Robert Hummel
Chief Scientist, Potomac Institute for Policy Studies
US Tax Policy on R&D
The US Tax Code allows businesses and taxpayers to deduct what are called “research and experimentation expenses” from their income before paying taxes, provided those expenses are “qualified,” according to Section 174 of the tax code. In addition, Section 41 permits a tax credit for increases in research and development (R&D) expenditures over a baseline amount, as long as those expenses qualify under Section 174 and satisfy certain other conditions. Section 174, as originally formulated, allowed a company to depreciate R&D expenses over five years, if the taxpayer so desired, enabling the deduction to apply when the fruits of R&D generated taxable returns. Seemingly, the US tax code treats R&D favorably.
However, this common perception is misleading; in reality, US tax policy is unfriendly to R&D funded by for-profit companies. The policy is complex, confusing, and counterproductive. Qualifying conditions make the tax code suspicious of companies claiming to conduct R&D. The tax code can be viewed as discouraging businesses from pursuing independent R&D that is not sponsored by the government or others. The provisions create a legal nightmare of subjective interpretations of R&D, and amount to a jobs program for lawyers and accountants in association with businesses’ R&D operations. Both Sections 174 and Section 41 pose challenges.
Recent changes have made the situation much worse.