SIMPLIFIED ILLUSTRATION OF R&D CREDIT CALCULATIONS

I. CREDIT CALCULATIONS

A. "Traditional" Credit
The traditional credit equals 20 percent of the excess of qualified research expense ("QRE") for the current tax year over a base period amount. The base period amount is the product of the taxpayer's (1) fixed-base percentage, and (2) average annual gross receipts for the four tax years preceding the current year. The base period amount cannot be less than 50 percent of qualified research expense for the credit year. The fixed-base percentage is the ratio of qualified research expenses to gross receipts over the 1984-1988 period.

B. Alternative simplified credit
The proposed alternative simplified credit equals 12 percent of the excess of current-year QREs (as defined under section 41(b)) over 50 percent of the taxpayer's average QREs for the prior three years.

C. AIRC
The alternative incremental research credit ("AIRC") has three rates (2.65%, 3.20%, and 3.75%), which apply to the extent that QRE exceeds each of three base amounts (1.0%, 1.5%, and 2.0% of average annual gross receipts for the preceding four tax years). The proposed legislation would increase the credit rates to 3%, 4%, and 5%.

II. COMPANY A
Company A has $100 in QRE in 2003, and its QRE and gross receipts for other relevant periods are as follows:

Year

1984

1985 1986 1987 1988 1999 2000 2001 2002 2003
QRE 50 52 54 56 58 84 88 92 96 100
Gross
Receipts
1100 1125 1150 1175 1200 1350 1400 1450 1500 N/A

A. "Traditional" credit ($6.6)
Company A had total of $270 in QRE and $5,750 in gross receipts in 1984-1988 base period. Thus, taxpayer's fixed base percentage is 4.7%. Company A's average gross receipts over four prior years was $1,425. Company A's base amount is therefore $67 (4.7% of $1,425). Company A's QRE in 2003 is $100. Company A's creditable amount for 2003 is therefore $33 ($100 QRE less $67 base amount). Taxpayer's credit for 2002 is $6.6 (20% of $33).

B. Alternative simplified credit ($6.48)
Company A's average QRE for three prior years was $92. Taxpayer's base amount thus is $46 (50% of $92). Therefore $54 of taxpayer's $100 of current-year QRE is eligible for 12-percent credit. Taxpayer's alternative simplified credit thus would be $6.48 (12% of $54), which is slightly less than under the traditional credit.

C. AIRC ($4.08)
Company A's average gross receipts over four prior years was $1,425. Company A's base amounts are therefore $14.25 (1% of average gross receipts), $21.375 (1.5% of average gross receipts), and $28.5 (2% of average gross receipts). QRE eligible for the 3% rate equals $7.125 ($21.375 minus $14.25), producing a credit of $0.21. QRE eligible for the 4% rate equals $7.125 ($28.5 minus $21.375), producing a credit of $0.29. QRE eligible for the 5% rate equals $71.5 ($100 minus $28.5), producing a credit of $3.58. Thus, the total credit under the AIRC is $4.08, which is substantially less than under the traditional credit and the alternative simplified credit.

III. COMPANY B
Like Company A, Company B has $100 in QRE in 2003 and identical 1984-88 base period facts. Unlike Company A, however, Company B after the 1984-88 base period has grown a line of business (e.g., a financial services arm) that generates significant gross receipts but does not perform any additional R&D activities. Company B's QRE and gross receipts for the relevant periods are as follows:

Year 1984 1985 1986 1987 1988 1999 2000 2001 2002 2003
QRE 50 52 54 56 58 84 88 92 96 100
Gross
Reveipts
1100 1125 1150 1175 1200 2350 2400 2450 2500 N/A

A. "Traditional" credit ($0)
Company B's fixed base percentage is 4.7%, the same as Company A. Company B's average gross receipts over four prior years was $2,425. Company B's base amount is therefore $114 (4.7% of $2,425). Company's QRE in 2003 is $100, which does not exceed the base. Company B thus is ineligible for the traditional credit.

B. Alternative simplified credit ($6.48)
Company B's alternative simplified credit is $6.48 (12% of $54), the same amount as would be available to Company A under the alternative simplified credit.

C. AIRC ($3.43)
Company B's average gross receipts over four prior years was $2,425. Company B's base amounts are therefore $24.25 (1% of average gross receipts), $36.375 (1.5% of average gross receipts), and $48.5 (2% of average gross receipts). QRE eligible for the 3% rate equals $12.125 ($36.375 minus $24.25), producing a credit of $0.36. QRE eligible for the 4% rate equals $12.125 ($48.5 minus $36.375), producing a credit of $0.49. QRE eligible for the 5% rate equals $51.5 ($100 minus $48.5), producing a credit of $2.58. Thus, the total credit under the AIRC is $3.43, which is substantially less than under the alternative simplified credit.