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Research Credit Legislative Prospects in 2007 Remain Uncertain
KPMG’s Research Credit group will be providing future updates of the status of the research credit as well as other related information in TaxNewsFlash-Research Credit. If you would like to receive future email alerts concerning the research credit, reply to
US-KPMGWNT@kpmg.com.
In December 2006, Congress reinstated the research credit, and enacted a new elective method of computing the credit, the Alternative Simplified Credit. These actions, however, had a short life—the research credit is once again set to expire, this time for amounts paid or incurred after December 31, 2007.
There has been some discussion in Congress this year about making the credit permanent, and about making changes to the Alternative Simplified Credit that would expand its attractiveness. While there has been no research credit-related action in the tax-writing committees in 2007, in the last few days there have been some indications that Congress might do more than talk about it.
Today, the Chairman of the Senate Finance Committee, Max Baucus (D-Mont) introduced a bill with Republican Finance Committee member Orrin Hatch (R-UT) that would make the credit permanent, with significant modifications. On Tuesday, Baucus announced that he hopes to have a mark-up of tax extenders legislation in the Finance Committee before October is over. On Wednesday, the Chairman of the House Ways and Means Committee, Charles Rangel (D-NY) announced that he expects his committee will mark up an extenders bill soon.
In this edition of TaxNewsFlash, after a brief summary of the current credit rules, we describe the Baucus bill and another research credit bill introduced earlier in the House, and we comment on the potential extenders legislation.
Background
The research credit has, under the traditional method in effect since 1990, allowed a credit of 20% of a taxpayer’s qualified research expenses (QRE) in excess of a base amount, generally determined as a “fixed base percentage” of the taxpayer’s average annual gross receipts for the preceding four tax years. The fixed base percentage is generally representative of the taxpayer’s spending on qualified research, in relation to gross receipts, for the 1984 through 1988 tax years. So-called start-up companies use a fixed base percentage determined, generally, by reference to more recent experience. In any case, no more than 50% of the current year’s QRE is eligible for the traditional credit.
The Alternative Simplified Credit (ASC), enacted last December, and effective for tax years ending after 2006, is an elective method of computing the credit in lieu of the traditional incremental method. The ASC is based entirely on a taxpayer’s recent spending on research compared to its spending in the three preceding tax years. The credit is 12% of the amount by which current year QRE exceeds 50% of the average QRE for those three years. If the taxpayer had no QRE in one or more of the three preceding years, the ASC is simply 6% of current year’s QRE. While 2007 is the first year in which the ASC is available, observers expect many taxpayers will be electing to use the ASC.
There is another elective method, the Alternative Incremental Research Credit (AIRC), available since 1996, under which the taxpayer is entitled to a credit (in 2007) ranging from 3% to 5% of its QRE that exceeds 1% of its average gross receipts for the four preceding tax years. This credit has not been widely used.
Regardless of the method in effect, the law currently provides that no credit will be allowed for QRE paid or incurred after December 2007.
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Current Legislative Proposals
On May 3, 2007, Congressmen Sander Levin (D-MI) and Dave Camp (R-MI) and 28 other members of the House Ways and Means Committee introduced H.R. 2138, the proposed Investment in America Act of 2007. The bill would make the research credit permanent. The traditional incremental credit would be available and computed as under current law. The ASC would be amended, for amounts paid or incurred after 2007, to apply at a 20% rate. The AIRC would be repealed for tax years beginning after 2007. H.R. 2138 currently has 142 co-sponsors in the House.
Today, October 19, 2007, Senators Baucus and fellow Finance Committee member Orrin Hatch (R-UT) introduced S.2209, the proposed Research Credit Improvement Act of 2007. Six other committee members were included as original co-sponsors. This bill—like the Levin-Camp proposal—would make the research credit permanent, and would increase the credit rate for the ASC to 20%. The ASC, however, would be set at 16% in 2008, at 18% in 2009, and at 20% in 2010, when the traditional method would be repealed (as would the AIRC). Other changes to the credit would be made, most notably raising the portion of contract research credit expenses treated as QRE from 65% to 80%. The bill would also require the Treasury Department to conduct a study of taxpayer compliance with the substantiation requirements for claiming the credit.
Many observers believe that most taxpayers would elect the ASC, if it were 20%, although there are likely to be taxpayers that would obtain a bigger benefit under the traditional method than under even a 20% ASC.
The anticipation of tax extenders legislation has been growing in recent weeks, as Congress is at least hoping to complete its legislative business for 2007 before Thanksgiving. An additional, strong impetus for extenders legislation this year is the need to provide an extension of a “patch” that would relieve many individual taxpayers from exposure to the alternative minimum tax for 2007. There are many issues unrelated to the research credit, such as revenue costs, that could affect, and possibly prolong, Congress’s consideration of an extenders package.
KPMG Observation
Extenders legislation could include structural modifications to the credit (as it did in 2006). Inclusion of a one or two year extension of the research credit in the package, however, could make it more difficult this year for Chairman Baucus to enact a phase-in of a higher ASC rate and repeal of the traditional method that takes effect in a future year.
Federal revenue considerations could be an issue for research credit legislation. The federal revenue cost of H.R. 2138 and S.2209 has not been officially determined. President Bush has proposed making the research credit permanent in his last several federal budget proposals. The staff of the Joint Committee on Taxation in March 2007 estimated that making the research credit permanent (with no modifications to the current law rules) would cost $98.9 billion over 10 years, with a cost of about $5 billion in 2008. The cost of a simple extenders bill is generally assumed to be about $15 billion a year, and a one-year AMT patch is expected to cost about $55 billion. One unresolved issue is whether Congress will decide it needs to include revenue raisers in any extenders legislation (and, if so, what they would be).
There are no procedural requirements or deadlines that would force Congress into action before it recesses for 2007. Congress allowed the research to lapse for over 11 months in 2006 before reinstating it, and there have been several gaps, filled retroactively, in the past. Consequently, an extension of the research credit in 2007—either temporary or permanent—as well as structural modifications remains a possibility, but is by no means a certainty Future editions of
TaxNewsFlash-Research Credit will keep you informed.
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For more information, contact a KPMG tax professional with the Research Credit group:
Christine Kachinsky, (212) 872-2187, ckachins@kpmg.com
Adam Uttley, (213) 593-6732, auttley@kpmg.com
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