26 U.S.C. § 41 — Credit for increasing research activities

(a) General rule This section adds up three amounts to get the research credit. First, 20% of the amount by which this year's qualified research expenses exceed a "base amount." Second, 20% of certain basic research payments to universities and research organizations. Third, 20% of amounts paid to energy research consortiums for energy research. (b) Qualified research expenses (1) "Qualified research expenses" are money a taxpayer spends running a trade or business on two things: in-house research expenses and contract research expenses. (2) In-house research expenses cover: wages paid to an employee for doing qualified research, or for directly supervising or supporting research; amounts spent on supplies used in the research (not land, land improvements, or property you depreciate); and, in some cases, amounts paid to another person for computer time used in the research. That last item doesn't count if the taxpayer also gets paid by someone else for the right to use the same kind of computer property. If someone's work is almost entirely qualified research or direct supervision/support of it, then all of their wages count as in-house research expenses, not just the research portion. "Wages" has the meaning in section 3401(a); for certain self-employed people it also includes their earned income under section 401(c)(2); it never includes wages already used to figure the work opportunity credit under section 51(a). (3) Contract research expenses are 65% of what a taxpayer pays to someone who isn't its employee, for qualified research. If the taxpayer prepays for research that will happen after this tax year ends, the expense is treated as paid in the year the research is actually done. The 65% becomes 75% for payments to a "qualified research consortium" — a tax-exempt scientific-research organization under section 501(c)(3) or 501(c)(6) that isn't a private foundation — doing research for the taxpayer and one or more unrelated taxpayers together. The 65% becomes 100% for energy research paid to an "eligible small business," a college or university, or a federal laboratory. An eligible small business is one where the taxpayer doesn't own 50% or more of its stock (or, if not a corporation, its capital and profits interest). A "small business" generally means 500 or fewer average employees in either of the last two calendar years; special rules (borrowed from section 220(c)(4)) apply to startups, controlled groups, and business predecessors. "Federal laboratory" has the meaning set by the Stevenson-Wydler Technology Innovation Act of 1980, as that Act read when the Energy Tax Incentives Act of 2005 was enacted. (4) A new venture can still count in-house research expenses even if it doesn't yet have an actual "trade or business," as long as its main purpose in spending the money is to use the research results in a future trade or business — either its own, or one belonging to another person grouped with it under the common-control rules in subsection (f)(1). (c) Base amount (1) The "base amount" is the taxpayer's "fixed-base percentage" multiplied by its average annual gross receipts for the 4 tax years before the credit year. (2) The base amount can never be less than 50% of the credit year's qualified research expenses. (3)(A) Normally, the fixed-base percentage is the ratio of the taxpayer's total qualified research expenses to its total gross receipts, both measured over tax years beginning after 1983 and before 1989. (B) Startup companies use a different formula if either: their first year with both gross receipts and research expenses began after 1983, or they have fewer than 3 such years between 1984 and 1988. For these companies, the fixed-base percentage is set year by year, counting only years after 1993 with qualified research expenses: — For each of the first 5 such years, the percentage is a flat 3%. — In the 6th such year: add up research expenses for years 4 and 5; add up gross receipts for years 4 and 5; divide the first sum by the second; use 1/6 of that result. — In the 7th such year: do the same divide using years 5 and 6 combined; use 1/3 of the result. — In the 8th such year: do the same divide using years 5, 6, and 7 combined; use 1/2 of the result. — In the 9th such year: do the same divide using years 5 through 8 combined; use 2/3 of the result. — In the 10th such year: do the same divide using years 5 through 9 combined; use 5/6 of the result. — For every year after that, the taxpayer picks any 5 of its 5th-through-10th such years, adds up research expenses for those years, adds up gross receipts for those years, and divides the first sum by the second — no fraction applied. The Secretary may write rules letting the taxpayer ignore very small ("de minimis") amounts of gross receipts or research expenses when doing this math. (C) The fixed-base percentage can never be more than 16%. (D) These percentages are rounded to the nearest 1/100th of a percent. (4) Alternative simplified credit — a taxpayer can instead elect a credit equal to 14% of the amount by which this year's qualified research expenses exceed half of its average qualified research expenses for the 3 prior tax years. If the taxpayer had zero qualified research expenses in any one of those 3 years, the rate is 6% of this year's expenses instead. Once made, this election applies to the year it's made and every year after, unless the IRS agrees to let the taxpayer revoke it. (5) Qualified research expenses used to figure a past year's fixed-base percentage must be counted the same way as this year's expenses — even if the deadline to amend that past year's return or claim has already passed. The Secretary can write rules to stop a change in accounting method from distorting these numbers between the current year and an earlier year used in the calculation. (6) Gross receipts are reduced by returns and allowances made that year. For a foreign corporation, only gross receipts connected with a trade or business conducted within the United States, Puerto Rico, or a U.S. possession count. (d) Qualified research defined (1) "Qualified research" is research where: the costs are treated as domestic research or experimental expenditures under section 174A; the research is meant to discover information that is technological in nature and useful in developing a new or improved "business component" of the taxpayer; and substantially all of the work is part of a genuine process of experimentation for a purpose described in paragraph (3). Activities listed in paragraph (4) never count as qualified research, no matter what. (2) This test applies separately to each "business component" — any product, process, computer software, technique, formula, or invention meant to be sold, leased, or licensed, or used by the taxpayer in its own trade or business. A manufacturing plant, process, or machinery for making a business component is treated as its own separate business component, not as part of the thing it's producing. (3) Research counts as being for a qualifying purpose if it relates to a new or improved function, performance, or reliability or quality. It never counts if it relates to style, taste, cosmetic features, or seasonal design. (4) "Qualified research" never includes: research done after the business component is already in commercial production; adapting an existing business component to one particular customer's needs; reproducing an existing business component from examining it, or from plans, blueprints, specifications, or public information about it; efficiency surveys; work on management functions or techniques; market research, testing, or development (including advertising or promotion); routine data collection; routine or ordinary quality-control testing or inspection; computer software developed mainly for the taxpayer's own internal use (with limited regulatory exceptions, and except when it's used in otherwise-qualified research or a qualifying production process); research done outside the United States, Puerto Rico, or a U.S. possession; research in the social sciences, arts, or humanities; and research funded by someone else's grant, contract, or other payment. (e) Credit for basic research payments to qualified organizations (1) If a taxpayer makes "basic research payments" in a tax year: only the amount by which those payments exceed the "qualified organization base period amount" counts toward the 20% credit in subsection (a)(2). The remaining part of the payment — up to that base period amount — is instead treated as an ordinary contract research expense under subsection (a)(1). (2)(A) A "basic research payment" is cash a corporation pays during the year to a qualified organization for basic research, but only if the payment follows a written agreement between them and the qualified organization is the one doing the research. (B) For two specific types of qualified organizations (described in (6)(C) and (6)(D) below), the research doesn't have to be performed by that organization itself. (3) The "qualified organization base period amount" equals the "minimum basic research amount" plus the "maintenance-of-effort amount." (4)(A) The "minimum basic research amount" is whichever is larger: 1% of the average amount the corporation spent (or incurred) on in-house and contract research during the "base period," or the amount that would have been treated as contract research expenses during the base period under this subsection as it read back then. (B) Unless the corporation existed for a full tax year at some point during the base period, the minimum basic research amount can't be less than 50% of the corporation's basic research payments for the year being figured. (5)(A) The "maintenance-of-effort amount" is figured this way: take the corporation's average "nondesignated university contributions" during the base period, multiply that average by a cost-of-living adjustment factor for the calendar year the current tax year begins in — that gives one number. Then subtract the corporation's actual nondesignated university contributions for the current tax year. If what's left is a positive number, that's the maintenance-of-effort amount; otherwise it's zero. (B) A "nondesignated university contribution" is a payment the corporation made to a qualified organization described in (6)(A) that it could deduct under section 170, and that it did not already count either as a research credit in a base-period year or as a basic research payment under this section. (C) The cost-of-living adjustment normally uses the formula in section 1(f)(3), but substitutes "calendar year 1987" for "calendar year 2016." If the corporation's base period doesn't end in 1983 or 1984, the formula instead substitutes whatever calendar year the base period actually ends in, in place of 2016 — not in addition to the 1987 substitution. (6) A "qualified organization" is one of: (A) an accredited college or university (as defined in section 3304(f)) that's also described in section 170(b)(1)(A)(ii); (B) a tax-exempt organization under section 501(c)(3)/501(a), not a private foundation, organized mainly to do scientific research; (C) a tax-exempt organization under section 501(c)(3) (not a private foundation) or 501(c)(6), organized mainly to promote scientific research by type-(A) organizations through written agreements, that currently spends nearly all of its funds — or nearly all the basic research payments it receives — on grants or contracts for basic research with type-(A) organizations; or (D) a tax-exempt section 501(c)(3) organization (other than a private foundation) established by, and maintained by, an organization that existed before July 10, 1981 and meets requirement (i), organized only to make grants to type-(A) organizations for basic research under written agreements, that elects (revocably only with IRS consent) to be treated as a private foundation for all purposes except the section 4940 excise tax. (7)(A) "Basic research" means original investigation to advance scientific knowledge without a specific commercial goal — except it never includes basic research done outside the United States, or basic research in the social sciences, arts, or humanities. (B) The "base period" is the 3 tax years right before the taxpayer's first tax year that begins after December 31, 1983. (C) Basic research payments counted under subsection (a)(2) are never also counted as qualified research expenses under (a)(1)(A), and never included when figuring the base amount under (a)(1)(B). (D) For purposes of the trade-or-business requirement in subsection (b)(1), basic research payments are treated as paid in carrying on a trade or business in the year they're paid, ignoring the special startup rule in (b)(3)(B). (E) "Corporation" here doesn't include an S corporation, a personal holding company (as defined in section 542), or a service organization (as defined in section 414(m)(3)). (f) Special rules (1)(A) All members of the same "controlled group of corporations" are treated as one taxpayer for figuring this credit; each member's actual credit is its proportionate share of the group's combined qualified research expenses, basic research payments, and energy research consortium payments. (B) Under Secretary-issued regulations, the same approach applies — trades or businesses under common control (incorporated or not) are treated as one taxpayer, and the credit is split proportionately — using principles similar to the controlled-group rule. (2)(A) Under regulations, rules like those in section 52(d) govern how the credit passes through estates and trusts. (B) For partnerships, the credit is allocated among partners under Secretary-issued regulations. (3)(A) Acquisitions — under regulations: (i) If a person (the "acquiring person") buys most of a trade or business, or a separate unit of one, from another person (the "predecessor"), then during the "measurement period" the acquiring person's qualified research expenses go up by the amount described in (ii), and its gross receipts go up by the amount described in (iii). (ii) For the year of the acquisition itself, the added research-expense amount is the "acquisition year amount" defined in (iv); for every later year, it's simply the predecessor's own research expenses from the acquired business during the measurement period. (iii) The added gross-receipts amount is calculated the same way as (ii), but substituting gross receipts for research expenses. (iv) The "acquisition year amount" equals the predecessor's research expenses from the acquired business during the measurement period, multiplied by a fraction: the number of days from the acquisition date to the end of the acquiring person's tax year, divided by the total number of days in that tax year. (v) If the acquiring person and the predecessor have tax years starting on different dates, special coordination rules apply: use the acquiring person's tax years as the reference; spread the predecessor's research expenses and gross receipts evenly across each day of the predecessor's own tax year; then, for each of the acquiring person's tax years, add up whichever days fall inside it. (vi) The "measurement period" is whatever earlier period is normally taken into account in figuring the acquiring person's credit for the year in question (for example, the years used to compute the fixed-base percentage). (B) Dispositions — if the predecessor gives the acquiring person the information needed to apply (A), then after a sale, the predecessor's own research-expense and gross-receipts history for the measurement period is reduced. For the tax year of the sale itself, the reduction is prorated: the predecessor's research expenses (or gross receipts) from the acquired business during the measurement period, multiplied by the number of days from the sale date to the end of the predecessor's tax year, divided by the total days in that tax year. For every tax year after the year of sale, the full amount is subtracted from the predecessor's history. (C) If, within the 3 tax years after a sale under (B), the seller (or someone required to be grouped with the seller under paragraph (1)) reimburses the buyer for research done on the seller's behalf, then the seller's fixed-base-percentage numbers for the relevant years are increased again — by whichever is smaller: the part of the (B) reduction allocable to those years, or the number of those years multiplied by the reimbursement amount. (4) For a short tax year, qualified research expenses and gross receipts must be annualized, under methods the Secretary prescribes by regulation. (5) "Controlled group of corporations" uses the definition in section 1563(a), except: "more than 50 percent" replaces "at least 80 percent" everywhere it appears in section 1563(a)(1), and the determination ignores subsections (a)(4) and (e)(3)(C) of section 1563. (6)(A) An "energy research consortium" is an organization that: is either a tax-exempt section 501(c)(3) organization organized mainly to do energy research, or is organized mainly to do energy research in the public interest (within the meaning of section 501(c)(3)); is not a private foundation; had at least 5 unrelated people pay or incur amounts (including as contributions) to it for energy research during the relevant calendar year; and had no single person pay or incur more than 50% of its total energy-research funding that calendar year. (B) People treated as a single employer under section 52(a) or (b) are treated as related persons for the "5 unrelated people" test, and as a single person for the "50 percent" test. (C) Energy research done outside the United States, Puerto Rico, or a U.S. possession doesn't count toward the credit in subsection (a)(3). (D) An amount counted under subsection (a)(3) (energy research consortium payments) can't also be counted under subsection (a)(1) or (a)(2). (E) "Energy research" doesn't include research unless it's also "qualified research." (g) Special rule for pass-through of credit If an individual owns an interest in an unincorporated trade or business, is a partner in a partnership, is a beneficiary of an estate or trust, or is a shareholder in an S corporation, the credit allowed to that person under subsection (a) can't exceed the tax attributable to the portion of their taxable income allocated from that specific business or entity. If the credit figured under subsection (a) is bigger than this limit, the extra amount can be carried to other tax years under section 39's carryover rules — using this special limit instead of the usual section 38(c) limit when applying section 39. (h) Treatment of credit for qualified small businesses (1) A "qualified small business" can elect, for a given tax year, to apply section 3111(f) (a payroll tax offset) to the "payroll tax credit portion" of its research credit. Once elected, that portion is not treated as a credit under subsection (a) for any other purpose except section 280C. (2) The payroll tax credit portion is the smallest of: the dollar amount the business specified in its election; the total credit determined under subsection (a) for the year (before applying this subsection); or, for a business that isn't a partnership or S corporation, the amount of business credit carried forward from that year under section 39 (before applying this subsection). (3)(A) A "qualified small business" is: a corporation or partnership whose gross receipts (figured under section 448(c)(3), without its subparagraph (A)) were under $5,000,000 for the year, and that had no gross receipts at all for any year before the 5-year period ending with that year; or any other person meeting those same two tests, based on that person's total gross receipts from all of their trades or businesses combined. (B) A tax-exempt organization under section 501 can never be a qualified small business. (4)(A) An election under this subsection must: state the dollar amount it applies to; be made by the due date (including extensions) of the relevant return — the partnership return under section 6031, the S corporation return under section 6037, or the regular tax return for anyone else; and be revocable only with the IRS's consent. (B)(i) The elected dollar amount can't exceed $250,000; for tax years beginning after December 31, 2022, that cap is $500,000 instead. (ii) A person can't make this election if they (or anyone grouped with them as a single taxpayer under paragraph (5)(A)) have already made this election for 5 or more earlier tax years. (C) For a partnership or S corporation, the election is made at the entity level, not by individual partners or shareholders. (5)(A) Except as (B) says, everyone treated as a single taxpayer under the aggregation rule in subsection (f)(1) is also treated as a single taxpayer for this subsection. (B) But each of those grouped persons can still make its own separate election under paragraph (1), and each $250,000 (or $500,000) cap is divided among all of them, using the same allocation method as subsection (f)(1)'s controlled-group or common-control rules. (6) The Secretary must write regulations needed to carry out this subsection, including: rules to stop people from dodging these limits and aggregation rules by using successor companies or similar tricks; rules to keep compliance and recordkeeping burdens low; and rules for recapturing the benefit of a section 3111(f) credit if the payroll tax credit portion is later adjusted — which may require filing amended income tax returns.