In the case of an individual who owns an interest in an unincorporated trade or business, who is a beneficiary of a trust or estate, who is a partner in a partnership, or who is a shareholder in an S corporation, the amount of credit that can be used in a particular year cannot exceed an amount (separately computed with respect to the person's interest in the trade or business or entity) equal to the amount of tax attributable to that portion of the person's taxable income which is allocable or apportionable to such interest.11 Any excess credit amount is eligible for the carryover rule described above.

Relation to deduction

The section 41 credit is available for incremental qualified research expenditures for the taxable year whether or not the taxpayer has elected under section 174 to deduct currently research expenditures. Under present law, the amount of any section 174 deduction to which the taxpayer is entitled is not reduced by the amount of any credit allowed for the same research expenditures. University basic research credit

A 20-percent tax credit also applies to the amount by which corporate cash expenditures (including grants or contributions) paid for university basic research exceed the sum of (1) the greater of two fixed research floors plus (2) an amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixed base period, as adjusted for inflation.

The amount of basic research expenditures to which the university basic research credit applies does not enter into the computation of the incremental credit. The remaining amount of basic research expenditures-i.e., the amount to which the university basic research credit does not apply-enters into the incremental credit computation, provided that such expenditures are eligible for the incremental credit.

a. Extension of credit

Explanation of the Bill

The bill would make permanent the incremental research credit and the university basic research credit.

11 For example, if in a particular year an individual partner derives no taxable income from a partnership which had made incremental qualified research expenditures, the individual may not use in that year any tax credit resulting from incremental qualified research expenditures of such partnership which otherwise would have been properly allowable to the partner (e.g., where the partnership had paid such research expenditures in carrying on a trade or business of the partnership and where any credit allowable to the partnership with respect to such expenditures had been properly allocated among the partners pursuant to Treasury regulations). If, in this example, the partner had derived taxable income allocable or apportionable to his or her partnership interest, then the amount of credit which may be used in that year by the individual partner may not exceed the lesser of (1) the general business credit limitation amount or (2) the separately computed additional limitation amount applicable to individuals, i.e., the amount of tax owed by the partner on income attributable to his or her partnership interest.

b. Modification of base period for incremental credit

In general

Under the bill, a taxpayer could elect either of two methods for computing the incremental research credit. Under either method, a specified credit rate would apply to the amount of the taxpayer's qualified research expenditures in the current year that exceeds a fixed base period amount (subject to certain adjustments), rather than a moving base period amount as under present law.

Under the first method (the "primary credit"), the base period amount would equal the average of the taxpayer's yearly qualified research expenditures for its taxable years beginning after December 31, 1982 and before January 1, 1988, with two adjustments. The five-year base period amount would be increased by seven percent; this would be a one-time only adjustment. In addition, the base period amount as so computed would be increased each year to reflect the GNP growth rate.12 If the primary credit is elected, a credit rate of 20 percent would apply to those qualified research expenditures in the current taxable year that exceed the base period amount.

Under the second method (the "alternative credit"), the base period amount would equal 75 percent of the base period amount as computed under the first method. If the taxpayer elects this method, the credit rate would be seven percent.

In any taxable year, a taxpayer can elect either the primary credit or the alternative credit, depending on which method results in the greater credit amount, regardless of the method selected by the taxpayer in the previous year.

New companies

A special rule would apply to determine the base period amount in the case of a taxpayer which did not have qualified research expenditures in at least three of the five years in the fixed base period (i.e., taxable years beginning after 1982 and before 1988). This rule would apply both to businesses formed after 1988 and to existing businesses that meet the definition (e.g., a business incorporated in 1984 that prior to 1988 had qualified research expenditures only in 1986 and 1987).

For such a new business, the base period amount would be computed as follows:

For the first taxable year (beginning after 1988) in which the firm incurs qualified research expenditures, and for each of the two succeeding years, the taxpayer's base would be deemed to be equal to 50 percent of its current year qualified research expenditures.

For the fourth year, the taxpayer's base would be deemed equal to the greater of (1) 50 percent of its current year qualified research expenditures or (2) one-third of the average of the taxpayer's actual yearly qualified research expenditures in the first three

12 The GNP growth rate means the nominal growth rate of the GNP published by the Bureau of Economic Analysis of the Department of Commerce. The adjustment to the base period would be the percentage (if any) by which GNP for the calendar year preceding the calendar year in which the taxable year begins exceeds GNP for the previous calendar year.

years, as adjusted to reflect any increase in GNP between the third and fourth year.

For the fifth year, the taxpayer's base would be deemed equal to the greater of (1) 50 percent of its current year qualified research expenditures or (2) the sum of (a) the base period amount applicable to year four plus (b) 15 percent of the taxpayer's actual qualified research expenditures in year four, with the sum adjusted to reflect any increase in GNP between the fourth and fifth year.

For the sixth year, the taxpayer's base would be deemed equal to the greater of (1) 50 percent of its current year qualified research expenditures or (2) the sum of (a) the base period amount applicable to year five plus (b) 15 percent of the taxpayer's actual qualified research expenditures in year five, with the sum adjusted to reflect any increase in GNP between the fifth and sixth year.

For the seventh year and subsequent years, the taxpayer's base would equal the base period amount applicable to the prior ↔ year, as adjusted to reflect any increase in GNP from the prior year. As under present law, the taxpayer's base period amount could not be less than 50 percent of its current-year expenditures, regardless of which credit computation method is selected.

c. Extension of credit to start-up businesses

In general

Under the bill, in-house research expenditures would be treated as meeting the "carrying on" test if the taxpayer's principal purpose in making such expenditures is to use the research results in the active conduct of a future trade or business of the taxpayer. Thus, otherwise qualified in-house research expenditures of a startup firm whose activities have not yet reached the point of constituting a trade or business would be eligible for the credit. (However, contract research expenditures would be eligible for the credit only pursuant to the present-law trade or business test.) If in the year the credit is earned the start-up firm does not have any income tax liability against which the credit could be used, this credit amount would be eligible for the 15-year carryover (subject to the general business credit limitation) provided under current law.

Limitations

The bill would not modify the present-law rule that the credit is not available to any partners (whether businesses or investors) in a partnership that does not meet the trade or business test at the partnership level.

Under the bill, as under present law, base period research expenditures would be treated as at least equal to 50 percent of qualified research expenditures for the current year.

Also, the bill would not affect the special present-law limitation on use of the credit by individuals. Under that limitation, in the

case of an individual who owns an interest in an unincorporated trade or business, is a partner in a partnership, is a shareholder in an S corporation, or is a beneficiary of a trust or estate, the amount of credit that can be used in a particular year cannot exceed an amount (separately computed with respect to the person's interest in the business or entity) equal to the tax attributable to that portion of the individual's taxable income that is allocable or apportionable to such interest.

Effective Date

The provisions would be effective for taxable years beginning after December 31, 1988.

Disclosure of Certain Tax Return Information to Veterans'

Administration

Present Law

The Internal Revenue Code prohibits disclosure of tax returns and return information of taxpayers, with exceptions for authorized disclosure in certain enumerated instances (Code sec. 6103). Unauthorized disclosure is a felony punishable by a fine not exceeding $5,000 or imprisonment of not more than five years, or both (sec. 7213). An action for civil damages also may be brought for unauthorized disclosure (sec. 7431).

Among the disclosures permitted under the Code is disclosure of return information to Federal, State, and local agencies administering certain programs under the Social Security Act or the Food Stamp Act of 1977. This disclosure, pursuant to a written request by the agency, is for the purpose of determining eligibility for, and the correct amount of benefits under, certain enumerated programs. Any authorized recipient of return information must maintain a system of safeguards to protect against unauthorized redisclosure of the information.

Explanation of the Bill

The bill13 would allow disclosure of certain tax return information to the Veterans' Administration to assist it in determining eligibility for, and establishing correct benefit amounts under, certain of its needs-based pension and other programs.

The Veterans' Administration would be required to comply with the safeguards presently contained in the Code and in section 1137(c) of the Social Security Act (governing the use of disclosed tax information). These safeguards include independent verification of tax data, notification to the individual concerned, and the opportunity to contest agency findings based on such information.

Effective Date

The bill would be effective on the date of enactment.

13 S. 2611 was favorably reported by the Senate Committee on Veterans' Affairs on July 6, 1988 (S. Rpt. 100-412), and was placed on the Senate Calendar.