Review of the Baucus-Hatch Bill with Proposed Improvements to the Research & Development Tax Credit

June, 2009

On June 8, 2009, Senate Finance Committee Chairman Max Baucus (D-Mont.) and Senator Orrin Hatch (R-UT) introduced legislation to improve and simplify the research and development (R&D) tax credit. The legislation is designed to encourage innovation of new technologies and services that will spur economic growth at home and American competitiveness abroad.

The proposed changes to the R&D Tax Credit are very significant. The chart below is an overview of those changes and their implications for the credit.

Proposals	Implications
Extend the R&D Tax Credit through December 31, 2010	Currently, the R&D Tax Credit is authorized through December 31, 2009
Make permanent the Alternative Simplified Credit (ASC)	This would make the R&D Tax Credit permanent and make the ASC the only available method to calculate the credit. The ASC is much easier to calculate than the Regular Method because it does not require a base percentage to be calculated.
Increase the ASC from 14% to 20% of the qualifying research expenditures (QREs) if the taxpayer has QREs in all of the 3 taxable years preceding the taxable year for which the credit is being determined	The ASC was increased from 12% to 14% for 2009 and this bill would increase it further to 20% for 2010 and beyond. The change results in a 42.9% increase in the credit. See sample calculations below.
Increase the ASC from 6% to 10% of the QREs if the taxpayer has no QREs in any of the 3 taxable years preceding the taxable year for which the credit is being determined	The change results in a 66.7% increase in the credit.
Allow the Regular R&D Tax Credit to expire in 2010	This eliminates the Regular method to calculate the credit and leaves the ASC as the only method remaining. The regular credit allows for companies to go back 3 open tax years and claim the credit. The ASC as it currently stands can only be used for current year and going forward. Paradigm has been in contact with tax advisors to the Senate Finance Committee and expressed concern that if companies are not allowed to go back 3 open tax years, it would significantly reduce the benefit of the bill’s changes. Their response was that they had already been contacted by other parties with the same concern so there will be further discussions about this particular area.

Sample Calculations for ASC Using Proposed Rate Changes

Sample 1

XYZ Company has $400,000, $600,000, $500,000, and $800,000 of qualified research expenditures in its prior three tax years and current tax year, respectively. Under the current law, a research credit of $77,000 may be claimed on its current tax return calculated as follows:

14% x [$800,000 – (50% x (($400,000 + $600,000 + $500,000)/3)) = $77,000

Using 20% under the proposed changes, the R&D tax Credit would be $110,000 – a 42.9% increase over $77,000.

Sample 2

XYZ Company has $800,000 of qualified research expenditures in its current tax year. No qualified research expenditures occurred in any previous tax year. Under the current law, a research credit of $48,000 may be claimed on its current tax return calculated as follows:

6% x $800,000 = $48,000

Using 10% under the proposed changes, the R&D tax credit would be $80,000 – a 66.7% increase over $48,000.

Summary

The elimination of the Regular Method to calculate credits after 2010 and making the Alternative Simplified Credit Method permanent will make calculating the credit easier and the increased rates will make much higher credits available to taxpayers. The only concern is the ability to capture credit for 3 open tax years for those taxpayers that have not taken the credit previously. The Finance Committee has been made aware of this concern. Remember the bill is a work in progress and may go through many changes before it is finally passed.

Disclaimer

The information contained in this document is in reference to Grow Research Opportunities with Taxcredits’ Help Act, as proposed by the Senate Finance Committee on June 8, 2009. This bill is still in the legislative process and may be changed at any time prior to its enactment or it may not be enacted at all.

To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. Federal tax advice contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of: (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed therein.

About the Authors:

The authors are Zee Makhani, Senior Engineering Director, with Paradigm Partners, and Mark Lauber, VP of Marketing at Paradigm Partners. Paradigm Partners is a national tax consulting firm specializing in niche tax services such as the R&D Tax Credit, the IC-DISC, WOTC and Cost Segregation. Mark's email is MLauber@ParadigmLP.com and his phone number is (281) 558-7100 X-105. Our website is www.ParadigmLP.com.