Restore and strengthen the R&D credit
Grant Thornton believes a strong R&D tax credit will boost economic growth, encourage domestic investment, create U.S. jobs and incentivize increased R&D activities for all businesses — small or large, start-up or established.
- Make the R&D credit permanent.
- Increase the alternative simplified credit (ASC) to 20% (10% for start-ups).
- Make a portion of the R&D credit refundable for small start-up ventures.
Lawmakers have taken steps forward and Grant Thornton encourages them to work together to make the research credit permanent, easier to use, and refundable to those businesses that need credit now.
Research and development (R&D) tax incentives are vital to domestic investment in innovation and creation of high-paying American jobs. Investments in research drive productivity gains and economic growth, and the research credit is critical to ensuring that those investments are made here in the U.S.
Research credit: dollar-for-dollar value to U.S. business and economy.
- Each dollar the government spends on the credit produces a dollar in additional research spending in the U.S.
- The credit directly supports some of the best jobs in the country, with wages comprising approximately 70% of research costs used to claim the credit.
Source: 2011 Treasury Department study
Throughout the 1980s, the U.S. R&D credit was considered the most generous R&D incentive in the world, but no more. In 2009, the Organisation for Economic Co-operation and Development (OECD) ranked the U.S. R&D incentives as the 24th most generous of 38 countries surveyed. Today, many of our global competitors offer both a lower corporate tax rate and much more generous R&D incentives. The UK, France, India, Brazil, China and many other countries have recently enhanced their R&D incentives, and it’s time for the U.S. to act to prevent our falling further behind in this highly competitive landscape.
If the goal of tax reform is to boost domestic growth and make U.S. businesses more competitive, then tax reform should maintain/protect R&D tax incentives that encourage innovation.
Background: How strengthening the R&D credit unlocks growth
R&D tax credit is temporary, so its effectiveness is limited
Since its inception as a temporary provision in 1981, the federal R&D tax credit has been extended 15 times, typically in one- or two-year increments, and is often allowed to expire before being extended retroactively. This lack of permanence means businesses can’t rely on it for business/investment planning.
A permanent credit would give companies the confidence to invest in R&D, offset the cost of innovation and level the playing field for high-paying jobs that strengthen the U.S. economy.
Businesses need a simple, more effective credit
Burdensome record-keeping requirements and complex administrative hurdles plague the R&D credit. To qualify for the traditional credit, businesses typically must establish a decades-long historical baseline for research spending. And while the alternative simplified credit (ASC) offers an easier claim and calculation process, it carries a reduced rate of 14%.
A strengthened ASC means an R&D credit that’s more effective in the global race for R&D investment. Grant Thornton supports increasing the ASC rate from 14% to 20%. Further, to balance the effective credit rate for start-up (fewer than three years of R&D spend) and established companies, we recommend a rate increase for start-ups from 6% to 10%. Finally, current Treasury regulations limiting the ASC to original returns create needless administrative burdens. Alleviate those burdens by allowing the ASC to be elected on amended tax returns.
A refundable credit encourages R&D expenditures
Many small companies, especially start-up ventures and pass-through entities, aren’t incentivized by the current credit scheme because the credit can only be used to offset regular taxable income. And while unused credits can carry forward, many companies don’t claim R&D credits early on because they won’t benefit for years. Factor in, too, that many pass-through owners are subject to alternative minimum tax that can’t be offset by R&D tax credits. All of this means that many of the entrepreneurial and dynamic companies that could drive growth and job creation receive no benefit from the R&D credit.
Grant Thornton believes that start-up ventures and pass-through entities are key drivers of innovation in America. An effective way to incentivize these companies to increase their R&D investment and maintain their growth within the U.S. is to make a portion of the R&D credit refundable. The refundable portion could be limited to start-up companies (e.g., first five years of existence) and/or based on the size of the company (say, under $50 million of annual revenues). Finally, place a cap on the annual refundable credit offered to each company (e.g., $250,000) to limit incentive enhancement costs.