Credit for Increasing Research Activities - IRC Section 41
20%
Credit on Excess QREs over Base Amount
65% / 75%
Contract Research Counted (Consortium: 75%)
16%
Max. Fixed-Base Percentage
50%
Min. Base Amount as % of Current QREs
Summary of the US federal research credit - 20% incremental credit over a base amount, 20% credit on basic research payments, inclusion of in-house wages, supplies, computer-use and contract research costs, and the four-part test for qualified research.
- •Issued by: United States · Internal Revenue Code · Title 26 · Subchapter A, Part IV
- •Based on the statutory text of IRC Sec. 41 as supplied (older version, see Sec. 8)
- •Administered by: Internal Revenue Service (IRS), US Treasury
- •Prepared as an advisory summary - not an official document
What the credit gives
IRC Section 41 provides a federal income tax credit to taxpayers that increase their spending on qualified research in carrying on a trade or business. For the purposes of Sec. 38 (general business credit), the research credit for a taxable year is the sum of:
- •41(a)(1): 20% of the excess (if any) of qualified research expenses (QREs) for the year over the base amount, and
- •41(a)(2): 20% of basic research payments determined under subsection (e)(1)(A).
Credit amounts that cannot be used in a year may be carried to other years under Sec. 39, and the credit passes through to partners, S-corporation shareholders and trust/estate beneficiaries (see Sec. 6 below).
What qualifies as research
Qualified Research - the Four-Part Test [41(d)(1)]
- •Section 174 test - expenditures must be eligible to be treated as research expenses under Sec. 174.
- •Technological information - undertaken to discover information that is technological in nature.
- •Business component - the application of the information is intended to be useful in developing a new or improved business component of the taxpayer.
- •Process of experimentation - substantially all of the activities are elements of a process of experimentation relating to a new or improved function, performance, or reliability or quality.
Key Definitions
| Term | Meaning |
|---|---|
| Business component [41(d)(2)] | Any product, process, computer software, technique, formula or invention to be held for sale, lease or license, or used by the taxpayer in its trade or business. The test is applied separately to each business component. A plant process, machinery or technique for commercial production is a separate business component. |
| Qualified research expenses [41(b)(1)] | In-house research expenses plus contract research expenses, paid or incurred in carrying on a trade or business. |
| In-house research expenses [41(b)(2)] | (i) Wages for qualified services; (ii) supplies used in qualified research; (iii) amounts paid to another person for the right to use computers in qualified research. |
| Qualified services | Engaging in qualified research, or direct supervision / direct support of it. If substantially all of an individual's services qualify, all of that person's wages qualify. |
| Supplies | Tangible property other than land or land improvements, and other than depreciable property. |
| Wages | As defined in Sec. 3401(a); for self-employed individuals and owner-employees, earned income under Sec. 401(c)(2). Wages already used for the work opportunity credit (Sec. 51(a)) are excluded. |
| Contract research expenses [41(b)(3)] | 65% of amounts paid to a non-employee for qualified research (75% for payments to a qualified research consortium). Prepaid amounts are treated as paid when the research is conducted. |
Start-up ventures: under 41(b)(4), in-house research expenses meet the trade-or-business requirement if the principal purpose is to use the results in the active conduct of a future trade or business of the taxpayer or a related person.
Credit quantum - exact figures
A. Regular Incremental Credit - 41(a)(1)
| Component | Rule |
|---|---|
| Credit rate | 20% of (QREs for the credit year minus base amount) |
| Base amount | Fixed-base percentage x average annual gross receipts of the 4 preceding years, but never less than 50% of current-year QREs [41(c)(1)-(2)] |
B. Alternative Incremental Credit as it appears in the supplied text - 41(c)(4)
| QREs as % of 4-year average gross receipts | Credit Rate |
|---|---|
| More than 1% but not more than 1.5% | 2.65% |
| More than 1.5% but not more than 2% | 3.20% |
| More than 2% | 3.75% |
The election applies to the year made and all later years unless revoked with the consent of the Secretary [41(c)(4)(B)].
These rates are from the older text supplied. Current law replaced this alternative with the Alternative Simplified Credit (understood to be 14% of QREs above 50% of the 3-year average QREs). Confirm against the current Code before computing any claim.
C. Basic Research Payments - 41(a)(2), 41(e)
20% of basic research payments in excess of the qualified organization base period amount. The portion of payments up to that base period amount is treated as contract research expenses for the regular credit.
D. Gross Receipts and Consistency - 41(c)(5)-(6)
- •Gross receipts are reduced by returns and allowances. For foreign corporations, only receipts effectively connected with a US trade or business count.
- •QREs used for the fixed-base percentage must be determined consistently with the credit year, even if the refund period has closed for those years.
How the benchmark is set
Fixed-Base Percentage - 41(c)(3)
| Taxpayer | Fixed-base percentage |
|---|---|
| Established taxpayers (general rule) | Aggregate QREs for tax years beginning after 31 Dec 1983 and before 1 Jan 1989, as a percentage of aggregate gross receipts of those years |
| Start-up companies - years 1 to 5 | 3% for each of the first 5 taxable years (beginning after 31 Dec 1993) with QREs |
| Start-up - year 6 | 1/6 of the QRE-to-receipts percentage for years 4 and 5 |
| Start-up - year 7 | 1/3 of that percentage for years 5 and 6 |
| Start-up - year 8 | 1/2 of that percentage for years 5, 6 and 7 |
| Start-up - year 9 | 2/3 of that percentage for years 5 to 8 |
| Start-up - year 10 | 5/6 of that percentage for years 5 to 9 |
| Start-up - later years | Percentage for any 5 years selected from the 5th through 10th years |
Start-up rule applies where the first year with both gross receipts and QREs begins after 31 Dec 1983, or there are fewer than 3 such years between 1984 and 1988. The fixed-base percentage can never exceed 16% and is rounded to the nearest 1/100th of 1%. The Secretary may disregard de minimis receipts and QREs.
What is not covered, and the strings attached
| Excluded Activity [41(d)(4)] | Notes |
|---|---|
| Research after commercial production | Any research conducted after the business component begins commercial production |
| Adaptation of existing components | Adapting a business component to a particular customer's requirement or need |
| Duplication of existing components | Reproducing a component from physical examination, plans, blueprints, specifications or public information |
| Surveys, studies etc. | Efficiency surveys; management function or technique; market research, testing or development (incl. advertising); routine data collection; routine testing or inspection for quality control |
| Internal-use computer software | Software developed primarily for the taxpayer's internal use, except for use in qualified research activity or a qualifying production process (subject to regulations) |
| Foreign research | Research conducted outside the US, Puerto Rico or a US possession |
| Social sciences, arts, humanities | Excluded entirely |
| Funded research | Research to the extent funded by a grant, contract or another person (including a government entity) |
| Style, taste, cosmetic, seasonal design | Never counts as a qualifying purpose [41(d)(3)(B)] |
The computer-use clause [41(b)(2)(A)(iii)] does not apply to the extent the taxpayer (or an aggregated person) receives or accrues amounts from others for the right to use substantially identical personal property.
Aggregation, pass-through and adjustments
- •Controlled group [41(f)(1)(A)]: All members of a controlled group of corporations are treated as a single taxpayer; credit is allocated in proportion to each member's QREs and basic research payments. "Controlled group" uses a more-than-50% test instead of 80% (41(f)(5)).
- •Common control [41(f)(1)(B)]: Trades or businesses under common control, incorporated or not, are treated as a single taxpayer under regulations.
- •Pass-through [41(f)(2)]: Estates and trusts follow Sec. 52(d) principles; partnership credit is allocated among partners under regulations.
- •Acquisitions and dispositions [41(f)(3)]: Prior-period QREs and gross receipts are increased for an acquired business, and decreased for a disposed one, so the base stays comparable. Certain post-disposition reimbursements for research on the taxpayer's behalf adjust the fixed-base calculation.
- •Short taxable years [41(f)(4)]: QREs and gross receipts are annualised as the Secretary prescribes.
- •Individuals, partners, beneficiaries, shareholders [41(g)]: The credit is capped at the tax attributable to the person's income from that business or entity; any excess carries forward under Sec. 39, with the Sec. 38(c) limit replaced by this cap.
Payments to universities and research bodies
| Item | Rule |
|---|---|
| Basic research payment [41(e)(2)] | Cash paid by a corporation to a qualified organization for basic research, under a written agreement, with the research performed by that organization (exception for grant organisations). |
| Basic research [41(e)(7)(A)] | Original investigation for advancing scientific knowledge without a specific commercial objective; excludes research outside the US and in social sciences, arts or humanities. |
| Base period amount [41(e)(3)-(5)] | Minimum basic research amount (greater of 1% of average in-house plus contract research in the base period, or amounts treated as contract research) plus the maintenance-of-effort amount (change in non-designated university contributions, with cost-of-living adjustment). |
| Qualified organisation [41(e)(6)] | (A) Higher-education institutions; (B) certain tax-exempt scientific research organisations; (C) scientific tax-exempt organisations that promote or fund such research; (D) certain grant organisations that elect private-foundation treatment. |
| Qualified research consortium [41(b)(3)(C)] | Exempt Sec. 501(c)(3) or 501(c)(6) organisation, organised primarily for scientific research, not a private foundation. Payments count at 75%. |
| Base period [41(e)(7)(B)] | The 3 tax years ending immediately before the first tax year beginning after 31 Dec 1983. |
Basic research payments are excluded from QREs and from the base amount computation. Eligible "corporations" do not include S corporations, personal holding companies or service organisations (Sec. 414(m)(3)) [41(e)(7)(E)].
Termination provisions in the supplied text
| When | What happens |
|---|---|
| After 31 Dec 1983 | Start of years used for the base period and fixed-base percentage; acquisition/disposition adjustments apply to transactions after this date. |
| 30 Jun 1995 - 1 Jul 1996 | Gap period - the section does not apply to amounts paid or incurred after 30 June 1995 and before 1 July 1996 [41(h)(1)(A)]. |
| After 30 Jun 2004 | The supplied text says the section does not apply to amounts paid or incurred after this date [41(h)(1)(B)]. Later legislation extended the credit and made it permanent. |
| Partial years [41(h)(2)] | Where the section applies for fewer days than the full year, the base amount is prorated by days. |
The termination dates above reflect the older statutory text supplied. They are not current law - the credit is understood to be permanent today. Always verify against the current US Code before relying on any provision.
Source
Statutory text of Section 41, Internal Revenue Code (26 U.S.C. 41), as supplied in "research_credit_basic_sec41.pdf". This page is an independent summary prepared by BookMyCA / AVPM & Associates and is not issued by, or affiliated with, the US Government or the IRS.
For advisory purposes only. The supplied text is an outdated version of Sec. 41. The US Code and IRS guidance prevail; confirm current rates, definitions and filing requirements (including Form 6765) with the current Code or a US tax professional before any claim.