Laura Kushner, Director of Marketing

Laura Kushner, Director of Marketing

The United States was one of the first countries to enact a federal tax credit for R&D in 1981, and throughout that decade we had the most generous R&D incentive in the world. However, other countries soon realized the benefit of the R&D credit and adopted not only similar but often more lucrative credits.

By 1996, the U.S. ranked only 7th in R&D tax generosity out of the countries that had an R&D credit, and by 2004 we had slipped to 17th place. The key reason — every other country with an R&D tax credit has increased the generosity of those credits. Not only has the U.S. not increased the credit, but to date Congress has not yet extended the credit for 2010. The result – by 2009 the U.S. ranked dead last — leaving the number one position to France.

However, if Congress were to enhance the R&D tax credit and make it permanent as other countries have done instead of simply extending it each year, the result would be an immediate and positive impact on U.S. innovation and job creation.

For example, a study by the Information Technology and Innovation Foundation think tank suggests that raising the Alternative Simplified (ASC) R&D tax credit rate from 14 to 20 percent would create 162,000 jobs in the short-term and an unspecified number of additional jobs in the longer-term. ITIF also estimates that raising the ASC would increase the annual GDP by $90 billion, the number of patents issued by 3,850 and federal tax revenues by $17 billion.

Raising the ASC to 20 percent would bump the U.S. R&D tax generosity rank to number 10. However, we would need to increase the ASC to 31 percent to move to 5th place and to a whopping 47 percent in order to reclaim the number one spot with the most generous R&D credit of the 21 countries that currently offer one.

Fortunately for American businesses, all but about 12 states offer a state R&D credit. Some of these state credits are more lucrative than the federal credit, and some are even fully refundable.

For example, New York has a refundable credit, specifically for companies with revenues under $10 million, that averages between 9-18%. Starting in tax year 2010, the Minnesota state credit will be expanded and made refundable. Louisiana has one of the most lucrative credits of all the states. Depending on the size of the company, the credit can be from 8 to 40 percent, and it is also refundable.

Companies located in states that offer a state R&D credit can realize significant dollars in tax credits, especially when combined with the federal credit. These dollars can be reinvested to fund additional R&D which, in turn, will boost both innovation and job creation in the U.S.

Good news. Congress may now be turning their attention to the expiring tax provisions, including the R&D tax credit. While the R&D credit has support from both sides of the aisle, it has been deferred as more hot items, such as state education funding, make their way through Congress.

The entire Republican contingent on the Senate Finance Committee has called on Sen. Max Baucus (D-MT), chairman of the panel, to schedule an early September mark-up of legislation dealing with expiring tax provisions. (August 6 letter to Sen. Baucus regarding markup request) The letter noted that during a July 22 committee meeting Baucus agreed “to process a tax bill in committee” that would cover the expiration of individual tax rates, expired provisions such as the R&D tax credit, a compromise regarding the estate tax, and energy taxes. “In exchange, we agreed to limit our amendments to those particular topics and to refrain from offering amendments that would introduce extraneous matters like corporate tax reform,” the letter said. “It would be a mistake for the Senate to consider such an important piece of tax legislation without its having first been marked up” by the committee, the GOP members wrote. A link to the letter can be found at http://finance.senate.gov/newsroom/ranking/release/?id=a646558c-2302-440b-ad73-9480f7eb2d58.

Matt Rader

Matt Rader, Director of EPAct §179D, Cost Segregation

Matt Rader, Director of 179D and Cost Segregation for SourceCorp, will speak at the Green Data Center Conference in New York on October 20 and the Sustainable Buildings Conference in San Francisco on October 27. His focus at both conference will be on the 179D tax deduction. If you plan to attend either conference, or even if you don’t, submit questions or comments here. Responses will be posted on this blog as well as addressed during the conferences.

Both conferences are sponsored by the Global Strategic Management Institute. To register follow this link. http://events.gsmiweb.com/events.php#October.

In addition to being able to claim the federal research and development tax credit, companies conducting R&D activities in the state of Maryland may be eligible for a state credit as well. Maryland offers a nonrefundable R&D credit for certain qualified activities and expenses consistent with the federal credit.

Businesses must submit an application for the credit to the Maryland Department of Business and Economic Development by September 15 of the year following the tax year in which the expenses were incurred. The state will certify the amount of credit available to the business by December 15, and companies are then notified as to how much of the credit claimed will be paid.

Total credits for all businesses may not exceed $6 million per year. Historically the amount of credits applied for exceeds the $6 million maximum, and companies are ultimately granted only a percentage of the total credits for which they apply.

There are two credits available; the basic credit and the growth credit. The basic credit is 3 percent on all qualified research expenses up to a base amount.  Spending beyond the base amount entitles a business to the growth credit which is 10 percent. The credit is taken against corporate or personal income tax, and any unused credit may be carried forward for seven years.

As of July 1, 2010, the Maryland state R&D tax credit was extended from 2011 to 2020.

Stephanie Woods, Director of Business Development for R&D

Stephanie Woods, Director of Business Development for R&D

Beginning with the 2009 tax year, the Louisiana Research & Development tax credit is refundable and is one of the most lucrative of any states. Companies that have Louisiana-based qualified research expenses are eligible for the R&D tax credit.

Qualified research expenses include:

  • Wages for employees who:
    • Engage in research
    • Directly supervise research
    • Directly support research
  • Supplies used to conduct research and development
  • Contract research expenses – 65 percent of any expense paid or incurred to persons other than an employee of the company

Companies that employ up to 50 Louisiana residents may be eligible for a 40 percent state R&D tax credit on their qualified research expenses.

Companies that employ 50-99 employees can claim a 20 percent state credit for increasing their research activities. For companies with 100 or more employees an 8 percent credit applies.

Louisiana also offers alternative methods to calculating the credit for increased research activities. Companies that perform work under the SBIR program may also qualify for the credit.

Credits claimed prior to 2009 that cannot be utilized may be carried forward, transferred or sold.

Prior to claiming an R&D tax credit, a company must apply for and obtain a credit certification from the Department of Economic Development. Understanding the application process and evaluating the most appropriate calculation is critical to maximizing the R&D tax credit benefit. An R&D study will expedite and help support the application process. With the September 15 deadline rapidly approaching, now is the time to evaluate whether your company meets the requirements to claim the newly refundable Louisiana state credit for 2009.

For a look at some examples of the Louisiana state R&D tax credit click here.

In addition to being able to claim the federal research and development tax credit, companies conducting R&D activities in the state of Utah may be eligible for a state credit as well. Utah offers a nonrefundable R&D credit, ranging from 2.5-9 percent, for certain qualified activities and expenses. Qualifying activities follow the same definition as the federal credit and include:

• Creating new or improved products, processes, formulas, software, techniques
• Implementing cost reduction initiatives
• Automating or improving manufacturing processes
• Developing prototypes, first articles, models
• Designing tools, jigs, fixtures and molds
• New materials testing
• Testing new concepts

The Utah R&D credit does not expire, but does have a three-year statute of limitations for amending prior returns thereby allowing companies to take advantage of overpaid tax liability in the three prior years and also claiming a current year credit.

The credit may be computed using two alternative methods each with their own advantages, so some tax planning is necessary as you evaluate the credit opportunity. One method is more lucrative in that the credit percentages are higher but excess credits under this method cannot be carried forward. Under the second method, the credit calculated may be less, but any excess credits from one year may carry forward for up to 14 tax years.

In addition, a state credit is available for machinery and equipment that is dedicated to R&D. The credit is 6 percent of the cost of the machinery and equipment and is nonrefundable. If the credit is more than the tax liability, it may be carried forward for the next 14 taxable years as well.

May 19,2010 — In a meeting with Treasury on May 19, SourceCorp made recommendations on the §179D tax deduction with regard to how it can be taken by A&E firms. Current law states that the owners of an A&E firm structured as a pass through entity can only take advantage of the §179D tax deduction up to the amount of basis in the business. The IRS recognizes this hindrance and requested the recommendations that are now being considered.

SourceCorp confirmed that distributions in excess of basis are always treated as long-term capital gains (i.e. 15%) as long as the partner/shareholder holding period is greater than one year. This means that an A&E firm will still get the rate arbitrage benefit (i.e. 15% vs. 35%) even if they don’t have basis. The benefit that remains, assuming the taxpayer is in the highest tax bracket, is approximately 57% of the original benefit.

SourceCorp is a leading provider of §179D tax deduction consulting for A&E firms across the country. In addition, the company provides cost segregation studies, R&D tax credit studies and LIFO inventory solutions.

Legislative outlook:

Neither house or Congress has moved meaningfully on a Congressional Budget Resolution beyond the Senate Committee action which we last reported to you, and Speaker Pelosi indicated this week that the House is unlikely to consider a budget this year. If that proves to be the case, the Senate will not be able to consider tax legislation under the filibuster-proof Reconciliation procedures this year, thereby creating a 60-vote threshold for any tax legislation which has serious opposition. That would be very good news for us.

While major tax legislation is expected at some point this year, thus far both houses remain focused on passing the tax extenders bill, extending expiring (or expired) tax provisions like the R&D tax credit, deductibility of state sales taxes, etc. There are a lot of additional issues that are wrapped up in the ongoing discussion of the extenders legislation, but for our purposes the concern is the “pay-fors” or tax increases that might be considered to help offset the revenue loss caused by extending the expiring provisions. LIFO has not been discussed as one of the pay-fors at this point, and Coalition meetings on Capitol Hill have provided no concrete suggestion that we are at risk in the extenders bill. We continue to watch and monitor those discussions closely, and Hill meetings continue, but so far the news has all been reassuring.

Once the extenders bill is finally enacted, we expect Congress to turn to other tax measures, in effect forced to that discussion because of the expiration at the end of this year of most of the tax cuts enacted in 2001 and 2003, including marginal tax rates at all levels and reduced rates on dividends and capital gains. The expiration at the end of last year of the “death tax” is also driving dicussion of tax legislation later this year. With many in Congress intent on extending some of the exipriring tax rate reductions beyond their scheduled exipration at the end of this year, Congress will need huge “pay-fors” to offset those continued reduced rates, and it is very possible that LIFO repeal will be discussed in that context. We remain committed to protecting LIFO, but we are by no means out of danger yet.

Home state meetings with Finance and Ways and Means members:

To that end, we would again encourage all of you to request and/or ask your members to request meetings with members of the Senate Finance and House Ways and Means Committees (or their key staff) while they are at home during the Memorial Day recess (May 21-31). There is no doubt that the many meetings you all scheduled and attended in home state offices last summer were critical in persuading key members of the House and Senate not to pursue LIFO repeal. Those meetings could make the difference again this year. You can find the list of state and district offices of all the relevant committee members at the links below. Please help with this effort, and please provide any feedback you get from calls or meetings you schedule/attend.

Last month, Minnesota Governor Tim Pawlenty signed into law a jobs bill that includes enhancements to the state’s Research and Development tax credit.

The bill expanded Minnesota’s R&D tax credit, making it more attractive for small to large-sized companies that conduct R&D activities in the state.

Major changes to the MN R&D Credit:

1. Effective for taxable years beginning after December 31, 2009, partners in a partnership and shareholders in an S corporation may now take the R&D credit. Previously, only C corporations could take the credit.
2. The tax credit increased and now equals 10 percent of the first $2 million of excess qualified research expenses for the taxable year over the base amount. For excess expenses over $2 million, the credit equals 2.5 percent.
3. The credit for taxable years beginning after December 31, 2009, is now refundable.

ACTION ITEMS

All pass-through entities should seek to take advantage of the Minnesota R&D in 2010.

In addition, all companies that have had losses for several years, and have never taken the state credit, should take advantage of the credit in 2010 to obtain a refund.