The federal tax credit for “increasing research activities” – commonly known as the R&D credit – is one of several “tax extenders” currently being discussed by lawmakers. The credit expired at the end of 2013, but the expectation is that it will be renewed, as it has done consistently since the credit was first enacted in 1981.
This article provides a brief summary of the R&D credit and outlines some of the proposals being considered.
In its most recent form, there are two methods for calculating the R&D credit: The regular credit and the alternative simplified credit (ASC). The regular credit is 20 percent of the amount by which qualified research expenditures (QREs) exceed an historical base amount. QREs include qualifying wages, supplies, and contract research expenditures. Calculating the regular credit involves examining QREs as a percentage of revenues during the period 1984 to 1988 and comparing them to current revenues and QREs. There are special rules for companies that didn’t exist – or didn’t have revenues or QREs – during that period.
The ASC offers an alternative to companies that have difficulty calculating the regular credit or would receive little benefit from the regular credit. To calculate the ASC, you start with a base amount equal to 50 percent of average QREs for the last three years. The credit is 14 percent of the amount by which current-year QREs exceed the base amount. For companies without QREs in the last three years, the ASC is 6 percent of current-year QREs.
In addition to the regular credit and ASC, a 20-percent credit is available for “basic research payments” to universities or other organizations above a certain threshold.
Several tax reform proposals would extend the R&D credit in some form. They include:
EXPIRE act. Recently, the Senate Finance Committee approved the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act of 2014, which would:
- Extend the R&D credit for two years (covering 2014 and 2015)
- Allow the credit to be claimed against alternative minimum tax (an important benefit for pass-through entities, such as S corporations and partnerships, whose owners claim credits on their individual returns)
- Enable certain startups without income tax liability to claim a credit of up to $250,000 against their payroll taxes.
President’s budget. The administration’s proposal would make the R&D credit permanent and would increase the ASC from 14 to 17 percent (starting in 2015).
Tax Reform Act of 2014. Proposed by House Ways and Means Committee Chair Dave Camp (R-Mich), this bill would:
- Make the ASC permanent, at a higher rate (15 percent; 10 percent for companies without QREs in the last three years)
- Eliminate the regular credit as an option (this would hurt some companies that relied on the regular credit in the past)
- Make the credit for basic research payments permanent at a reduced rate (15 percent)
- Eliminate credits for computer software research
- Exclude supplies from QREs, and
- Reduce the percentage of certain contract expenditures included in QREs
The fate of the R&D credit and other expired tax breaks remains to be seen. Many commentators believe Congress won’t deal with tax reform until after the midterm elections in November. On the other hand, the EXPIRE Act enjoyed strong bipartisan support in the Senate Finance Committee, so it’s possible Congress will act sooner.