By Brent Willett, CEcD
This blog first appeared March 09 on IowaBiz.com.
Congressional leaders reached an agreement on federal spending and avoided a government shutdown at the end of last year when omnibus appropriations and tax bills were signed by President Obama on December 18. Buried in the discussion around the trillion-dollar agreement are important boosts to funding for many science and economic development initiatives important to Iowa, as well as an increase credits for small and high-tech businesses.
The 12 bills approved under the omnibus package will fund the government at $1.15 trillion in discretionary funds through the end of the 2016 fiscal year. Separate legislation, the Protecting Americans for Tax Hikes Act of 2015 (PATH) makes over 20 key tax provisions permanent while extending and enhancing others.
Why are you telling me this?
The important news for job creation in Iowa [and the country] is that the PATH Act finally makes the federal R&D tax credit permanent. This is a big deal for American research and development- activities which have been primary contributors to our country’s emergence as the global center of commerce and innovation in the last hundred years.
Iowa’s Research Activities Tax Credit is more or less is indexed to the federal credit- meaning if your business’s R&D expenditure activities qualify for the federal credit, those activities more than likely qualify your company for the state credit. Creating certainty around the federal program offers a boost to the competitiveness of states like Iowa with well-designed state R&D credit programs which work in concert with the federal programs.
In addition to permanence, the federal R&D program was expanded to pre-tax startup companies; it will allow them to use the R&D credit against their payroll tax liability. This is important to the sorts of innovative, small startups we seek to cultivate in Iowa who are pre-revenue [which creates no tax liability with which to access a tax credit], yet spend large sums on R&D. To qualify for this treatment, the company must by no more than 5 years old and it must have revenues below $5 million. The credit is capped at $250,000 per year.
Businesses with $50 million or less in gross receipts may use the federal credit against alternative minimum tax liability, and certain businesses with $5 million or less in gross receipts will now be able to apply the credit against payroll taxes. These changes are also intended to benefit smaller businesses and startups, which were unable to take advantage of the credit in the past. In 2010, Iowa’s 260,000 businesses averaged about $685,000 in gross receipts.
Federal support for R&D: past and present
The R&D tax credit was first enacted in 1981 at a rate of 25% in an effort to encourage private sector investment in R&D to act as a salve to the decline in private R&D investment that began in the 1960s. Bill writers and leading economists of the day believed that this decline was to blame for the slowdown in U.S. productivity growth and the unexpected loss of U.S. industrial competiveness in the 1970s. The program has been reworked and tweaked every couple of years since.
There are four separate components of today’s federal R&D tax credit, but the two most commonly used are the “Regular” research credit and the “Alternative Simplified” credit, both of which offer a tax break equal to a percentage of spending on “qualified research expenses.” The regular method offers a credit of up to 20% and the alternative simplified method offers a credit of up to 14%.
Qualified research expenses include wages and salaries, cost of equipment and supplies. To qualify, expenses must be experimental for the purpose of discovering information that is technological in nature and used to develop a new product, process, computer software technique, formula or invention that is to be leased, licensed or used by the company.
What took so long? J/K; it’s Congress.
Why is the R&D tax credit only now being made permanent? At least 15 times in the past, the R&D credit was allowed to expire by Congress and was retroactively extended. The main issue is/was [drumroll…] cost; the program carries a price tag of almost $180 billion. Despite the perceptively steep cost, both political parties and economists generally agree that there is economic justification for subsidizing R&D spending; studies have shown that R&D spending does not only benefit the private firm, but society as a whole in terms of return from innovation.
Although until now the federal R&D program has existed in a state of uncertainty, Iowa’s R&D program has remained steadfast since its creation over a decade ago.
What to know: Iowa program meets fed program
Iowa’s Research Activities Credit has several important ties to the federal credit. A company must meet the qualifications of the federal R&D tax credit in order to be eligible for the credit in Iowa. The credits are also similar in the fact that the Iowa credit can be calculated using either the regular or alternative simplified credit method. Also, the definition of qualified research expenditures are the same in both cases, including wages, supplies and other expenses used to discover information that is technical in nature and aimed at the development of a new product. Iowa is one of only a few states to offer a refundable research activities credit.
Iowa’s program offers an incremental credit, meaning that only research expenditures which exceed a base amount are eligible for the credit. The Iowa regular credit is 6.5% of the qualifying research expenditures that exceed a base amount or 50% of qualifying research expenditures.
A total of $57,147,847 in total Research Activities Tax Credits was claimed by Iowa companies and individuals between January 1 and December 31, 2015, according to a recently-released report from the Iowa Department of Revenue. A total of $44,428,444 in tax credit refunds was paid last year – representing about 77.7% of the total research activities tax credit claims made. In total, 186 companies received approximately $42 million in tax credit refunds last year.
The media throws shade on R&D all the time. It’s not helpful.
Despite the decisive importance of attracting innovation investment to any state attempting to compete in the 21st century knowledge economy, sustained, bewildering media fire trained on the R&D program in Iowa has become the norm. The coverage [it’s been going on for years], fortunately, has not bent the will of the people of this state and our representatives. And good thing, too; the message sent by a state which pulls back its R&D programming in the face of rare congressional action to strengthen the federal program would be devastating to the efforts of communities across Iowa working to encourage innovation and the jobs that come with it.