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Evolution of R&D Tax Credit

The R&D Tax Credit: Rewarding More Businesses Everyday

If you still think a company needs to cure a disease or invent a cutting-edge spaceship to qualify for the R&D tax credit, then you’re still thinking about yesterday’s R&D incentives. The original credit came on the scene in 1981 and required that you invent something impactful, but to qualify today, you just have to improve something you’re already doing, or a product you’ve already made. And, you don’t even have to succeed—the government rewards companies just for trying. That’s the tip of the iceberg in terms of how the credit has evolved over the years to include more activities and benefit more companies.

Here’s a look at the evolution of R&D incentives.

1981:  The R&D Tax Credit is Born

The credit, also known as the Research and Experimentation (R&E) tax credit, was introduced in 1981 to incentivize companies to keep high-paying jobs in the U.S. Under the Discovery Rule, companies had to create or produce new products or processes to qualify for the credit—meaning only a few of the more cutting-edge companies were able to benefit.

2003: The Discovery Rule is Eliminated

If there was one thing standing between innovative taxpayers and the benefit of the R&D tax credit, it was the Discovery Rule. To qualify for the credit, the Discovery Rule mandated that R&D activities must be “new to the world.” Without the rule, activities only need to be “new to the taxpayer,” meaning more companies—and more industries—can qualify for the credit.   

For example, if a cell phone company were to create a new type of camera for a phone, it would be eligible for the R&D tax credit—but so would a competitor cell phone company that creates the same camera two years later. This is because the competitor’s development would still qualify as being new to that taxpayer.

2006: Calculations Get Simpler

After the Discovery Rule was abolished, the IRS and the U.S. Department of Treasury continued to explore ways to make the credit more generous and available to more companies. In 2006, they introduced the alternative simplified credit and easier way to calculate the R&D credit. The Alternative Simplified Credit offers companies more flexibility in calculating the credit and possibly, increasing the dollar amount of the credit.

2015: The PATH Act Makes the Credit Permanent and Benefits More Companies

Almost a decade later, in 2015, the Protecting Americans from Tax Hikes (PATH) Act was signed into law, making the R&D Tax credit permanent and retroactive. Companies no longer had to put spending on hold waiting to see if the credit would be renewed.

The PATH Act also helped start-up companies who were operating with losses. Before the PATH Act, companies operating in the red were not able to immediately monetize the R&D tax credit because they weren’t taxable. Thanks to the PATH Act, these companies could apply the credit to their payroll liability.

The PATH Act came through for companies who wanted to use the credit to offset the alternative minimum tax (AMT), as well. Before the PATH, companies with an AMT amounting to more than their regular tax liability couldn’t use the credit. Or, if their liability was a little above the AMT, they could only use the R&D tax credit to reduce the amount owed down to the AMT level. Since 2015, companies who can show average gross receipts for the last three years below $50 million are able to use the R&D tax credit to offset AMT liability.

2018: Tax Cuts and Jobs Act Increases the Credit for Some Taxpayers

The Tax Cuts and Jobs Act (TCJA) came on the scene in 2018, reducing the corporate tax rate from 35 percent to 21 percent. Which means Taxpayers claiming a reduced tax rate see an increase in their R&D tax credit.

2020: Even with all these changes, the U.S. still comes in 24 out of 34 OECD countries in terms of R&D generosity. So, there’s work to be done—and U.S. policymakers are already on top of it. Various proposals to expand the credit—and allow even more companies to benefit from it are in the works. For example, if the recently proposed FORWARD Act passes, it will incentivize more companies to manufacture at home. And if the R&D proposals in the American Growth Act become reality, medical companies will get special incentives and the credit could double overall.

What’s in store for R&D in the United States?  Read what the presidential administration may mean for the R&D tax credit here.