« back
Playing Political Football with the Research Tax Credit
By David M. Hull, CPA, Founding Partner
Permanently "Temporary"?!?!
Lucy swears this time she is going to hold the football for Charlie Brown. She’s pulled it away at the last moment so many times as Charlie was about to kick it. Each time he’s fooled — landing on his back with a thump. The latest extension of the popular federal research tax credit got pulled out of a bill at the last moment just as Charlie, I mean, Congress was about to pass it. Of course, Lucy was holding a bigger political football this year — AMT reform.
It’s hard to find anyone in Congress who doesn’t like the Federal Research Tax Credit. The credit, around in some form since 1981, rewards a taxpayer’s efforts to improve its products or processes. It’s a reward for moving technology forward. Who could be against that? One side of the aisle likes ANY tax credit; the other side likes anything that associates them with high-tech. Yet each year the “temporary” research tax credit fails to be made permanent.
No one in Congress thinks the credit is going away. There are advantages to Congress perennially extending the credit. Namely, Congress lives on 10-year budget forecasts. When the credit is temporary, it doesn’t affect the revenue side of the budget equation for those years past the most recent extension. In fact, the credit’s popularity is what makes it a political football. One party puts the credit extension in a bill the other party finds hard to stomach — either enticing them to approve it or daring them to vote against it. It gets voted down — then Congress quietly passes the credit well after it has expired.
There does seem to be significant progress in the movement toward making the research credit permanent. Many of the things proponents said must happen before the credit is likely to be made permanent have happened. The IRS issued final regulations in December of 2003 related to Internal Revenue Code Section 41 (the current incarnation of the credit). Also, the IRS seems to have come to a consensus on how to audit the credit. In April of 2007, it issued a directive raising the credit to Tier One status, officially raising the scrutiny on claims for the credit.
In addition, IRS engineers and technical experts across the country now seem to be on the same page about what they consider qualified research and what documentary standards they require to substantiate the expenditures associated with that research. I, for one, applaud the IRS on how they handled the credit in 2007. Many decry the higher documentary standards, yet there had been many abusive claims involving the credit. The IRS has merely set a standard about what is considered qualified research and what documentation is necessary to make a claim. These are both necessary in order to have a legitimate credit. The IRS now acknowledges what a few experts in this field have been saying for a while: The question of what is qualified research is an engineering question — not an accounting question.
Congress also took an important step in 2006 to fix a nagging problem involving the calculation. IRS Section 41 has several calculations that compare a taxpayer’s current year qualified expenditures with a calculated base amount — then the amount that exceeds this base amount is multiplied by some factor to produce the credit amount. Sounds good on paper! The problem has been this: What base period applies; how does a taxpayer document that period; and what if that period produces a fixed base percentage that is so high as to preclude the taxpayer from using that method? A new credit calculation was introduced for 2007 in the last extension Congress passed. A taxpayer could elect to compare the current year’s qualifying research expenditures to 50 percent of the average expenditures over the prior three years (the Alternative Simplified Credit).
Senate Finance Chairman Max Baucus (D-Mont.) and senior committee member Orrin Hatch (R-Utah) introduced the Research Credit Improvement Act in October 2007. The act would fix the base period problem and make the credit permanent. “This (current) base period creates problems for the taxpayer in trying to calculate the credit,” Baucus explained. “And it creates problems for the IRS in trying to administer and audit those claims.” Now there have been many bills introduced over the years to make the research tax credit permanent, however, this bill has was introduced by a big hitter from each party.
The Baucus-Hatch bill would phase in the Alternative Simplified Credit to replace the cumbersome collection of current calculations. “Beginning in 2008, our bill would create a simpler credit for qualifying research expenses that exceed 50 percent of the average expenses for the prior three years,” Baucus said. “The simplified credit would phase in over three years. And just as important, the bill makes the credit permanent.”
I like that last part.
Whether or not the Baucus-Hatch bill gets pass soon, the credit as it lies is the most likely construction of the permanent credit.
As irritating as it is that Congress has not made the credit permanent, have no doubt that it is here to stay. Also understand that the definitions of what is qualified research and how to document such research will, at best, make only slight movement from here on out. Don’t ask an accountant if you qualify — ask an engineer.
« back |
