For the US to remain the world's leading economy, and to compete with China's real GDP growth, its rate of innovation needs to accelerate. Making the federal research and development tax credit transferable would unlock its full potential.
Congress established the research and development tax credit in 1981 to drive growth, but its current structure limits its impact and falls short in two main ways: It delays benefits and fails to target the businesses that would actually increase their R&D efforts -- the small business innovation sector. Companies can only redeem credits when they have taxable income, which is typically years after their initial R&D investments. This delay diminishes the value of the incentive.
With key provisions of the Tax Cuts and Jobs Act set to expire, Congress is negotiating new tax policies. One pressing decision is whether to continue the amortization of R&D expenses under Section 174, which creates untenable tax liabilities for companies.
The Committee for a Responsible Federal Budget estimates a full repeal of Section 174 would cost $150 billion. However, targeted relief for small businesses would likely cost less than $25 billion, given they represent roughly 10% to 15% of R&D spending.
Reversing Section 174 alone isn't enough. To regain lost ground, Congress must ensure the R&D tax credit better incentivizes investment, directing funds toward businesses that are most likely to increase their current R&D spending. Without action, the US risks falling behind in new technologies as competitors such as Canada, Germany, and South Korea adopt more favorable tax policies.
Tech giants are often thought of as the drivers of innovation, but the reality is they're more likely to buy new technology than create it. Why? Large companies excel at scaling and commercializing new technology but can't keep up with the pace of discovery that small players bring. Simply put, big companies rely on small businesses to push the boundaries.
Effective tax policy should reflect that small businesses are the true pioneers but often lack the financial means to bring their ideas to life. Meanwhile, companies such as Apple Inc., Meta Platforms Inc., and Microsoft Corp. are sitting on hundreds of billions in cash. Their problem isn't funding R&D -- it's finding the next big idea worth investing in.
If cash-poor small businesses could immediately realize the benefits of R&D tax credits, they would expand research, hire more engineers, and accelerate product development. Making the credit transferable is the most effective way to make this happen.
A transferable R&D tax credit would allow small businesses to sell their credits for immediate capital, enabling faster reinvestment in innovation. Consider a small firm with $10 million in revenue and $1 million in net income. Over two years, it invests all its profits into R&D, generating $200,000 in tax credits to offset tax liability it doesn't have.
Under the current system, the company might not see benefits until year five, when it becomes profitable. If the credits were transferable, the firm could sell them immediately, securing $140,000 to $180,000 in upfront funding. This additional capital would help offset risk and accelerate product development, aligning with Congress' goal of fostering innovation.
A common misconception is that small businesses already receive adequate support through the startup R&D payroll tax credit. While helpful for early-stage companies, this provision excludes established small businesses with more experience and higher survival rates. Directing R&D tax credits toward these businesses would yield far greater economic benefits.
The current policy's narrow focus on startups overlooks a broader segment of the innovation ecosystem. Further, large companies' substantial cash positions suggest that providing them with more benefits would amount to pushing on a string. Overall, the current structure delivers a sub-optimal return on investment for taxpayers.
The Inflation Reduction Act's credit transfer model -- currently applied to clean energy credits -- offers a proven blueprint. Since its enactment, the market for transferable energy credits has grown quickly, reaching about $9 billion in transactions in 2023. Last year, the broader transferable tax credit market saw an estimated $30 billion in transactions, proving strong demand and improved business liquidity.
However, transferability also raises concerns about misuse, such as recapture, misrepresentation, or market manipulation. The IRA mitigates these risks through certified intermediaries, transaction transparency, and compliance measures -- safeguards that could be adapted for R&D tax credits.
Transferability doesn't increase the deficit; it accelerates when credits are used, improving cash flow without long-term revenue loss.
Keeping the US from falling behind other countries isn't just about national pride. Without faster rates of innovation and its resulting productivity, the US economy could falter. Making the credit transferable would allow the US to fully tap into small businesses' innovation abilities, creating a stronger economy and a higher return for taxpayers.
With a major tax bill on the table, Congress should strengthen the R&D tax credit now. While tax policy often prioritizes rate reductions, the US' greatest economic asset is its ability to innovate. Making the R&D credit transferable would fuel innovation, drive growth, and expand the tax base, ensuring US businesses stay competitive in the global economy.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Rick Kleban is the president and founder of Sycamore Growth Group, a tax credit advisory firm specializing in complex tax credit matters and compliance best practices.
Jenna Tugaoen is a tax attorney at Sycamore Growth Group focused on R&D economic incentives and tax controversy.
James Bean, CPA, is a senior researcher and R&D tax controversy specialist at Sycamore Growth Group.