Congress is awhirl in the all-too-familiar cycle for a number of tax provisions: enactment, expiration, and extension.
More than 50 corporate and individual tax provisions, including the popular research credit, are not a permanent part of the Internal Revenue Code. Instead, these temporary provisions typically expire every year or two and are usually given new life as part of legislative packages known as “tax extenders.”
Fiscal policy aside, businesses universally support tax extenders because of the valuable incentives they bring to the economy. However, the temporary nature of the provisions can create challenges for companies, which must determine how to manage tax incentive programs that are not certain to continue. Here are some considerations as the legislative process unfolds, as well as some practical insights for planning in the interim.
We’ve Seen This Movie Before
The research credit and other provisions included in an extenders package are typically extended as a group, expediting a process that would be even more protracted if each individual provision required a separate vote. Due to the current federal deficit, the extenders endure an increasingly contentious approval process in Congress before they are finally signed into law by the president, thus causing uncertainty for business tax professionals.
The research credit has been renewed and extended by Congress nearly 20 times since its inception in 1981. Since tax extenders are laws that will expire after a certain date, the Congressional Budget Office must assume that these laws are temporary, which results in a distortion of the true budget picture — specifically, a projection of a healthier budget balance than is likely to occur.
Theoretically, there are good reasons to enact a tax provision on a temporary basis — in response to a natural disaster or economic downturn, for instance. However, critics argue that tax extenders are not meaningfully evaluated, create unnecessary uncertainty, and are less effective than a permanent provision. Although temporary provisions theoretically force Congress to examine the costs and benefits of each measure before deciding to extend it, critics counter that a true systematic review does not occur, since the extenders are grouped and passed as a package.
Examining the Research Credit
The research credit is the most expensive element of the extenders legislation based on budgeted costs. Widely popular in Congress and business circles alike, it provides tax incentives across a broad range of industries and companies of all sizes. Thousands of taxpayers have taken advantage of the research credit in recent years, as it is generally available for a wide swath of product, process, and software development activities.
Failure to swiftly extend the research credit is costly for the government because the IRS must prepare two versions of impacted 2015 tax forms pending the outcome of the extender legislation. Because of the number of expiring tax incentives, the IRS cannot wait for the legislation to pass to start marking up tax forms.
The research tax credit last expired on December 31, 2014, and Congress waited until mid-December to pass the extenders package. That legislation only retroactively renewed most of the 55 traditional extenders that had expired at the end of 2013 through the end of 2014, so in 2015, taxpayers have so far endured a year without the research tax credit and other expired tax provisions.
What’s Next for Legislation
This summer, Congress has mobilized to extend the research tax credit and other expired provisions sooner rather than later. On July 21, the Senate Finance Committee approved legislation extending more than 50 tax provisions, including the research credit, through December 31, 2016.
Back in May, the House passed a series of permanent extensions of tax incentives, including the research credit, which is projected to cost $181.6 billion. The House bill would provide a permanent, simplified method for calculating the research credit, with a rate of 20%, and it would change the base period for the basic credit from a fixed period to a three-year rolling average. The White House, though, has said it would veto the measure because it’s not offset with other spending cuts or tax increases.
Once the Senate votes to approve the two-year extenders package passed by the Finance Committee (it’s expected to happen after the August recess), the bill would return to the House to be reconciled with its permanent extender package passed in May. The reconciled extenders legislation would then require approval by both legislative bodies before going to the president.
What to Expect Next — and What to Do about It Now
Given the current climate regarding tax reform, it is very likely that any extenders legislation (either two-year or permanent) won’t be finalized until near year-end, even with Congress’s recent efforts. This will have financial statement implications for companies that claim the research credit. So the question becomes: What can be done in the interim to address this uncertainty? Here are some thoughts:
- Understand the financial statement tax implications of the current lapse in extenders. Businesses need to understand how retroactive extensions complicate financial reporting. For example, the research credit and other tax extenders may directly affect a company’s effective tax rate and cash flow. Because companies cannot record the financial statement benefit until the extenders bill is passed and signed into law by the president, distortions in tax footnotes for calendar-year companies inevitably occur (especially if extenders are signed into law after December 31, 2015).
- Consider business needs first and foremost. Companies should evaluate whether the cost of maintaining programs that take advantage of extenders. History shows that most of the popular temporary tax provisions, such as the research credit and work opportunity tax credit, will be extended. But business needs should almost always take precedence in determining when and how to invest capital. For example, bonus depreciation on qualified property, another provision that has been extended, is a nice additional incentive, but if a business needs its assets to operate effectively in the short term, then investment decisions should be made with only a cursory acknowledgement of the tax implications.
- Identify and understand processes that must be followed regardless of the outcome. Businesses should understand how — and which — tax extenders impact their specific business operations and then assess how to invest limited resources on tax incentives with an uncertain future. Waiting to document certain incentives such as the work opportunity tax credit will mean losing the benefit, because filing and reporting requirements are short term in nature even in periods of expiration. Similarly, neglecting to follow a normal process of documenting and calculating the research credit could result in collecting insufficient information to claim the credit on an originally filed return. This could have negative implications at both the federal and state level.
- Monitor legislation for changes that will impact year-end planning and the ability to obtain future tax incentives. Although the research credit is widely supported in Washington, a permanent extension would face a likely veto unless offsets are included in any final permanent extenders legislation forwarded by Congress. Even though both Congress and President Obama have said that a permanent research credit is one of their goals, the cost of a permanent extension could make the likelihood of its eventual enactment low. Therefore, a two-year extension through December 31, 2016 appears to be the most likely outcome.
Kathleen King is a managing director with Alvarez & Marsal Taxand. She is based in Washington, D.C.