AIRC opportunities and new allocation regs.
Congress enacted the AIRC in 1996 to benefit taxpayers unable to claim the conventional credit because of economic circumstances relative to the base period. Many businesses that continued to increase their research spending after the 1984-1988 base period found the conventional credit unusable, because they had rapidly growing sales. Under the AIRC, taxpayers can elect to calculate the research credit without reference only to the 1984-1988 base period. Instead, the credit is calculated with reference to the taxpayer's average annual gross receipts for the prior four tax years.
Revoking the AIRC Election
When Congress enacted the AIRC, taxpayers could elect it only in their first tax year beginning after June 30, 1996. In 1997, Congress provided that an AIRC election could be made in any tax year beginning after that date. Some taxpayers, however, elected the AIRC that first year. In hindsight, some of these companies should have remained under the conventional research credit regime. Because an AIRC election applies to all succeeding years (unless the IRs consents to its revocation), some taxpayers are "stuck" with an AIRC election they do not want; going back to the conventional credit regime would require the Service's consent.
In Letter Ruling 200016005, the IRs consented to a taxpayer's revocation of the AIRC. While the letter ruling does not set forth the IRS's rationale for consent, it appears reasonable to conclude that the presence of a "life event" increases the likelihood that the Service will agree to a revocation request. An example might be when a corporation that has elected the AIRC acquires a target corporation, resulting in a controlled group with a base amount considerably lower than the acquirer's. Because of this, the controlled group might be eligible for higher conventional research credits, possibly justifying revocation of the AIRC election. A demonstration of good faith (rather than seeking to bounce back and forth between the conventional credit and the AIRC to maximize tax benefits) presumably would make a taxpayer's AIRC revocation request more acceptable to the IRS.
Timing of Revocation Requests
Prop. Regs. Sec. 1.41-8(b)(3) states that a consent to revoke an AIRC election must be attached to a taxpayer's timely filed original return (including extensions) for the tax year of the revocation. Some taxpayers, however, may not become aware of their need to revoke the AIRC election until relatively late in the return preparation process. While such taxpayers may be able to submit their AIRC revocation request before filing a timely return, they may not be able to obtain the Service's consent by that time. The proposed regulations are unclear as to the deadline for requesting an AIRC revocation, instead establishing a deadline based on when the IRS acts on the taxpayer's request.
In the absence of definitive guidance, taxpayers should file an AIRC revocation request as early as possible, by the date the original return (with extensions) is timely filed at a minimum. If the taxpayer has not obtained the Service's consent by that date, it should attach a copy of the election revocation request to the return. On the return, the taxpayer should state the reason the consent is not attached and that an amended return will be filed if and when the IRS consents to the AIRC revocation.
Unless the taxpayer obtains and attaches the Service's consent to the original return, it should calculate the credit under the AIRC regime. If, at a later date, the IRS grants its consent, the taxpayer should file an amended return calculating the credit under the conventional research credit regime, attaching the consent and an explanatory statement. Because Prop. Regs. Sec. 1.41-8(b)(3) states that the Service's consent must be attached to the original return, every attempt should be made to comply.
Increase in AIRC Rates
While some taxpayers may benefit from revoking their AIRC election, others that used the conventional credit now may benefit from electing the AIRC. (As noted, taxpayers may elect the AIRC for any tax year beginning after June 30, 1996.) In 1999, Congress increased the AIRC rates by 1%, effective for tax years after June 30, 1999.
For prior years, the AIRC had been the sum of:
1. 1.65% of the qualified research expenses for the tax year that exceed 1% of the average described in Sec. 41(c)(1)(B), but do not exceed 1.5% of such average;
2. 2.2% of such expenses that exceed 1.5% of such average, but do not exceed 2% of such average; and
3. 2.75% of such expenses that exceed 2% of such average.
Effective for tax years after June 30, 1999, each percentage "AIRC bracket" has been increased by 1 percentage point, to 2.65%, 3.2% and 3.75%, respectively. Thus, some taxpayers currently engaged in qualified research may find the AIRC an attractive option.
Allocation Among Controlled Group Members
While the research credit (whether conventional or AIRC) is calculated on a "single taxpayer" basis, it is allocated to each member of a controlled group of corporations. Recently issued proposed regulations explain how to allocate the conventional research credit and the AIRC.
The determination of whether a taxpayer is a controlled group member for research credit purposes is similar to the general determination of whether a corporation is a controlled group member, except that the at-least-80% requirement is replaced with a more-than-50% requirement. Under the proposed regulations, all members of a research credit controlled group are treated as a single taxpayer. Thus, Sec. 41 applies only to the aggregate computation of the base amount.
Prop. Regs. Sec. 1.41-8(a)(5) provides that, if the credit is computed under the AIRC regime, it would be allocated to the controlled group members, assigning a ratio to each group member and multiplying that ratio by the aggregate AIRC amount. Prop. Regs. Sec. 1.41-8(a)(6), Example 2, illustrates that the ratio's numerator for each member would be the amount that the member's QREs exceed 1% of its average annual gross receipts for the four prior tax years. The ratio's denominator (which would be the same for all the members) would be the sum of the amounts by which each member's QREs exceed 1% of its average annual gross receipts for the four prior tax years. These allocation regulations generally would be effective for tax years ending after Dec. 28, 1999, but would be retroactive in certain circumstances "to prevent taxpayers that are members of a controlled group from together claiming in excess of" 100% of the credit for a prior year.
FROM J. ANTHONY COUGHLAN, J.D., LL.M., WASHINGTON, DC, AND KENDALL B. FOX, CPA, SAN JOSE, CA
Robert Zarzar, CPA Partner Washington National Tax Services PricewaterhouseCoopers Washington, DC
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|Title Annotation:||IRS regulations; alternative incremental research credit|
|Author:||Fox, Kendall B.|
|Publication:||The Tax Adviser|
|Date:||Jul 1, 2000|
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