By Dean Zerbe, National Managing Director at alliantgroup and Former Senior Counsel to the U.S. Senate Finance Committee
March 29, 2021
Chairman Wyden, Ranking Member Crapo, and distinguished Members of the Committee, thank you very much for the opportunity to submit written comments in response to your important hearing to discuss the effect of the U.S. tax code on domestic manufacturing.
My name is Dean A. Zerbe and I am alliantgroup’s National Managing Director based in Washington, D.C. alliantgroup serves a broad spectrum of clients, from start-ups to the largest Fortune 1,000 companies in nearly every industry. Our professionals consist of CPAs (including former partners at “Big Four” accounting firms) and attorneys, in addition to individuals from a wide array of disciplines. alliantgroup works with businesses and their CPA firms to identify powerful, government-sponsored, cash-generating credits, incentives, and deductions. As background, I had the honor to serve as Senior Counsel and Tax Counsel for the Senate Finance Committee from 2001-2008.
I want to thank all of the Committee members for bringing forward this critically important discussion. The effect that the tax code, particularly the Research and Development Tax Credit (R&D Credit), has on American businesses cannot be understated. Even more so, the potential this tax incentive has for growing important businesses in the U.S. to compete globally is vast. The Finance Committee, under the current leadership and under the previous leadership of Chairman Grassley, has been a strong advocate for the R&D Credit and ensuring that the credit works for small and medium businesses (SMBs). I particularly commend the Finance Committee for championing changing the law to allow SMBs to take the R&D Credit against AMT, a seemingly small change that has made an enormous difference for thousands of innovative SMBs to utilize and benefit from the R&D Credit that translated into a great number of good jobs at good wages for many Americans. The Finance Committee now has the chance to build on its excellent work.
It is vitally important to the U.S. economy and to your constituents that Congress helps American businesses, particularly those small and medium in size, remain and become financially viable. Enhancing certain aspects of our tax code can be the key to more employees getting hired, better pay and more equipment being bought, built or exported. Unfortunately, the U.S. tax code has created barriers that have limited – or will limit in the near future – businesses from enjoying the full benefit of the R&D Credit.
It was, however, encouraging to hear many during the panel acknowledge the harms wrought by the amortization provision of IRC Sec. 174. The provision, which was included in the Tax Cuts and Jobs Act (“TCJA”) as a revenue raiser, will stifle innovation, be incredibly costly for job creators, reduce employment and cause massive administrative headaches for both taxpayers and the Internal Revenue Service (“IRS”). According to the Congressional Budget Office, the amortization of R&D expenses will result in a 17-percentage point increase in the effective tax rate on R&D investments at the end of this year. The requirement of amortizing all research and experimental expenditures over five years only serves to penalize taxpayers who perform research by disallowing immediate deductions of their R&D expenditures that could put necessary capital into business owners’ hands in the short term.
As an example, imagine an Automotive Parts Co. (“APC”) in Ohio that has $40 million in annual revenue, 150 employees, and income of $4 million. Assume APC is an S-corporation with a single shareholder who is married and will be filing jointly. The total IRC Sec. 41 qualified research expenditures (“QREs”) total $2.5 million, the IRC Sec. 41 credit (after reduction) totals $200,000, and the total IRC Sec. 174 expenditures total $4 million.
Under the current law, the total taxable income would be approximately $3.2 million ($4,000,000 – $800,000 IRC Sec. 199A). The total tax liability for APC would be approximately $915,000 ($1,125,000-$200,000 R&D Credit). Under the new IRC Sec. 174 provision, the taxable income would be approximately $5.76 million ($4,000,000 + $4,000,000 IRC Sec. 174 Cost*.8 – $1,440,000 Sec. 199A). This would leave APC with an approximately $1.87 million tax liability ($2,070,000 – $200,000 R&D Credit).
The above example isn’t a one-off, as we look at our clients we see a similar story repeated again and again across the country. Amortization of R&D will be crushing for businesses and jobs. Given my experience at alliantgroup working with thousands of businesses to claim the R&D Credit, I am certain that companies will refuse to take the credit if the current amortization rules, scheduled to take place in 2022, remain. alliantgroup has worked with companies in nearly every industry and through our work we have seen the tremendous impact that the R&D Credit has had on these businesses’ ability to hire and retain technical talent and invest in themselves to innovate at a higher level. From automotive companies in Ohio to agricultural businesses in Idaho, I have been amazed at the innovations brought forward by companies who have been able to leverage this incentive in order to make themselves more competitive. The Committee should strongly consider any legislation that will remove the amortization provision and allow for the continuation of the long-held practice of immediate R&D expensing that will allow companies to utilize the R&D Credit incentive to its full potential.
The Committee and hearing witnesses were also correct in acknowledging the ways in which COVID-19 exposed the weaknesses in America’s supply chain. The manufacturing sector is a crucial component of our country’s economic engine, and there are tools that Congress can implement to help ensure that the industry is operating at maximum capacity.
alliantgroup has long supported a more generous tax credit to support domestic manufacturing. The Committee should encourage R&D that translates into U.S. manufacturing jobs by providing a greater R&D Credit to those companies that conduct a significant percentage of their manufacturing domestically. An enhanced R&D Credit for domestic manufacturers would particularly benefit SMBs and would potentially create tens of thousands of manufacturing jobs domestically while discouraging companies from moving offshore.
There are several proposed bills that I encourage the Finance Committee to give hard consideration. Those include, introduced in the previous Congress, the FORWARD Act introduced by Senators Chris Coons (D-Del.), Pat Roberts (R-Kan.), Catherine Cortez Masto (D-Nev.), Todd Young (R-Ind.), Maggie Hassan (D-N.H.), and Steve Daines (R-Mont.), along with U.S. Representatives Suzan DelBene (D-Wash.) and Jackie Walorski (R-Ind.). The FORWARD Act provides an enhanced R&D Credit for U.S. companies to the extent they also manufacture in this country. The bill also proposes to expand the ability of start-ups to take advantage of the refundable R&D Credit.
The American Innovation and Jobs Act, introduced by Senators Todd Young (R-IN), Maggie Hassan (D-NH), Catherine Cortez Masto (D-NV), Rob Portman (R-OH), and Ben Sasse (R-NE), is also a great start to bolstering the R&D Credit. The proposed bill would restore immediate expensing for R&D expenditures for tax years beginning after December 31, 2021, and would also expand the refundable research credit for small businesses.
These bipartisan proposals offer Congress a way to significantly strengthen one of the most powerful tools for success available to American SMBs. China currently plans to significantly increase its available R&D Credit as part of its “14th Five-Year Plan for Economic and Social Development.” China will continue to allow for a 75 percent deduction for corporate R&D expenses, while increasing the allowable deductions of manufacturing firms to 100 percent and offering other tax incentives to increase R&D investments. If the U.S. wants to remain a world leader in innovation, we must keep pace with other countries in terms of available tax incentives that allow more monies to be allocated toward research and development efforts.
In closing, I wanted to also thank the Committee for acknowledging the STEM crisis that America faces. Hundreds of thousands of technical jobs go unfilled every year because American businesses are not able to find qualified talent. To date, alliantgroup has provided more than $640,000 in scholarships to young students who have committed themselves to a STEM career. The strengthening of the R&D Credit is only as powerful as the amount of technical workers that can leverage the incentive. I’m proud of alliantgroup’s leadership in encouraging young people to embrace a STEM career.
I want to again thank the Committee for the opportunity to comment on the topics covered during the hearing, and for its historic leadership in making the R&D Credit an effective tool for small and medium sized American businesses across the country.
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington, D.C. office. Prior to joining alliantgroup, Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman of the Finance Committee, Senator Charles Grassley, on tax legislation. During his tenure on the Finance Committee, Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law, including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform) and the Pension Protection Act.