fixed-base percentage for an existing company (any company that isn’t a start-up company) is figured by dividing the aggregate qualified research expenses for the tax years beginning after 1983 and before 1989 by the aggregate gross receipts for those tax years. The fixed-base percentage for all companies (existing and start-up) must be rounded to the nearest 1/100th of 1% (that is, four decimal places) and can’t exceed 16%.

      In computing the fixed-base percentage, 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 fixed-base percentage could potentially be distorted.

      In cases where prior year QRE 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 and has had QRE in the prior three years.  After computing QRE for the claim year (assume QRE of $100,000), the taxpayer could then apply this 20% 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). 

      Similarly, acquisitions and dispositions must be accounted for in calculating base period QRE and gross receipts. If a taxpayer acquires the major portion of either a trade or business or a separate unit of a trade or business of another person, then the taxpayer’s base period QRE is increased by the amount of QRE incurred or paid by the acquired business.  Also, the gross receipts of the taxpayer are increased by the amount of gross receipts of the acquired business. Similarly, if the taxpayer disposes of the major portion of a trade or business and furnishes information to the acquirer, the taxpayer may decrease its base period QRE and gross receipts by the amount attributable to the disposed portion.