Credit for Increasing Research Activities, 65722-65732 [E6-18909]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 71, Number 217 (Thursday, November 9, 2006)]
[Rules and Regulations]
[Pages 65722-65732]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-18909]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9296]
RIN 1545-BD60


Credit for Increasing Research Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations relating to the 
computation and allocation of the credit for increasing research 
activities for members of a controlled group of corporations or a group 
of trades or businesses under common control. These final regulations 
reflect changes made to section 41 by the Revenue Reconciliation Act of 
1989, which introduced the current computational regime for the credit, 
and the Small Business Job Protection Act of 1996, which introduced the 
alternative incremental research credit.

DATES: Effective Date: These regulations are effective November 9, 
2006.
    Applicability Dates: For dates of applicability see Sec. Sec.  
1.41-6(j) and 1.41-8(b)(5).

FOR FURTHER INFORMATION CONTACT: Nicole R. Cimino (202) 622-3120 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends 26 CFR part 1 to provide revised rules for the 
research credit under section 41, specifically section 41(f). On May 
24, 2005, the Treasury Department and the IRS published in the Federal 
Register (70 FR 29662) proposed amendments to the regulations under 
section 41(f) by cross-reference to temporary regulations (REG-134030-
04) and temporary regulations (70 FR 29596) (TD 9205) (collectively, 
the 2005 regulations) relating to the computation and allocation of the 
credit for increasing research activities (research credit) under 
section 41 for members of a controlled group of corporations or a group 
of trades or businesses under common control (controlled groups). The 
2005 notice of proposed rulemaking withdrew the proposed regulations 
published in the Federal Register on July 29, 2003 (68 FR 44499) (REG-
133791-02) (the 2003 proposed regulations). A public hearing was held 
on October 19, 2005. After considering the comments received and the 
statements made at the public hearing regarding the 2005 regulations, 
the 2005 regulations are adopted as revised by this Treasury decision. 
These final regulations generally retain the provisions of the 2005 
regulations with the modifications discussed below.

Summary of Comments and Explanation of Provisions

Allocation of the Group Credit

    The 2005 regulations required that the group credit that did not 
exceed the sum of the stand-alone entity credits of all the members of 
the group be allocated among the members of a controlled group in 
proportion to the relative amounts of each individual member's stand-
alone entity credit, computed for each member using the method that 
would have yielded the largest stand-alone entity credit for that 
member. Any excess of the group credit over the sum of the stand-alone 
entity credits of all the members of the group was allocated among all 
the members of the group based on the ratio of an individual member's 
qualified research expenditures (QREs) to the sum of all the members' 
QREs.
    Although commentators generally agreed that the 2005 regulations 
fixed the anomalous results (for example, none of the group credit 
would be allocated to the members of the controlled group if no member 
had stand-alone entity credits) created by the method in the 2003 
proposed regulations, some commentators continued to disagree with the 
stand-alone entity credit method. Commentators again suggested that the 
members of a controlled group should be permitted to use any reasonable 
method to allocate the group credit as long as the group's members 
collectively do not claim more than 100 percent of the group credit, or 
that if one method must be prescribed for all situations, a method that 
allocates the group credit based on the relative amounts of each 
member's total QREs (gross QREs method) is more appropriate than any 
other method.
    The Treasury Department and the IRS continue to believe that the 
allocation method under section 41(f) should be based on a group 
member's QREs in excess of a base amount, and that the stand-alone 
entity credit method reflects the incremental nature of the credit. The 
Treasury Department and the IRS believe that the stand-alone entity 
credit method of the 2005 regulations is consistent with the purpose of 
section 41(f) and its underlying legislative history. Further, a 
single, prescribed method is necessary to ensure the group's members 
collectively do not claim more than 100 percent of the group credit. 
For the reasons stated above and in the preamble to the 2005 
regulations, the final regulations do not adopt the changes suggested 
by the commentators, and retain the allocation method contained in the 
2005 regulations.

Special Allocation Rule for Consolidated Groups

    The 2005 regulations provide that, for purposes of allocating the 
group credit among the members of a controlled group (first-tier 
allocation), a consolidated group (whose members are members of the 
controlled group) is treated as a single member of the controlled 
group, and a single stand-alone entity credit is computed for the 
consolidated group. If the consolidated group is the only member of the 
controlled group, the stand-alone entity credit computed for the 
consolidated group is equal to the group credit. The portion of the 
group credit allocated to a consolidated group must be allocated among 
the members of the consolidated group (second-tier allocation) in 
proportion to the stand-alone entity credits of the members of the 
consolidated group. Under the 2005 regulations, this rule applied only 
to taxable years ending on or after May 24, 2005.
    One commentator argued that the treatment of a consolidated group 
as a single member of a controlled group is contrary to the statutory 
language of sections 41(f)(5) and 1563. The

[[Page 65723]]

Secretary is granted broad authority under section 1502 to provide 
rules regarding the determination of the tax liability of an affiliated 
group of corporations filing a consolidated return. The Treasury 
Department and the IRS believe that the treatment of a consolidated 
group as a single member of a controlled group of corporations for 
purposes of section 41(f) is within the broad authority of section 
1502. Moreover, this treatment is consistent with the single entity 
treatment of a consolidated group under certain other provisions of the 
Code.
    One commentator argued that treating a consolidated group as a 
single member of the controlled group adds unnecessary complexity and 
is administratively burdensome because it requires additional rounds of 
allocations of each consolidated group's credit among its members and 
additional computations of each consolidated group member's stand-alone 
entity credit. One commentator urged that, if the consolidated group 
rule is retained, then the final regulations should not provide 
specific rules for how the second-tier allocation is to be made.
    The Treasury Department and the IRS continue to believe that 
computing a stand-alone entity credit for each member of a consolidated 
group does not impose a greater burden than computing a stand-alone 
entity credit for a corporation that is not a member of a consolidated 
group. The Treasury Department and the IRS also believe that specific 
allocation rules are necessary with respect to the second-tier 
allocation in order to prevent distortions and provide certainty 
concerning each consolidated group member's share of the credit, for 
example, if a member ceases to be a member of the consolidated group or 
if a member's share of credits becomes subject to section 383. 
Accordingly, the final regulations retain the rules contained in the 
2005 regulations. The final regulations make clear, however, that the 
special allocation rule for consolidated groups applies prospectively 
only. Accordingly, the consolidated group rule contained in these final 
regulations applies only to taxable years ending on or after the date 
these final regulations are published in the Federal Register. For 
taxable years ending on or after May 24, 2005, and before the date 
these final regulations are published in the Federal Register, 
taxpayers must use the special allocation rule for consolidated groups 
contained in the 2005 regulations. However, taxpayers may choose to 
apply the rule retroactively to taxable years ending before May 24, 
2005, provided that all the members of the controlled group treat the 
consolidated group as a single member of the controlled group.
    One commentator stated that the 2005 regulations are unclear 
whether, for purposes of the second-tier allocation, each consolidated 
group member's stand-alone entity credit is to be computed in the same 
manner as a controlled group member's stand-alone entity credit is 
computed for purposes of a first-tier allocation (that is, using the 
method that would have yielded the largest stand-alone entity credit 
for that consolidated group member). The Treasury Department and the 
IRS believe that the final regulations are clear that this is the rule, 
as they provide that ``the principles of paragraph (c)'' (which 
contains the rule) apply for purposes of the second-tier allocation. In 
addition, this rule is illustrated in Example 3 of Sec.  1.41-6(e).

Start-Up Companies

    For purposes of computing the group credit, Sec.  1.41-6T(b)(2) of 
the 2005 regulations treated a controlled group as a start-up company 
if the first taxable year in which at least one member of the group had 
gross receipts and at least one member of the group had QREs begins 
after December 31, 1983; or there were fewer than 3 taxable years 
beginning after December 31, 1983, and before January 1, 1989, in which 
at least one member of the group had gross receipts and at least one 
member of the group had QREs. One commentator suggested that the rule 
was not clear in a situation in which one member of the group has both 
gross receipts and QREs in a taxable year beginning before January 1, 
1984. Although the Treasury Department and IRS believe that the 
temporary regulations are clear that the start-up rules do not apply if 
the group had QREs and gross receipts in a year beginning before 
January 1, 1984, no matter which member(s) of the group had the QREs 
and gross receipts, the final regulations clarify the start-up company 
rule of Sec.  1.41-6(b)(2) to make it explicit.

Alternative Incremental Research Credit

    Section 41(c)(4) provides an election to determine the research 
credit using the alternative incremental research credit (AIRC) 
computation. Section 41(c)(4)(B) provides that the election to use the 
AIRC method applies to all succeeding taxable years unless revoked with 
the consent of the Secretary. The 2005 regulations generally provide 
that elections (or revocations) of the AIRC method are made by 
completing the portion of Form 6765, ``Credit for Increasing Research 
Activities,'' relating to the AIRC method (in the case of an election 
of the AIRC method) or to the regular method (in the case of a 
revocation of the AIRC method), and attaching the completed form to the 
taxpayer's timely filed original Federal income tax return for the year 
to which the election (or revocation) applies. Once an election (or 
revocation) is made for a taxable year, the taxpayer may not change the 
election (or revocation) on an amended return. The 2005 regulations 
provide that the provisions relating to AIRC elections and revocations 
apply to taxable years ending on or after May 24, 2005.
    The 2005 regulations provide special rules for making (or revoking) 
an election for controlled groups under section 41(f)(1) (in which one 
or more of the members do not join in filing a consolidated return). In 
such cases, the designated member must make (or revoke) the AIRC 
election on behalf of the group's members. The election (or revocation) 
by the designated member is binding on all the members of the group for 
the taxable year to which the election (or revocation) relates. The 
2005 regulations provide that the designated member is that member of 
the group that is allocated the greatest amount of the group credit. In 
the event the members of a group compute the group credit using 
different methods (either the regular method or the AIRC method) and at 
least two members of the group qualify as the designated member, the 
designated member is the member that computes the group credit using 
the method that yields the greater group credit. If all the members of 
a controlled group are members of a single consolidated group, the AIRC 
election (or revocation) is made by the agent of the consolidated 
group, determined pursuant to the rules of Sec.  1.1502-77.
    One commentator suggested that the language contained in Sec.  
1.41-8T(b)(4)(i) of the 2005 regulations be clarified to avoid any 
implication that additional requirements (other than completing the 
appropriate portion of Form 6765 and attaching the form to a timely 
filed original Federal income tax return) apply to a designated member 
seeking to elect (or revoke) the AIRC method. The final regulations 
clarify that a designated member must follow the same procedures for 
making (or revoking) an AIRC election that apply to other taxpayers.
    A commentator also noted that the regulations do not address 
whether and how changes to a member's research credit information after 
the original Federal income tax return is timely filed may affect its 
status as the designated

[[Page 65724]]

member. The commentator suggested that the final regulations clarify 
what happens if the designated member at the time of filing 
subsequently is determined not to be the designated member. The 
Treasury Department and the IRS agree that clarification regarding this 
issue is needed. Accordingly, the final regulations are clarified to 
provide that the term designated member means the member of the group 
that is allocated the greatest amount of the group credit under 
paragraph (c) of Sec.  1.41-6 based on the amount of credit reported on 
the original timely filed Federal income tax return.
    A commentator questioned what happens if the designated member 
fails to timely file an original Federal income tax return. The 
Treasury Department and the IRS believe that the designated member must 
timely file a return in order for the group to elect (or revoke) the 
AIRC method. Accordingly, if the designated member fails to timely file 
for the current credit year (and thus, fails to elect (or revoke) the 
AIRC method for that year), then the method used by the group in the 
immediately preceding credit year remains the method in effect for the 
current credit year. The final regulations are amended to clarify this 
rule.
    The commentator also suggested that the final regulations allow the 
members of a controlled group to decide which member of the group will 
be the designated member. The Treasury Department and the IRS believe 
that it is necessary to have a bright-line test, applicable to all 
controlled groups, to provide certainty as to the identity of the 
designated member, and that to allow the members of a controlled group 
to decide which member's election (or revocation) will bind all the 
members of the group would not provide certainty in all situations. 
Accordingly, this comment has not been adopted.
    Another commentator urged the Treasury Department and the IRS to 
allow taxpayers to elect the AIRC method on an amended return. 
Alternatively, the commentator argued that if taxpayers cannot elect 
the AIRC method on an amended return, the final regulations should 
provide a special rule under which a taxpayer's research credit, 
computed by the taxpayer under the regular method, may not be adjusted 
on audit below the amount that would have been allowable under the AIRC 
method. The Treasury Department and the IRS believe that requiring an 
election to be made only on a timely filed original Federal income tax 
return is consistent with the statute and the doctrine of elections, 
and that the commentator's suggestion would inappropriately limit the 
authority of the IRS to conduct examinations. Thus, these final 
regulations retain the rules as contained in the 2005 regulations.
    Finally, a commentator suggested that, with respect to the AIRC 
provisions, the effective date for the 2005 regulations should not be 
limited to taxable years ending on or after May 24, 2005, but should 
apply as well to any taxable year ending before that date, provided 
that the original Federal income tax return for that year has not yet 
been filed. The Treasury Department and the IRS believe that making 
this option available retroactively to taxpayers that have not yet 
filed their returns would treat similarly situated taxpayers 
differently. For example, taxpayers that already had filed their 
returns would have been required to request permission for a 
revocation, while taxpayers that had not filed their returns would be 
eligible for the automatic revocation procedures set forth in the 2005 
regulations. Thus, the Treasury Department and the IRS believe that it 
is appropriate to limit the application of this rule to prospective use 
only. The final regulations are effective for taxable years ending on 
or after the date these final regulations are published in the Federal 
Register. For taxable years ending on or after May 24, 2005, and before 
the date these final regulations are published in the Federal Register, 
taxpayers must use the rules contained in the 2005 regulations.

Other

    Several commentators mentioned that the definition of trade or 
business in the 2005 regulations was changed from the prior 
regulations. The change in the 2005 regulations was inadvertent, and 
the definition has been returned to the language from the regulations 
existing prior to the issuance of the 2005 regulations. For taxable 
years prior to the effective date of these final regulations, taxpayers 
may rely upon the definition of trade or business in these final 
regulations.
    Another commentator requested that the regulations provide guidance 
as to whether the section 280C(c) election is made member by member or 
by the entire controlled group. This issue is beyond the scope of these 
final regulations, as guidance would have to be provided under the 
authority of section 280C rather than section 41. The Treasury 
Department and the IRS may consider addressing this issue in separate 
guidance.

Effective Date

    The preamble to the 2005 regulations states that because the 
Treasury Department and the IRS decided to retain the general rules for 
the computation and allocation of the group credit contained in the 
2003 proposed regulations, with certain modifications, the 2005 
regulations were effective for taxable years ending on or after May 24, 
2005. For taxable years prior to those covered by the 2005 regulations, 
a taxpayer generally may use any reasonable method of computing and 
allocating the group credit. As explained in the preamble to the 2005 
regulations, paragraph (b) of the 2005 regulations, relating to the 
computation of the group credit, and paragraph (c) of the 2005 
regulations, relating to the allocation of the group credit, apply to 
taxable years ending on or after December 29, 1999, if the members of a 
controlled group, as a whole, claimed more than 100 percent of the 
amount that would be allowable under paragraph (b). In the case of a 
controlled group whose members have different taxable years and whose 
members use inconsistent methods of allocation, the members of the 
controlled group are deemed to have, as a whole, claimed more than 100 
percent of the amount that would be allowable under paragraph (b).
    One commentator argued that the 2005 regulations should not be 
effective until final regulations are published in the Federal 
Register. The Treasury Department and the IRS continue to believe that 
the general May 24, 2005, effective date is appropriate, because these 
final regulations are substantially similar to the 2003 proposed 
regulations.
    Another commentator objected to the use of the December 29, 1999, 
effective date for the portions of the 2005 regulations that are 
retroactive, because that is the date that the previous proposed 
regulations (2000 proposed regulations) were sent to the Federal 
Register, and not the date (January 4, 2000) on which they were 
published. The Treasury Department and the IRS continue to believe that 
the December 29, 1999, effective date is the appropriate date, because 
this is the date the 2000 proposed regulations were filed with the 
Federal Register and, thus, were made available to the public. 
Additionally, section 7805(b)(3) allows any regulation to take effect 
or apply retroactively to prevent abuse.
    Another commentator criticized the retroactive application of the 
rule requiring that a member's stand-alone entity credit be computed 
using whichever method results in the greater stand-alone entity credit 
for that member, without regard to the method used to compute the group 
credit. The

[[Page 65725]]

commentator stated that the incentive effect sought can only be 
achieved prospectively, and that to allow use of the rule retroactively 
may cause abusive inconsistencies where some members of the group rely 
on the 2003 proposed regulations, while other members amend to follow 
the new rule. While the Treasury Department and the IRS do not want to 
encourage potentially abusive inconsistencies in years that taxpayers 
believe are settled, the Treasury Department and the IRS believe that 
one bright line is appropriate and do not want to treat similarly 
situated taxpayers differently.
    Another commentator suggested that the final regulations make clear 
that the special rule for consolidated groups is to be applied 
prospectively only. The 2005 regulations required paragraph (b) of 
those regulations, relating to the computation of the group credit, and 
paragraph (c) of those regulations, relating to the allocation of the 
group credit, to be applied retroactively in certain instances of 
abuse. The 2005 regulations did not require paragraph (d), relating to 
the special rule for consolidated groups, to be applied retroactively. 
Thus, the Treasury Department and IRS did not intend that taxpayers be 
required to apply retroactively the special rule for consolidated 
groups. Accordingly, the final regulations clarify that the special 
rule for consolidated groups applies only to taxable years ending on or 
after the date these final regulations are published in the Federal 
Register. The 2005 regulations apply for taxable years ending on or 
after May 24, 2005, and before the date these final regulations are 
published in the Federal Register. However, a controlled group may 
choose to apply the rule in paragraph (d) retroactively if all the 
members of the group do so, so that the controlled group, as a whole, 
does not claim more than 100 percent of the group credit.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because 
these regulations do not impose on small entities a collection of 
information requirement, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis 
is not required. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding these final regulations were submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Nicole R. Cimino, 
Office of Associate Chief Counsel (Passthroughs and Special 
Industries). However, personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.41-6T and adding an entry in numerical order to 
read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.41-6 also issued under 26 U.S.C. 1502. * * *


0
Par. 2. In Sec.  1.41-0, the table of contents is amended by removing 
the entries for Sec.  1.41-6T and Sec.  1.41-8T and adding entries for 
Sec.  1.41-6 and Sec.  1.41-8 to read as follows:


Sec.  1.41-0  Table of contents.

* * * * *


Sec.  1.41-6  Aggregation of expenditures.

(a) Controlled groups of corporations; trades or businesses under 
common control.
(1) In general.
(2) Consolidated groups.
(3) Definitions.
(b) Computation of the group credit.
(1) In general.
(2) Start-up companies.
(c) Allocation of the group credit.
(1) In general.
(2) Stand-alone entity credit.
(d) Special rules for consolidated groups.
(1) In general.
(2) Start-up company status.
(3) Special rule for allocation of group credit among consolidated 
group members.
(e) Examples.
(f) For taxable years beginning before January 1, 1990.
(g) Tax accounting periods used.
(1) In general.
(2) Special rule when timing of research is manipulated.
(h) Membership during taxable year in more than one group.
(i) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
(j) Effective date.
* * * * *


Sec.  1.41-8  Special rules for taxable years ending on or after May 
24, 2005.

(a) Alternative incremental credit.
(b) Election.
(1) In general.
(2) Time and manner of election.
(3) Revocation.
(4) Special rules for controlled groups.
(5) Effective date.


0
Par. 3. Section 1.41-6 is added to read as follows.


Sec.  1.41-6  Aggregation of expenditures.

    (a) Controlled group of corporations; trades or businesses under 
common control--(1) In general. To determine the amount of research 
credit (if any) allowable to a trade or business that at the end of its 
taxable year is a member of a controlled group, a taxpayer must--
    (i) Compute the group credit in the manner described in paragraph 
(b) of this section; and
    (ii) Allocate the group credit among the members of the group in 
the manner described in paragraph (c) of this section.
    (2) Consolidated groups. For special rules relating to consolidated 
groups, see paragraph (d) of this section.
    (3) Definitions. For purposes of this section--
    (i) Consolidated group has the meaning set forth in Sec.  1.1502-
1(h).
    (ii) Controlled group and group mean a controlled group of 
corporations, as defined in section 41(f)(5), or a group of trades or 
businesses under common control. For rules for determining whether 
trades or businesses are under common control, see Sec.  1.52-1 (b) 
through (g).
    (iii) Credit year means the taxable year for which the member is 
computing the credit.
    (iv) Group credit means the research credit (if any) allowable to a 
controlled group.
    (v) Trade or business means a sole proprietorship, a partnership, a 
trust, an estate, or a corporation that is carrying on a trade or 
business (within the meaning of section 162). Any corporation that is a 
member of a commonly controlled group shall be deemed to be carrying on 
a trade or business if any other member of that group is carrying on 
any trade or business.
    (b) Computation of the group credit--(1) In general. All members of 
a controlled group are treated as a single taxpayer for purposes of 
computing the research credit. The group credit is

[[Page 65726]]

computed by applying all of the section 41 computational rules on an 
aggregate basis. All members of a controlled group must use the same 
method of computation, either the method described in section 41(a) or 
the alternative incremental research credit (AIRC) method described in 
section 41(c)(4), in computing the group credit for a credit year.
    (2) Start-up companies--(i) In general. For purposes of computing 
the group credit, a controlled group is treated as a start-up company 
for purposes of section 41(c)(3)(B)(i) if--
    (A) There was no taxable year beginning before January 1, 1984, in 
which a member of the group had gross receipts and either the same 
member or another member also had qualified research expenditures 
(QREs); or
    (B) There were fewer than three taxable years beginning after 
December 31, 1983, and before January 1, 1989, in which a member of the 
group had gross receipts and either the same member or another member 
also had QREs.
    (ii) Example. The following example illustrates the principles of 
paragraph (b)(2)(i) of this section:

    Example. A, B, and C, all of which are calendar year taxpayers, 
are members of a controlled group. During the 1983 taxable year, A 
had QREs, but no gross receipts; B had gross receipts, but no QREs; 
and C had no QREs or gross receipts. The 1984 taxable year was the 
first taxable year for which each of A, B, and C had both QREs and 
gross receipts. A, B, and C had both QREs and gross receipts in 
1985, 1986, 1987, and 1988. Because the first taxable year for which 
each of A, B, and C had both QREs and gross receipts began after 
December 31, 1983, each of A, B, and C is a start-up company under 
section 41(c)(3)(B)(i) and each is a start-up company for purposes 
of computing the stand-alone entity credit. During the 1983 taxable 
year, at least one member of the group, A, had QREs and at least one 
member of the group, B, had gross receipts, thus, the group had both 
QREs and gross receipts in 1983. Therefore, the controlled group is 
not a start-up company because the first taxable year for which the 
group had both QREs and gross receipts did not begin after December 
31, 1983, and there were not fewer than three taxable years 
beginning after December 31, 1983, and before January 1, 1989, in 
which a member of the group had gross receipts and QREs.

    (iii) First taxable year after December 31, 1993, for which the 
controlled group had QREs. In the case of a controlled group that is 
treated as a start-up company under section 41(c)(3)(B)(i) and 
paragraph (b)(2)(i) of this section, for purposes of determining the 
group's fixed-base percentage under section 41(c)(3)(B)(ii), the first 
taxable year after December 31, 1993, for which the group has QREs is 
the first taxable year in which at least one member of the group has 
QREs.
    (iv) Example. The following example illustrates the principles of 
paragraph (b)(2)(iii) of this section:

    Example. D, E, and F, all of which are calendar year taxpayers, 
are members of a controlled group. The group is treated as a start-
up company under section 41(c)(3)(B)(i) and paragraph (b)(2)(i) of 
this section. The first taxable year after December 31, 1993, for 
which D had QREs was 1994. The first taxable year after December 31, 
1993, for which E had QREs was 1995. The first taxable year after 
December 31, 1993, for which F had QREs was 1996. Because the 1994 
taxable year was the first taxable year after December 31, 1993, for 
which at least one member of the group, D, had QREs, for purposes of 
determining the group's fixed-based percentage under section 
41(c)(3)(B)(ii), the 1994 taxable year was the first taxable year 
after December 31, 1993, for which the group had QREs.

    (c) Allocation of the group credit--(1) In general. (i) To the 
extent the group credit (if any) computed under paragraph (b) of this 
section does not exceed the sum of the stand-alone entity credits of 
all of the members of a controlled group, computed under paragraph 
(c)(2) of this section, such group credit shall be allocated among the 
members of the controlled group in proportion to the stand-alone entity 
credits of the members of the controlled group, computed under 
paragraph (c)(2) of this section:
[GRAPHIC] [TIFF OMITTED] TR09NO06.005

    (ii) To the extent that the group credit (if any) computed under 
paragraph (b) of this section exceeds the sum of the stand-alone entity 
credits of all of the members of the controlled group, computed under 
paragraph (c)(2) of this section, such excess shall be allocated among 
the members of a controlled group in proportion to the QREs of the 
members of the controlled group:
[GRAPHIC] [TIFF OMITTED] TR09NO06.006

    (2) Stand-alone entity credit. The term stand-alone entity credit 
means the research credit (if any) that would be allowable to a member 
of a controlled group if the credit were computed as if section 
41(f)(1) did not apply, except that the member must apply the rules 
provided in paragraphs (d)(1) (relating to consolidated groups) and (i) 
(relating to intra-group transactions) of this section. Each member's 
stand-alone entity credit for any credit year must be computed under 
whichever method (the method described in section 41(a) or the method 
described in section 41(c)(4)) results in the greater stand-alone 
entity credit for that member, without regard to the method used to 
compute the group credit.
    (d) Special rules for consolidated groups--(1) In general. For 
purposes of applying paragraph (c) of this section, a consolidated 
group whose members are members of a controlled group is treated as a 
single member of the controlled group and a single stand-alone entity 
credit is computed for the consolidated group.
    (2) Start-up company status. A consolidated group's status as a 
start-up company and the first taxable year after December 31, 1993, 
for which a consolidated group has QREs are determined in accordance 
with the principles of paragraph (b)(2) of this section.
    (3) Special rule for allocation of group credit among consolidated 
group members. The portion of the group credit that is allocated to a 
consolidated group is allocated to the members of the consolidated 
group in accordance with the principles of paragraph (c) of this 
section. However, for this purpose, the stand-alone entity credit of a 
member of a consolidated group is computed without regard to section 
41(f)(1), but

[[Page 65727]]

with regard to paragraph (i) of this section.
    (e) Examples. The following examples illustrate the provisions of 
this section. Unless otherwise stated, no members of a controlled group 
are members of a consolidated group, no member of the group made any 
basic research payments or paid or incurred any amounts to an energy 
research consortium, and except as provided in Example 6, the group has 
not made an AIRC election:

    Example 1. Group credit is less than sum of members' stand-alone 
entity credits--(i) Facts. A, B, and C, all of which are calendar-
year taxpayers, are members of a controlled group. For purposes of 
computing the group credit for the 2004 taxable year (the credit 
year), A, B, and C had the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                                         A               B               C           aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................................           $200x            $20x           $110x           $330x
1984-1988 QREs..................................             40x             10x            100x            150x
1984-1988 Gross Receipts........................          1,000x            350x            150x          1,500x
Average Annual Gross Receipts for 4 Years                 1,200x            200x            300x          1,700x
 Preceding the Credit Year......................
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The research 
credit allowable to the group is computed as if A, B, and C were one 
taxpayer. The group credit is equal to 20 percent of the excess of the 
group's aggregate credit year QREs ($330x) over the group's base amount 
($170x). The group credit is 0.20 x ($330x-$170x), which equals $32x.
    (B) Group's base amount--(1) Computation. The group's base amount 
equals the greater of: The group's fixed-base percentage (10 percent) 
multiplied by the group's aggregate average annual gross receipts for 
the 4 taxable years preceding the credit year ($1,700x), or the group's 
minimum base amount ($165x). The group's base amount, therefore, is 
$170x, which is the greater of: 0.10 x $1,700x, which equals $170x, or 
$165x.
    (2) Group's minimum base amount. The group's minimum base amount is 
50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $330x, which equals $165x.
     (3) Group's fixed-base percentage. The group's fixed-base 
percentage is the lesser of: The ratio that the group's aggregate QREs 
for the taxable years beginning after December 31, 1983, and before 
January 1, 1989, bear to the group's aggregate gross receipts for the 
same period, or 16 percent (the statutory maximum). The group's fixed-
base percentage, therefore, is 10 percent, which is the lesser of: 
$150x/$1,500x, which equals 10 percent, or 16 percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, each member's stand-alone entity credit must be computed 
using the method that results in the greater stand-alone entity credit 
for that member. The stand-alone entity credit for each of A, B, and C 
is greater using the method described in section 41(a). Therefore, the 
stand-alone entity credit for each of A, B, and C must be computed 
using the method described in section 41(a). A's stand-alone entity 
credit is $20x. B's stand-alone entity credit is $2x. C's stand-alone 
entity credit is $11x. The sum of the members' stand-alone entity 
credits is $33x. Because the group credit of $32x is less than the sum 
of the stand-alone entity credits of all the members of the group 
($33x), the group credit is allocated among the members of the group 
based on the ratio that each member's stand-alone entity credit bears 
to the sum of the stand-alone entity credits of all the members of the 
group. The $32x group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......................            $20x             $2x            $11x            $33x
Allocation Ratio (Stand-Alone Entity Credit/Sum            20/33            2/33           11/33  ..............
 of Stand-Alone Entity Credits).................
Multiplied by: Group Credit.....................            $32x            $32x            $32x  ..............
Equals: Credit Allocated to Member..............         $19.39x          $1.94x         $10.67x             32x
----------------------------------------------------------------------------------------------------------------

    Example 2. Group credit exceeds sum of members' stand-alone 
entity credits--(i) Facts. D, E, F, and G, all of which are 
calendar-year taxpayers, are members of a controlled group. For 
purposes of computing the group credit for the 2004 taxable year 
(the credit year), D, E, F, and G had the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                         D               E               F               G           aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................           $580x            $10x            $70x            $15x           $675x
1984-1988 QREs..................            500x             25x            100x             25x            650x
1984-1988 Gross Receipts........          4,000x          5,000x          2,000x         10,000x         21,000x
Average Annual Gross Receipts             5,000x          5,000x          2,000x          5,000x         17,000x
 for 4 Years Preceding the
 Credit Year....................
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The research 
credit allowable to the group is computed as if D, E, F, and G were one 
taxpayer. The group credit is equal to 20 percent of the excess of the 
group's aggregate credit year QREs ($675x) over the group's base amount 
($527x). The group credit is 0.20 x ($675x-$527x), which equals 
$29.76x.
    (B) Group's base amount--(1) Computation. The group's base amount 
equals the greater of: The group's fixed-base percentage (3.10 percent) 
multiplied by the group's aggregate average annual gross receipts for 
the 4 taxable years preceding the credit year ($17,000x), or the 
group's minimum

[[Page 65728]]

base amount ($337.50x). The group's base amount, therefore, is $527x, 
which is the greater of: 0.031 x $17,000x, which equals $527x, or 
$337.50x.
    (2) Group's minimum base amount. The group's minimum base amount is 
50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $675x, which equals $337.50x.
    (3) Group's fixed-base percentage. The group's fixed-base 
percentage is the lesser of: The ratio that the group's aggregate QREs 
for the taxable years beginning after December 31, 1983, and before 
January 1, 1989, bear to the group's aggregate gross receipts for the 
same period, or 16 percent (the statutory maximum). The group's fixed-
base percentage, therefore, is 3.10 percent, which is the lesser of: 
$650x/$21,000x, which equals 3.10 percent, or 16 percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, each member's stand-alone entity credit must be computed 
using the method that results in the greater stand-alone entity credit 
for that member. The stand-alone entity credits for D ($19.46x) and F 
($1.71x) are greater using the AIRC method. Therefore, the stand-alone 
entity credits for D and F must be computed using the AIRC method. The 
stand-alone entity credit for G ($0.50x) is greater using the method 
described in section 41(a). Therefore, the stand-alone entity credit 
for G must be computed using the method described in section 41(a). E's 
stand-alone entity credit computed under either method is zero. The sum 
of the members' stand-alone entity credits is $21.67x. Because the 
group credit of $29.76x is greater than the sum of the stand-alone 
entity credits of all the members of the group ($21.67x), each member 
of the group is allocated an amount of the group credit equal to that 
member's stand-alone entity credit. The excess of the group credit over 
the sum of the members' stand alone entity credits ($8.09x) is 
allocated among the members of the group based on the ratio that each 
member's QREs bear to the sum of the QREs of all the members of the 
group. The $29.76x group credit is allocated as follows:

 
----------------------------------------------------------------------------------------------------------------
                                         D               E               F               G             Total
----------------------------------------------------------------------------------------------------------------
Group Credit....................  ..............  ..............  ..............  ..............         $29.76x
Minus: Sum of Stand-Alone Entity         $19.46x          $0.00x          $1.71x          $0.50x          21.67x
 Credits........................
Equals: Excess Group Credit.....  ..............  ..............  ..............  ..............           8.09x
Excess Group Credit.............          $8.09x          $8.09x          $8.09x          $8.09x  ..............
Multiplied By Allocation Ratio:          580/675          10/675          70/675          15/675  ..............
 QREs/Sum of QREs...............
Excess Group Credit Allocated...          $6.95x          $0.12x          $0.84x          $0.18x  ..............
Plus: Stand-Alone Entity Credit.         $19.46x          $0.00x          $1.71x          $0.50x  ..............
Equals: Credit Allocated to              $26.41x          $0.12x          $2.55x          $0.68x         $29.76x
 Member.........................
----------------------------------------------------------------------------------------------------------------

    Example 3. Consolidated group within a controlled group--(i) 
Facts. The facts are the same as in Example 2, except that D and E 
file a consolidated return.
    (ii) Allocation of the group credit--(A) In general. For purposes 
of allocating the controlled group's research credit of $29.76x among 
the members of the controlled group, D and E are treated as a single 
member of the controlled group.
    (B) Computation of stand-alone entity credits. The stand-alone 
entity credit for the consolidated group is computed by treating D and 
E as a single entity. Under paragraph (c)(2) of this section, the 
stand-alone entity credit for each member must be computed using the 
method that results in the greater stand-alone entity credit for that 
member. The stand-alone entity credit for each of the DE consolidated 
group ($17.55x) and F ($1.71x) is greater using the AIRC method. 
Therefore, the stand-alone entity credit for each of the DE 
consolidated group and F must be computed using the AIRC method. The 
stand-alone entity credit for G ($0.50x) is greater using the method 
described in section 41(a). Therefore, the stand-alone entity credit 
for G must be computed using the method described in section 41(a). The 
sum of the members' stand-alone entity credits is $19.76x.
    (C) Allocation of controlled group credit. Because the group credit 
of $29.76x is greater than the sum of the stand-alone entity credits of 
all the members of the group ($19.76x), each member of the group is 
allocated an amount of the group credit equal to that member's stand-
alone entity credit. The excess of the group credit over the sum of the 
members' stand-alone entity credits ($10.00x) is allocated among the 
members of the group based on the ratio that each member's QREs bear to 
the sum of the QREs of all the members of the group. The group credit 
of $29.76x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                                        DE               F               G             Total
----------------------------------------------------------------------------------------------------------------
Group Credit....................................  ..............  ..............  ..............         $29.76x
Minus: Sum of Stand-Alone Entity Credits........         $17.55x          $1.71x          $0.50x          19.76x
Equals: Excess Group Credit.....................  ..............  ..............  ..............         $10.00x
Excess Group Credit.............................         $10.00x         $10.00x         $10.00x
Multiplied By Allocation Ratio: QREs/Sum of QREs         590/675          70/675          15/675  ..............
Excess Group Credit Allocated...................          $8.74x          $1.04x          $0.22x  ..............
Plus: Stand-Alone Entity Credit.................         $17.55x          $1.71x          $0.50x  ..............
Equals: Credit Allocated to Member..............         $26.29x          $2.75x          $0.72x          29.76x
----------------------------------------------------------------------------------------------------------------

    (iii) Allocation of the group credit allocated to consolidated 
group--(A) In general. The group credit that is allocated to a 
consolidated group is allocated among the members of the consolidated 
group in accordance with the principles of paragraph (c) of this 
section.
    (B) Computation of stand-alone entity credits. Under paragraph 
(c)(2) of this section, the stand-alone entity credit for each member 
of the consolidated group must be computed using the method that 
results in the greater stand-alone entity credit for that member. The 
stand-alone entity credit for D ($19.46x) is

[[Page 65729]]

greater using the AIRC method. Therefore, the stand-alone entity credit 
for D must be computed using the AIRC method. The stand-alone entity 
credit for E is zero under either method. The sum of the stand-alone 
entity credits of the members of the consolidated group is $19.46x.
    (C) Allocation among members of consolidated group. Because the 
amount of the group credit allocated to the consolidated group 
($26.29x) is greater than $19.46x, the sum of the stand-alone entity 
credits of all the members of the consolidated group, each member of 
the consolidated group is allocated an amount of the group credit 
allocated to the consolidated group equal to that member's stand-alone 
entity credit The excess of the group credit allocated to the 
consolidated group over the sum of the consolidated group members' 
stand alone entity credits ($6.83x) is allocated among the members of 
the consolidated group based on the ratio that each member's QREs bear 
to the sum of the QREs of all the members of the consolidated group. 
The group credit of $26.29x allocated to the DE consolidated group is 
allocated between D and E as follows:

----------------------------------------------------------------------------------------------------------------
                                                                         D               E             Total
----------------------------------------------------------------------------------------------------------------
Group Credit....................................................  ..............  ..............         $26.29x
Minus: Sum of Stand-Alone Entity Credits........................         $19.46x          $0.00x          19.46x
Excess Group Credit.............................................  ..............  ..............           6.83x
Excess Group Credit.............................................          $6.83x          $6.83x  ..............
Multiplied By Allocation Ratio: QREs/Sum of QREs................         580/590          10/590  ..............
Excess Group Credit Allocated...................................          $6.71x          $0.12x  ..............
Plus: Stand-Alone Entity Credit.................................         $19.46x          $0.00x  ..............
Equals: Credit Allocated to Member..............................         $26.17x          $0.12x          26.29x
----------------------------------------------------------------------------------------------------------------

    Example 4. Member is a start-up company--(i) Facts. H, I, and J, 
all of which are calendar-year taxpayers, are members of a 
controlled group. The first taxable year for which J has both QREs 
and gross receipts begins after December 31, 1983, therefore, J is a 
start-up company under section 41(c)(3)(B)(i). The first taxable 
year for which H and I had both QREs and gross receipts began before 
December 31, 1983, therefore, H and I are not start-up companies 
under section 41(c)(3)(B)(i). For purposes of computing the group 
credit for the 2004 taxable year (the credit year), H, I, and J had 
the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                                         H               I               J           aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................................           $200x            $20x            $50x           $270x
1984-1988 QREs..................................             55x             15x              0x             70x
1984-1988 Gross Receipts........................          1,000x            400x              0x          1,400x
Average Annual Gross Receipts for 4 Years                 1,200x            200x              0x          1,400x
 Preceding the Credit Year......................
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if H, I, and J 
were one taxpayer. The group credit is equal to 20 percent of the 
excess of the group's aggregate credit year QREs ($270x) over the 
group's base amount ($135x). The group credit is 0.20 x ($270x--
$135x), which equals $27x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (5 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($1,400x), or the group's minimum base amount ($135x). The group's 
base amount, therefore, is $135x, which is the greater of: 0.05 x 
$1,400x, which equals $70x, or $135x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $270x, which equals $135x.
    (3) Group's fixed-base percentage. Because the first taxable 
year in which at least one member of the group has QREs and at least 
one member of the group has gross receipts does not begin after 
December 31, 1983, the group is not a start-up company. Therefore, 
the group's fixed-base percentage is the lesser of: the ratio that 
the group's aggregate QREs for the taxable years beginning after 
December 31, 1983, and before January 1, 1989, bear to the group's 
aggregate gross receipts for the same period, or 16 percent (the 
statutory maximum). The group's fixed-base percentage, therefore, is 
5 percent, which is the lesser of: $70x/$1,400x, which equals 5 
percent, or 16 percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, the stand-alone entity credit for each member of the 
group must be computed using the method that results in the greater 
stand-alone entity credit for that member. The stand-alone entity 
credits for H ($20x), I ($2x), and J ($5x) are greater using the 
method described in section 41(a). Therefore, the stand-alone entity 
credits for each of H, I, and J must be computed using the method 
described in section 41(a). The sum of the stand-alone entity 
credits of the members of the group is $27x. Because the group 
credit of $27x is equal to the sum of the stand-alone entity credits 
of all the members of the group ($27x), the group credit is 
allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of the 
stand-alone entity credits of all the members of the group. The 
group credit of $27x is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                                         H               I               J             Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......................            $20x             $2x             $5x            $27x
Allocation Ratio (Stand-Alone Entity Credit/Sum            20/27            2/27            5/27  ..............
 of Stand-Alone Entity Credits).................
Multiplied by: Group Credit.....................            $27x            $27x            $27x  ..............
Equals: Credit Allocated to Member..............            $20x             $2x             $5x             27x
----------------------------------------------------------------------------------------------------------------

    Example 5. Group is a start-up company--(i) Facts. K, L, and M, 
all of which are calendar-year taxpayers, are members of a 
controlled group. The taxable year ending on December 31, 1999, is 
the first taxable year in which a member of the group had QREs and 
either the same member or another member also had gross receipts. In 
that year, each of K, L, and M had both QREs and gross

[[Page 65730]]

receipts. The 2004 taxable year is the fifth taxable year beginning 
after December 31, 1993, for which at least one member of the group 
had QREs For purposes of computing the group credit for the 2004 
taxable year (the credit year), K, L, and M had the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                                         K               L               M           aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................................           $255x            $25x           $100x           $380x
1984-1988 QREs..................................              0x              0x              0x              0x
1984-1988 Gross Receipts........................              0x              0x              0x              0x
Average Annual Gross Receipts for 4 Years                 1,600x            340x            300x          2,240x
 Preceding the Credit Year......................
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit--(A) In general. The 
research credit allowable to the group is computed as if K, L, and M 
were one taxpayer. The group credit is equal to 20 percent of the 
excess of the group's aggregate credit year QREs ($380x) over the 
group's base amount ($190x). The group credit is 0.20 ($380x--
$190x), which equals $38x.
    (B) Group's base amount--(1) Computation. The group's base 
amount equals the greater of: the group's fixed-base percentage (3 
percent) multiplied by the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year 
($2,240x), or the group's minimum base amount ($190x). The group's 
base amount, therefore, is $190x, which is the greater of: 0.03 x 
$2,240x, which equals $67.20x, or $190x.
    (2) Group's minimum base amount. The group's minimum base amount 
is 50 percent of the group's aggregate credit year QREs. The group's 
minimum base amount is 0.50 x $380x, which equals $190x.
    (3) Group's fixed-base percentage. Because the first taxable 
year in which at least one member of the group has QREs and at least 
one member of the group has gross receipts begins after December 31, 
1983, the group is treated as a start-up company under section 
41(c)(3)(B)(i) and paragraph (b)(2)(i) of this section. Because the 
2004 taxable year is the fifth taxable year beginning after December 
31, 1993, for which at least one member of the group had QREs, under 
section 41(c)(3)(B)(ii)(I), the group's fixed-base percentage is 3 
percent.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, the stand-alone entity credit for each member of the 
group must be computed using the method that results in the greater 
stand-alone entity credit for that member. The stand-alone entity 
credit for each of K ($25.5x), L ($2.5x), and M ($10x) is greater 
using the method described in section 41(a). Therefore the stand-
alone entity credits for each of K, L, and M must be computed using 
the method described in section 41(a). The sum of the stand-alone 
entity credits of all the members of the group is $38x. Because the 
group credit of $38x is equal to sum of the stand-alone entity 
credits of all the members of the group ($38x), the group credit is 
allocated among the members of the group based on the ratio that 
each member's stand-alone entity credit bears to the sum of the 
stand-alone entity credits of all the members of the group. The $38x 
group credit is allocated as follows:

----------------------------------------------------------------------------------------------------------------
                                                         K               L               M             Total
----------------------------------------------------------------------------------------------------------------
Stand-Alone Entity Credit.......................          $25.5x           $2.5x            $10x            $38x
Allocation Ratio (Stand-Alone Entity Credit/Sum          25.5/38          2.5/38           10/38  ..............
 of Stand-Alone Entity Credits).................
Multiplied by: Group Credit.....................            $38x            $38x            $38x  ..............
Equals: Credit Allocated to Member..............          $25.5x           $2.5x            $10x             38x
----------------------------------------------------------------------------------------------------------------

    Example 6. Group alternative incremental research credit--(i) 
Facts. N, O, and P, all of which are calendar-year taxpayers, are 
members of a controlled group. The research credit under section 
41(a) is not allowable to the group for the 2004 taxable year 
because the group's aggregate QREs for the 2004 taxable year are 
less than the group's base amount. The group credit is computed 
using the AIRC rules of section 41(c)(4). For purposes of computing 
the group credit for the 2004 taxable year (the credit year), N, O, 
and P had the following:

----------------------------------------------------------------------------------------------------------------
                                                                                                       Group
                                                         N               O               P           aggregate
----------------------------------------------------------------------------------------------------------------
Credit Year QREs................................             $0x            $20x           $110x           $130x
Average Annual Gross Receipts for 4 Years                 1,200x            200x            300x          1,700x
 Preceding the Credit Year......................
----------------------------------------------------------------------------------------------------------------

    (ii) Computation of the group credit. The research credit 
allowable to the group is computed as if N, O, and P were one 
taxpayer. The group credit is equal to the sum of: 2.65 percent of 
so much of the group's aggregate QREs for the taxable year as 
exceeds 1 percent of the group's aggregate average annual gross 
receipts for the 4 taxable years preceding the credit year, but does 
not exceed 1.5 percent of such average; 3.2 percent of so much of 
the group's aggregate QREs as exceeds 1.5 percent of such average 
but does not exceed 2 percent of such average; and 3.75 percent of 
so much of such QREs as exceeds 2 percent of such average. The group 
credit is [0.0265 x [($1,700x x 0.015)--($1,700x x 0.01)]] + [0.032 
x [($1,700x x 0.02)--($1,700x x 0.015)]] + [0.0375 x [$130x--
($1,700x x 0.02)]], which equals $4.10x.
    (iii) Allocation of the group credit. Under paragraph (c)(2) of 
this section, the stand-alone entity credit for each member of the 
group must be computed using the method that results in the greater 
stand-alone