In war over R&D tax credits, companies keep winning

The Washington PostJanuary 25, 2014 

WASHINGTON -- One of the most generous offerings for corporate America in the U.S. tax code is about to become even more bountiful under an Obama administration proposal.

The new rules, which are being finalized by the U.S. Treasury Department, would lift restrictions on the types of activities that qualify for a 30-year-old tax credit and related deductions -- raising the prospect that Boeing, Lockheed Martin and many smaller firms could reap hundreds of millions of dollars in fresh savings.

Administration officials say the change merely clarifies existing rules and would not dramatically broaden eligibility for the tax breaks.

"These rules are part of our ongoing work to clarify the tax code to provide incentives for businesses that are innovating," assistant secretary for tax policy Mark Mazur said in a

statement. "They do not expand the definition of research."

But corporate tax lawyers have enthusiastically embraced the proposed changes. And Marty Sullivan, chief economist for the nonprofit Tax Analysts, called the new rules "a significant giveaway to business."

"The IRS is under a lot of pressure from lobbyists to be accommodating," Sullivan said. "This is a pretty obscure issue. The only voice the IRS hears is the voice of discontent from business. There's no bright line to divide what should and shouldn't get the credit. So over the years, business has been successful in pushing that boundary out."

The new rules are the result of a decades-long legal battle waged by Dow Chemical and others to broaden the standards used to decide what kind of research deserves to be subsidized by the federal government. Together, the research credit and related deductions already save firms more than $12 billion a year.

Tax breaks as a reward

The tax breaks were created to reward companies for undertaking expensive -- and often uncompensated -- research that stands the chance of producing broad benefits for society. But after losing a number of recent lawsuits, the Treasury Department last fall proposed to let firms claim the credit for building prototypes of new products, even when the companies then sell the prototypes at a profit.

The tax benefits under the new rules would be retroactive, permitting firms to reduce tax bills dating back years. Corporate tax lawyers who are paid to follow such changes say the new rules significantly expand the range of eligible expenses.

"When you talk about expanding the breadth -- or acknowledging what qualifies for R&D -- almost anybody who is making, designing things in the United States potentially could qualify for some of these benefits," said Jeremy Fingeret, senior managing director at alliantgroup, a tax consulting firm in Houston. "It's a very, very broad scope."

The research and development credit is hugely popular in both parties, and President Barack Obama has vowed to expand it and make it permanent. The credit was among dozens of temporary tax breaks that expired on Dec. 31, but lawmakers are already laying plans to revive it and extend it retroactively, as they have done routinely in the past.

Away from the political spotlight, however, the tax break is deeply controversial. Some studies indicate it rewards business activity that likely would have occurred anyway; others have found it a useful incentive. Meanwhile, companies claiming the credit automatically raise red flags at the IRS -- and have a good chance of being audited.

Incentive for businesses

The research tax credit was created as a temporary tax break in 1981 under President Ronald Reagan. At the time, policymakers were rattled by fears that the U.S. economy was falling behind Japan. The tax credit was offered as an incentive for businesses to pursue discoveries and innovations that could help America regain a competitive edge, despite high and potentially unrecoverable costs.

The difficulty of drawing a sharp line between activities that meet that standard and those that do not quickly became clear. Administrations have since toggled back and forth between tightening and loosening the rules.

The Treasury Department under President Bill Clinton added a so-called "discovery rule," in which the activity was required to produce information that "exceeds, expands, or refines the common knowledge of skilled professionals in a particular field of science or engineering."

The Bush administration largely tossed that language out. Since then, companies have continuously fought the IRS in court.

"With the rapid pace of technology development, any bright line that sought to define R&D would be artificial and unrealistic," Mazur, the assistant secretary for tax policy said. "It is simply too difficult to make clear cut distinctions that would stand the test of time."

Unlike a tax bill on Capitol Hill, the new rules come with no official estimate of how much they would cost in lost revenues. Alex Sadler, a tax lawyer with Ivins, Phillips & Barker in Washington, estimates that for a single large company, the proposed changes could amount to hundreds of millions of dollars in savings.

In the trench warfare between corporate tax lawyers and the government, companies like Boeing have taken note.

Earlier this month, as Treasury officials and tax lawyers gathered in a windowless auditorium at the IRS to discuss the new rules, a tax lawyer from Boeing was the only scheduled speaker.

And in its quarterly report last fall, the aviation giant mentioned the new rules, calling them "generally taxpayer favorable." When they take effect, perhaps later this year, Boeing said it expects to claim new savings on tax bills dating back as far as 2007.

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