The IRC §280C election is an election made on a timely filed tax return that reduces the amount of research and development (R&D) tax credit by the maximum corporate tax rate (e.g. 21%). By making the §280C election, the taxpayer is not required to add back the amount of the R&D tax credit to reduce deductions (as would otherwise be required), thus preventing a double benefit related to the R&D credit (i.e., expense & credit).
As an example: a C-Corporation has exclusively U.S.-based qualifying R&D activities, with taxable income of $1 million. It generates Qualified Research Expenses (QREs) of $1 million. If the base amount is the 50% of the current credit year QREs, then the resulting gross R&D credit is $100,000 (10% of the total current year QREs).
Scenario #1: Without §280C Election for the 2021 tax year
The C-Corporation is required to add back the full amount of R&D credit to their taxable income. As such, the C-Corporation’s tax liability is calculated as follows:
| Taxable Income | 1,000,000 |
| Addback R&D Credit | 100,000 |
| Subtotal | 1,100,000 |
| Tax Liability (@21%) | 231,000 |
| Gross R&D Credit | (100,000) |
| Final Tax Liability | 131,000 |
Scenario #2: With §280C Election for the 2021 tax year
Following the same fact pattern outlined above, except the C-Corporation makes the §280C election to claim a reduced credit. The reduced credit is the product of the $100,000 gross R&D credit and the maximum tax rate for Corporations of 21%, resulting in a reduced credit of $79,000. In this scenario, the C-Corporation is not required to add back the $100,000 to taxable income. As such, the C-Corporation’s tax liability is calculated as follows:
| Taxable Income | 1,000,000 |
| Addback R&D Credit | – |
| Subtotal | 1,000,000 |
| Tax Liability (@21%) | 210,000 |
| Reduced R&D Credit | (79,000) |
| Final Tax Liability | 131,000 |
All other factors being equal, a C-corporation subject to the top corporate tax rate pays the same tax whether or not it makes the §280C election.
Advantages and Disadvantages of Claiming the 280C Election
Taxpayers should always consult their tax preparers to evaluate whether making the §280C election is beneficial to their tax position each year. Some considerations to evaluate making the §280C election:
Examples of Advantages:
- Reduces the administrative burden of adding back deductions
- Prevents the need to amend all federal and state tax returns if the research credit amounts are modified in future years
- Generally a better tax position for taxpayers subject to federal alternative minimum tax
- Generally reduces its state taxable income by the amount of the credit
Examples of Disadvantages:
- Evaluate and reconsider the election if taxpayers whose tax rate is less than the maximum corporate rate
- Evaluate other items that are impacted by the taxable income (e.g. domestic production activities deduction)
Changes to IRC §280C(c) by the Tax Cuts and Jobs Act (TCJA)
The TCJA made conforming amendments to IRC §280C that also take effect for tax years beginning after December 31, 2021.
For tax years starting after December 31, 2021, IRC §280C(c)(1) states that if the amount of the credit determined for the taxable year under IRC §41(a)(1) exceeds the amount allowable as a deduction for such taxable year for qualified research expenses or basic research expenses, the amount chargeable to capital account for the taxable year for such expenses shall be reduced by the amount of such excess. Just as before, a valid IRC §280C(c)(2) election to take a reduced credit must be made on a timely filed return (including extensions). It is important to note that the election is irrevocable and only applies to the tax year in which it is made.
Should taxpayers evaluate the benefit of the §280C election starting with the 2022 tax year?
Yes. When a taxpayer considers its total tax position, it is a complex decision for a taxpayer to evaluate whether or not to make a §280C election to claim a reduced rate of credit in lieu of a reduction in deductions. However, many taxpayers might decide not to make an election for a reduced rate of credit because the gross credit may offer a higher net value for tax years starting after December 31, 2021.
Scenario #3: Without §280C Election for the 2022 tax year
Continuing with the same facts above, but in 2022, the C-Corporation’s IRC §174 deduction related to R&D credit would be 10% of the current QREs (under the new IRC §174 requirement – please click here for more details) and the amount of the credit determined under IRC §41(a)(1) (which mathematically is 10% of current credit year QREs) will not exceed the amount allowable as a deduction for such QREs. In this instance §280C(c)(1) does not apply and results in lower final tax liability.
| Taxable Income | 1,000,000 |
| Addback excess R&D Credit | 0 |
| Subtotal | 1,000,000 |
| Tax Liability (@21%) | 210,000 |
| Gross R&D Credit | (100,000) |
| Final Tax Liability | 110,000 |
Even if §280C(c)(1) does apply, taxpayers that have historically elected the reduced credit may discover that the gross R&D credit now provides a lower final tax liability for the current year due to mandatory capitalization of IRC §174 R&E expenditures.
Please note that some benefits of claiming the §280C election still exist (i.e. reducing the administrative burden), but there are more factors to consider to determine whether to make the election to reduce the research credit or not starting with the 2022 tax year.
