R&D Tax Credit Ignites Love But Not Always Action Among Midmarket Businesses, says McGladrey’s Kaplan

Having expired at the start of the year, the R&D tax credit is once more garnering headlines as Congress debates the bill that includes the R&D measure along with 50-plus other temporary tax breaks. While the R&D credit’s popularity among businesses is unrefuted, statistics show that only a portion of middle-market businesses have historically taken advantage of it. Or so Ben Kaplan, a director in McGladrey LLP’s Baltimore Tax Practice, has been seeking to expose as he tries to enlighten firms about the credit’s untapped potential.

MME: How widely do businesses use the R&D tax credit?

Kaplan: According to the latest statistics available from the IRS, there were 12,941 companies that claimed the credit. The amount of credit that was claimed was $8.5 billion, which clearly is a lot of money, but the way the procedure works is that a company filing for the credit has to report the amount of its spending, so when the IRS added up all of the spending on research, in the aggregate it was $171 billion. (This was from 2010, but it is the latest data that the IRS has issued.) Here’s the thing: The National Science Foundation also reports on total research spending within the United States, and they reported that private industry spent $271 billion on research in that same year. About $100 billion in research spending by private industry went unclaimed. This is not an aberration. I went back and found that a similar gap exists all the way back to 2001. On average, about 35 percent of research spending goes unclaimed. This was backed up by a survey done by the Small Business Administration, which looked at high-technology firms; they learned that 62 percent of firms in the high-technology sector don’t claim the research credit.

MME: This is surprising in light of how high-tech firms are known to be research-driven …

Kaplan: What we find is that companies sometimes take a narrow view of what research is. Second, they don’t see an immediate benefit. The research credit is a credit against taxes that are payable, so if you’re in a loss position, you may say, “Well, I’m not getting any benefit — I don’t necessarily want to invest in the time that is necessary to claim the credit.” This is a little shortsighted, because the credit can be carried forward for 20 years. It’s kind of like banking something and then saying, “Okay, as I become profitable, I’ll be able to use it.” You can also carry it back one year. So there are just some wrong preconceptions.

MME: Could it be that middle-market companies may not view certain spending as research, even though it should rightfully be classified as such?

Kaplan: That’s exactly it, and that’s what gave rise to our article on tax credit myths and some of the reasons companies are not claiming credit that they are otherwise entitled to. If you think about eligibility or what makes something available to the research tax credit, the crux of it is technical uncertainty. The regulations talk about it in terms of activity related to eliminating uncertainty, and you try to eliminate uncertainty when you are trying to do some development or improvement. What the regulations also say is that it is information that is available to the taxpayer, so it’s not like you have to know things that other companies don’t, or don’t share. When you think about technical uncertainty, it applies both to product development and improvement as well as to process development and improvement. A lot of companies are not claiming the process improvements, which in a way is surprising because companies — manufacturers in particular — see process improvement as being a big driver of increasing their profitability and making them more competitive. Somehow they don’t relate this to the research credit, and it seems to me that they forgo a great opportunity for reducing their tax burden and getting the benefit that other companies take by claiming the credit.

MME: Since the R&D tax credit expired at the start of the year, it’s been making headlines again as Congress debates the larger tax package of which it’s part. Any reason to think that Congress won’t get it renewed?

Kaplan: I’m an optimist, and I think that it will eventually go through. It’s been renewed 14 or 15 times since 1986, and it has a history of being temporary. It has almost always been renewed every year, except for one year when they made it retroactive for 6 months, which was 1996. I think there is a general consensus that it is beneficial for the business climate and businesses in general.