Large corporations have dominated the use of the research tax credit, with 549 corporations with receipts of $1 billion or more claiming over half of the $6 billion of net credits in 2005, the most recent year available, according to a new study by the Government Accountability Office.
The GAO report argues that the design and administration of the tax credit for qualified research expenses could be improved. Based on an analysis of historical data and simulations, the GAO identified significant disparities in the incentives provided to different taxpayers, with some taxpayers receiving no credit and others eligible for credits up to 13 percent of their incremental spending. In addition, a substantial portion of credit dollars provides a windfall for some corporate taxpayers, providing them with a fortune in tax credits for spending research dollars that they would have spent anyway, instead of helping support potentially beneficial new research.
An important cause of this problem is that the base for the regular version of the credit was determined by research spending dating back to the 1980s. Taxpayers now have an alternative simplified credit option, but it provides larger windfalls to some taxpayers and lower incentives for new research. Problems with the credits design could be reduced by eliminating the regular credit and modifying the base of the alternative simplified credit to reduce windfalls.
Credit claims have been contentious, however, with disputes erupting between the IRS and taxpayers over what qualifies as legitimate research expenses and how to document those expenses. Insufficient guidance has led to disputes over the definitions of internal use software, depreciable property, indirect supervision, and the start of commercial production.
Also disputed is the documentation needed to support a claim, especially in cases affected by changes in the tax laws years after the expenses were originally recorded. Such disputes leave taxpayers uncertain about the amount of credit to be received, reducing the incentive to claim it.
The GAO recommended that the Treasury Secretary clarify the definition of qualified research expenses and organize a working group to develop standards for documentation. The Treasury Department agreed with the GAOs recommendation and plans to provide additional guidance in the next few months.
Treasury and the Internal Revenue Service are currently working on guidance involving several of the interpretive issues surrounding the research credit, wrote Acting Assistant Secretary for Tax Policy Michael Mundaca. For example, we are developing guidance to clarify the definition of gross receipts, the treatment of inventory property under Section 174, and the definition of internal use software.
The tax credit is due to expire at the end of December, but the House of Representatives is expected to debate a bill this week to extend it. Legislation has also been introduced in both chambers of Congress to make the research credit permanent and increase the alternative simplified credit option from 14 to 20 percent.
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