Category: Deductions & Credits
Subject: R&D Credit
Title: Special Rule for Computing "Base Amount"
IRC Sections: 41
Filename: 1202.html
Date Produced: 02/95

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Issue
Is there a special rule for computing the "base amount" for purposes of dealing with the 65% category of research credit?

Answer
Yes, the base amount for purposes of computing the general research credit cannot be less than 50% of the qualified research expenses for the credit year.

Discussion
Section 41(a) provides a credit of 20% of the excess of qualified research expenses over the base amount plus 20% of basic research payments as determined under Section 41(e)(1)(A).

Qualified research expenses means in-house research plus 65% of contract research. Secs. 41(b)(1), 41(b)(2), and 41(b)(3). I assume this is the 65% category of research credits to which you are referring in your query.

The base amount for purposes of Section 41(a), which is the part of Section 41 on which one would rely for the 65% category research credit, is defined in Section 41(c). Section 41(c)(2) provides that in no event shall the base amount be less than 50% of the qualified research expenses for the credit year. It is clear then that there is a 50% floor rule applicable to the general computation of research credits including the 65% category about which you are concerned.

The general 50% base amount floor is similar to the language you pointed out to me with respect to so-called basic research under Section 41(e). There is a special 50% base amount floor rule at Section 41(e)(4)(B) applicable only for purposes of subsection (e). Because Section 41(e) dealing with basic research created a new term of art, "the qualified organization base period amount", a stand-alone floor rule is necessary to achieve for purposes of dealing with basic research under Section 41(e) the same 50% floor rule that would otherwise be provided by the general 50% floor rule found at Section 41(c)(2). I believe this special stand-alone 50% floor rule is the source of the confusion in this matter.

Important Additional Consideration
In performing this research an additional issue presented itself. I have not researched the issue, but I would be happy to assist you further if you so desire.

Section 41(b)(1) requires that research expenses be paid or incurred in carrying on any trade or business of the taxpayer [emphasis added]. Section 41(b)(4) provides a special rule that relaxes the trade or business requirement with respect to in house research. There is no such relaxation for contract research. Since the factual pattern you described includes contract research in a clear start-up situation, it seems to me that this may be a potential issue in your case. The existence or non-existence of a trade or business has been an area of controversy in both the research credit as well as research expense area for many years.