Research and development credits 

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Hello, and welcome to our series Educating Taxpayers regarding research and development or R&D Tax Credits. In this video, we will discuss consistency and the application of this principle to acquisitions.

The Internal Revenue Code, section 41 or IRC 41, offers R&D tax credits to businesses that increase their research activities. The credit is calculated as a percentage of the amount by which the tax year's qualified expenditures exceed a base amount.

For highly acquisitive companies. Maintaining consistency and base amount calculations under IRC 41 is crucial for accurately reflecting the increases and decreases in qualified R&D activities. The consistency rule requires companies to use the same accounting methods and principles in calculating the qualified research expenditures in the base amount, as they use calculating the qualified research expenditures in the year they filed the credit under the regular credit calculation method.

The base amount is determined using a percentage of the company's average annual gross receipts for the preceding four years. The percentage is called the fixed base percentage, calculated using QREs and gross receipts in the base year under the Alternative Simplified Credit Method, or ASC. The base amount is determined using an average of the company's credits from the prior three years.

To ensure consistency, the QREs considered computing the fixed base percentage or the prior year QREs must be determined on a basis consistent with the determination of QREs for the credit year. Let us look at an example. Imagine company A includes wages from three specific cost centers when calculating wage increase in the credit year to maintain consistency, company A must include or at least evaluate the qualified wages from the same three specific cost centers.

When calculating wage quarries in the years used for the base amount calculation. Assuming those cost centers were in existence, this would be true even if company A excluded those partners from wage QRE when calculating the R&D credit for those base years,

The consistency concept plays out with the acquisition rules that apply for companies who acquire or dispose of subsidiaries or business units. For example, when a company acquires a new entity, it must integrate the entity's financial data not only into the calculation year, but also into the base year. Aligning accounting methods for the purpose of comparing apples to apples.

Continuing with this example, assume company A acquires company B into the consolidated group on a date when 75% of the credit year remains. If company A includes the post-acquisition qualified wages from company B in the credit year, our calculation. The base amount calculation must also include 75% of the wages and gross proceeds of company B from the relevant base year in the following year, when company B is part of the consolidated group, or 100% of the year, the base in the calculation will include 100% of the wages and gross receipts of company B from the relevant base years.

The percentage of time is based on the number of calendar days. Consistency and base amount calculations under IRC 41 reduces distortion in the measurement of increases in QREs. It also helps in accurately determining the tax credits available to the company, which can significantly impact financial planning and investment decisions. By adhering to the consistency rule and related concepts, and comparing apples to apples with base year and credit year, QRE and gross receipts calculations, highly acquisitive companies can ensure that their credit calculations are supportable and trustworthy.

Strengthening the company's financial integrity and credibility with investors. Thank you for watching. If you have any questions or need further assistance, feel free to reach out to a member of the credits and incentives team here at Baker Tilly.