After more than three years of work from House Ways and Means Committee Chairman Dave Camp (R-MI) and his staff, the comprehensive tax reform discussion draft was released on February 26, 2014. The nearly 200-page plan includes repeals, modifications, reform, and simplification of taxes and credits for individuals and corporations. The tax reform plan may be brought up for discussion in Congress later this year. Of particular interest is the currently expired Research & Experimentation (R&E) tax credit. Congress’ original intent of adding the R&E tax credit in 1981 was to serve as an “investment stimulus” necessary for economic expansion. It was designed to help upgrade the nation’s industrial base, stimulate productivity and innovation.
A Permanent Research Tax Credit
The tax reform act provides that a modified research credit would be made permanent. The research credit would equal:
- 15 percent of the qualified research expenses for the tax year that exceed 50 percent of the average qualified research expenses for the three tax years preceding the tax year for which the credit is determined (thus making the Alternative Simplified Method (ASC) permanent), plus
- 15 percent of the basic research payments for the tax year that exceed 50 percent of the average basic research payments for the three tax years preceding the tax year for which the credit is determined. The provision would retain the rule under the ASC that allows a taxpayer to claim a reduced research credit if the taxpayer has no qualified research expenses in any one of the three preceding tax years.
- The general 20 percent credit would be repealed, as well as the 20 percent credit for amounts paid for basic research and the 20 percent credit for amounts paid to an energy research consortium.
Under the provision, amounts paid for supplies or with respect to computer software would no longer qualify as qualified research expenses. In addition, the special rule allowing 75 percent of amounts paid to a qualified research consortium and 100 percent of amounts paid to eligible small businesses, universities, and federal laboratories to qualify as contract research expenses would be repealed (though such amounts still would qualify as contract research expenses subject to the 65-percent inclusion rule).
In addition, the provision would repeal the election to claim a reduced research credit in lieu of reducing deductions otherwise allowed.
The provision would be effective for tax years beginning after 2013, and for amounts paid and incurred after 2013.
Benefits of a Permanent Research Tax Credit
The research credit has had eight expirations and 15 extensions since 1981, resulting in uncertainty and limiting the ability to plan for businesses who invest in research and development. Making the R&E tax credit permanent will enable business to commit to and plan ahead for research expenditures.
Simplification of the research tax credit computation will ease the administrative burdens and ability of taxpayers to document and support the calculation. Removing supply costs will eliminate disagreements with the Internal Revenue Service, perhaps encouraging business that once shied away from the credit to reconsider.
Under the tax reform provision, the Alternative Minimum Tax (AMT) would be repealed. Currently, taxpayers are limited in their ability to immediately recognize the benefit of the research tax credit by the AMT. A repeal would incentivize middle market business taxpayers to invest in research and experimentation.