On April 3, 2015, the U.S. Treasury Department published final and temporary regulations that provide taxpayer guidance on the allocation of research and experimentation (“R&E”) tax credits to members of a controlled group. The new regulations update existing Treasury Regulations to make them consistent with changes that were made to Internal Revenue Code Section 41(f) when the R&E tax credit was renewed as part of the Taxpayer Relief Act of 2012 (“the 2012 Act”). Prior to the 2012 Act, members of a controlled group that claimed federal R&E tax credits were required to compute the group credit as a single taxpayer and then allocate the resulting credit to individual members of the controlled group based on the amount of credit that would have been available to each member if its credit were computed on a stand-alone basis.
For purposes of the federal R&E tax credit, a controlled group includes all entities that are at least 50% owned by a common parent. The controlled group rules are different from the 80% ownership requirement that allows corporate taxpayers to file a consolidated federal tax return. As a result, it is possible that a single controlled group’s federal R&E tax credit will be claimed on more than one taxpayer’s consolidated income tax return. Computing each member’s credit on a stand-alone basis and allocating the group credit based on these pro forma results was a complex and confusing process that created problems for many taxpayers.
The 2012 Act revised the federal R&E statute to allow controlled group members to allocate the group credit based on each member’s proportionate share of the aggregate qualified research expense, basic research payments, and amounts paid or incurred to energy research consortiums (collectively referred to as “QRE”). This simplified allocation methodology is much easier for taxpayers to administer. But when the 2012 Act was signed, the prevailing Treasury Regulations related to Section 41(f) reflected the allocation methodology based on member credits that were calculated on a stand-alone basis. The Internal Revenue Service (IRS) published Notice 2013-20 shortly after the 2012 Act was signed into law, to advise taxpayers that they could allocate group credits using the proportionate QRE method. The Treasury’s recent regulatory action formalizes the guidance advanced by the 2013 notice. The regulations also establish rules that enable taxpayers in a controlled group to make a consistent reduced credit election for the entire group.
Taxpayers are cautioned that the new controlled group allocation rules are effective for tax years ending after December 31, 2011 (as allowed by Notice 2013-20, or allowed by the effective date of the new regulations, April 3, 2015). Any amendments to returns for tax years ending before 2012 must still follow the allocation rules determined by member credits on a stand-alone basis.
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