The latest tax reform lowered the corporate tax rates and at the same time eliminated many corporate business tax credits. This is an excellent idea, in general, as it would give corporations additional money to invest in their companies as they see fit rather than be incentivized to invest the money as the government would prefer.
I was, however, dismayed to see that one credit kept in the law was the research tax credit. In my years working with this credit at the IRS as one of the National Coordinator’s for the research credit issue for the Appeal’s Division I can tell you that this is one credit that needs to be eliminated.
First, the law is very poorly written with what qualifies for the credit so ambiguous that no one, even the tax professionals, can tell just what qualifies. This has led some unscrupulous practitioner firms to attempt to qualify all manner of research that almost certainly was not intended to qualify by Congress. Activities that I saw attempted to be qualified during my time at the IRS included time spent deciding the most optimal size of armholes for sleeveless dresses, determining the proper depth to dig sewer or cable lines and time spent determining the proper number of lanes for routine road construction. None of these activities should be incentivize through a research tax credit as they were routine activities that produced no material innovation.
The current research tax credit statute defines qualified research as an activity related to discovering information through a systematic experimentation process to overcome a technical uncertainty that has a goal of producing a functional improvement in a business component. It is the relatively low standard of “overcoming an uncertainty” that tempts taxpayers/practitioners to attempt to qualify questionable activities. There is limited case law that sheds some light on what activities might qualify but the rulings have been somewhat inconsistent and have left the question of exactly what is qualified research very vague. In fact, the number of court cases to address qualified research have been relatively few as neither the Government or Taxpayers really want to litigate the question due to the uncertainties.
Second, it is questionable how much research the credit incentivizes. The law allows for claims to be filed for past years where the credit was overlooked. Therefore, a taxpayer can get the research credit though it was not aware of the credit at the time it conducted the research and therefore the credit provided no incentive for innovative research.
Thirdly, the amount of time spent by practitioners, taxpayers and the government to compute and audit the credit is very significant. Once the standard for qualified research was lowered in 2003 to the current standard many boutique firms were created or began specializing in mining new and expanded research credit claims for taxpayers. Correspondingly, the IRS has had to commit significant resources to this issue from its limited resources. The effect I noted while in Appeals were many questionably/sloppy studies from practitioners and many sloppy/incomplete audits from IRS Exam as it tried to cope with a multitude of questionable research credit claims for which it had limited staffing.
President Trump should be congratulated on attempting to limit corporate credits in favor of reduced marginal tax rates. However, he should include the research tax credit in his credit eliminations as the law is ambiguous, does not incentivize innovative research in many cases, and is costly to adjudicate.