The Research and Development (R&D) tax credit is a general business tax credit under Internal Revenue Code Section 41, available to companies that incur research and development costs in the United States. It was originally passed in 1981 to encourage private companies to conduct research. It is an effective tool for assisting U.S. businesses in staying competitive, and also has positive external benefits to society, such as when discoveries made by businesses led to the invention of the automobile tire and the Internet.
As described in the 2016 IRS Form 6765 “Credit for Increasing Research Activities” instructions, “The research credit is generally allowed for expenses paid or incurred for qualified research. Qualified research means research for which expenses may be treated as section 174 expenses. This research must be undertaken for discovering information which is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer. Additionally, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability or quality. All of the research activities must be applied separately with respect to each business component of the taxpayer.” Certain types of activities are not eligible for the credit. This credit is at least as complicated to properly calculate as this definition of the credit. Simplifying the credit, even more than has been done in the past, would greatly improve small companies’ ability to claim it.
Before I discuss potential future changes to the R&D tax credit, it is important to recap the accomplishments in the R&D tax credit arena by the passage of the Protecting Americans from Tax Hikes (PATH) Act in December of 2015. The PATH Act included significant positive changes to the R&D tax credit especially for qualified small businesses and start-up companies. These changes which increased the availability and use of the credit included:
- The credit for increasing research activities was made permanent.
- Eligible small businesses (businesses with less than $50 million in average gross receipts over the past three years) can use the R&D tax credit to offset alternative minimum tax (amt).
- Qualified small businesses, with less than $5 million in gross receipts in the tax year of the claim, can offset the R&D tax credit against the employer portion of social security tax.
Both President Trump’s tax plan and the House Republicans’ tax blueprint propose retaining the permanent R&D tax credit. Many proponents of this credit in both the House and the Senate believe the credit should be simplified and/or expanded. It is probable the R&D tax credit will be expanded under the current Administration considering the Senate and Congress have a Republican majority. Changes being considered include substantially increasing the alternative simplified credit rate from 14 percent, allowing the R&D tax credit to offset amt for large businesses, and allowing the credit to be taken on amended federal income tax returns. Two recent proposals for changes to the R&D tax credit which I would favor, one of which is especially innovative, are discussed in a June 12, 2017 article by Dean Zerbe, which you can access by clicking here.