On October 19, senior Senate Finance Committee member Orrin Hatch (R-UT) introduced the "Research Credit Improvement Act of 2007," which would make permanent the research credit while at the same time phasing in an increase in the alternative simplified credit and repealing after 2009 the base-period credit and alternative incremental credit. (S. 2209) The bill, which is co-sponsored by Senate Finance Chairman Max Baucus (D-MT), could be considered later this year when the Finance Committee addresses expiring tax provisions.
Current Research Tax Credit
Congress has extended the research credit 11 times since it was first enacted in 1981, and has modified the credit on several occasions. Until 2006, the credit could be claimed using either the "traditional" credit calculation, which is based on incremental increases in qualified research expenses compared to a mid-1980's base period, or the "alternative incremental" credit calculation. In 2006, Congress added a third method, the "alternative simplified credit" (ASC), which is an incremental credit based on an average of the prior three years research expenses. All three methods are set to expire at the end of 2007.
Hatch/Baucus Bill
S. 2209 would terminate the traditional credit calculation and the alternative incremental credit calculation for taxable years beginning after 2009 and would increase the current 12-percent ASC. Under the bill, the ASC would equal a percentage -- 16 percent for 2008, 18 percent for 2009, and 20 percent thereafter -- of the qualified research expenses for the taxable year that exceeds 50 percent of the average qualified research expenses for the three taxable years preceding the taxable year for which the credit is being determined. If the taxpayer has no research expenses in at least one of the three preceding years, then the credit would be 10 percent of qualified research expenses for the taxable year.
In addition, S. 2209 would provide that 80 percent, as opposed to the current 65 percent, of expenses for research performed by other parties for the taxpayer count as qualified research expenses. The bill also would simplify the application of the credit to certain basic research payments.
The Hatch/Baucus Bill would require a Treasury study of taxpayer compliance with substantiation requirements for claiming the credit, to be completed within one year of enactment of the bill. Treasury is to report to the tax-writing committees on the study results, including any recommendations for administrative or legislative actions to improve compliance.
In May 2007, Rep. Sander Levin (D-MI), a senior House Ways and Means Committee member, introduced H.R. 2138, the "Investment in America Act of 2007." This bill also would make permanent the research credit but proposes both to retain the "traditional" credit and to increase the ASC to 20 percent for 2008; the "alternative incremental" credit method of calculating the credit would be repealed.
Outlook
Congress is expected to address the research credit as part of a year-end "extenders" package covering numerous business and individual expiring or expired tax provisions. In the past, the revenue impact of extending and modifying the credit has been an issue, with the most recent extension covering 2006 and 2007 reducing revenues by $16.5 billion over 10 years. Revenue considerations also could be a concern this year since Congress currently is operating under "pay-as-you-go" budget rules requiring revenue raisers or permanent spending reductions to offset the cost of tax legislation.
As a result, Congress may not agree this year to a permanent extension of the credit. Instead, Senate Finance Committee staff have indicated that the committee will focus on extending the credit for at least two years, through December 31, 2009. In terms of the structure of the research credit, the new bill introduced by Senator Hatch and Finance Chairman Baucus indicates interest in modifying the credit to place greater emphasis on the alternative simplified credit method. An aide to Senator Hatch has stated that the goal will be to begin the transition to an enhanced ASC as part of this year's extenders bill.
Larry Campbell is a director in PricewaterhouseCoopers' Legislative and Regulatory Services Group. He was press secretary and legislative assistant to House Ways and Means Committee senior member William Coyne (D-Pa.) until 1995. Stephen Snow is a manager on tour-of-duty in PricewaterhouseCoopers' Washington National Tax Services Office.
Written by Larry Campbell and Stephen Snow
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