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Tuesday, May 7, 2013

Research Tax Credit: Current Law and Policy Issues for the 113th Congress

Gary Guenther
Analyst in Public Finance

Technological innovation is a primary engine of long-term economic growth, and research and development (R&D) serves as the lifeblood of innovation. The federal government encourages businesses to invest more in R&D in several ways, including a tax credit for increases in spending on qualified research above a base amount.

This report describes the current status of the credit, summarizes its legislative history, discusses policy issues it raises, and describes legislation in the 113
th Congress to modify or extend it. The report will be updated as warranted by legislative activity and other developments affecting the credit.

The research credit (also known as the research and experimentation (R&E) tax credit) has never been a permanent provision of the federal tax code. It expired at the end of 2011 and was retroactively extended in January 2013 through the end of that year. Since its enactment in mid- 1981, the credit has been extended 15 times and significantly modified five times. While the credit is usually assumed to be a single credit, it actually consists of four discrete credits: (1) a regular credit, (2) an alternative simplified credit (ASC), (3) a basic research credit, and (4) an energy research credit. A taxpayer may claim one of the first two and each of the other two, provided it meets the requirements for each.

In essence, the research credit attempts to boost business investment in basic and applied research by reducing the tax price (or after-tax cost) of undertaking qualified research above a base amount. As a result, the credit’s effectiveness hinges on the sensitivity of the demand for this research to decreases in its cost. It is unclear from available studies how sensitive that demand is.

While most analysts and lawmakers endorse the use of tax incentives to generate increases in business R&D investment, some have some reservations about the current credit. Critics contend the credit is not as effective as it could be because of certain flaws in its design, such as a lack of permanence, uneven and inadequate incentive effects, non-refundability, and an unsettled definition of qualified research.

The 112
th Congress made few changes to the credit. Under the American Taxpayer Relief Act of 2012 (ATRA, P.L. 112-240), the credit was extended from January 1, 2012 through the end of 2013. ATRA also clarified the rules governing the use of the credit by companies involved in acquisitions to ensure that taxpayers who sell or otherwise dispose of a business unit receive the credit for qualified research expenses incurred before the change in ownership. Finally, the act altered the rules used to determine the allocation of the credit among members of a controlled group of businesses to make that allocation proportionate to each member’s share of total qualified research expenses for the group.

Several bills to further modify the credit have been introduced in the 113
th Congress, though none has been considered at the committee level. H.R. 119 would permanently extend the current credit. H.R. 120 would extend the credit through the end of 2014, increase the rates of the regular and ASC credits for 2013 and 2014 only, and allow qualified small businesses to transfer any credit they can claim to other businesses for cash and exclude that cash from their gross income. H.R. 905 would permanently extend the current credits and raise the rate for the ASC to 17%. And three bills (H.R. 714, S. 193, and S. 310) would allow eligible small firms to apply up to
$250,000 of any research credit they claim but cannot use in the current tax year because of insufficient income tax liability against their federal payroll taxes.

Date of Report: April 23, 2013
Number of Pages: 38
Order Number: RL31181
Price: $29.95

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