As part of the Tax Relief and Health Care Act of 2006 passed in late
December 2006, the research and development (R&D) credit, which expired
at the end of 2005 is reinstated retroactively for 2006 and extended through 2007. In addition, for tax years ending after 2006, the new law enhances the credit by:

(1) Increasing the rates of the alternative incremental credit, and

(2) Creates an alternative simplified credit that does not use gross receipts
as a factor, thus allowing newer businesses to qualify for the credit.

Although the computation can be more complicated, generally a taxpayer
can claim a research credit equal to 20 percent of the business’s incremental increases in qualified research expenses.

Expenses qualifying for this credit generally include: (1) in-house wages and supplies attributable to qualified research; (2) certain time-sharing costs for computer use in qualified research; and (3) sixty-five percent of expenses of research contracted out to others.

New alternative simplified credit – The alternative simplified credit available in tax years after 2006 is equal to 12 percent of qualified research expenses that exceed 50 percent of the average qualified research
expenses for three preceding taxable years. The rate is reduced to 6
percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years.

Option to deduct R&D expenses – As an alternative, a taxpayer may
elect to deduct R&D expenses that do not create an asset or extend an asset’s useful life. Where an asset is created, or the life is extended, the expenses must be capitalized. However, deductions allowed to a taxpayer must be reduced by an amount equal to 100 percent of the taxpayer’s research tax credit for the taxable year. Taxpayers can alternatively elect to claim a reduced research tax credit amount (13 percent) in lieu of reducing deductions otherwise allowed.