After two years of $0 tax bills, Amazon finally owed money to Uncle Sam in 2019, paying $162 million in taxes on $13.9 billion in pre-tax income—a total federal tax rate of just 1.2%, compared to the 14.2% federal tax rate paid by the average American taxpayer.
Amazon’s low tax bills have drawn fire from both sides of the political spectrum, but in fact Jeff Bezos is doing everything right. His e-commerce giant isn’t dodging taxes by offshoring its headquarters—it’s decreasing its taxes by using legitimate tactics, including claiming R&D credits designed to foster innovation and boost our economy. The problem isn’t that Amazon is using these credits. The problem is that it’s so hard for smaller companies to do the same.
The rationale for R&D tax incentives is clear: every dollar invested in R&D drives over $20 in new economic activity. In other words, we’re all better off if companies spend their money on innovation instead of giving it to the government. At present, though, virtually everything about our R&D system is designed to favor big corporations, and to put federal incentives out of reach of the small, scrappy startups that are the true engines of innovation and economic growth.
New legislation (H.R. 7766) introduced last month by Indiana Republican Rep. Jackie Walorski (R-Ind.) would strengthen R&D credits, but doesn’t do nearly enough to help small companies that want to invest in R&D. Rep. Walorski’s bill doubles the total R&D tax breaks available to U.S. businesses, but also perpetuates the structural problems that currently make it far harder for American startups to invest in innovation than it is for major corporations.
Part of the problem is that the R&D tax credit system is a confusing mishmash that small companies, and especially startups seeking to gain a foothold in the marketplace, struggle to navigate. Big companies like Amazon can afford lawyers and accountants to process their R&D credits; smaller outfits often wind up missing out.
Worse still, under the present system, the bulk of R&D incentives are framed as a credit against a company’s federal tax bill; only a far smaller slice can be used to offset payroll taxes. That’s fine for companies like Amazon, which have huge tax liabilities to offset, but it’s a real problem for early-stage companies that don’t yet have substantial operating profits or big tax bills. If I’m running a well-capitalized startup, I might invest substantial amounts in innovation—but still wind up unable to claim as much in incentives as larger competitors.
Rep. Walorski’s bill recognizes the need to help startups, allowing new companies to apply their R&D tax credits towards up to $500,000 per year in social security payroll taxes—a big improvement from the current $250,000 cap, and one that would help companies that don’t yet have substantial profits to get a cash benefit from R&D credits. However, it would still require companies to claim credits over time, using the convoluted tax system, rather than simply giving young, innovative companies a quick injection of cash.
With the remainder of the credit still needing to be applied against a company’s federal tax bill, many early-stage companies, even under Walorski’s R&D system, would wind up getting relatively little government support. That’s in stark contrast to the system in Canada, for instance, where small businesses can get back as much as 64% of R&D spending, much of it received as a refundable tax credit—so if a company doesn’t yet have a big tax bill, the Canadian government will cut them a check for the balance of their credit.
In other words, an early-stage Canadian company that spends $210,000 a year on R&D, but makes no profits and so has no tax obligations, could receive $135,000 a year in direct payments from the government. The same company operating in the United States would be fortunate to recoup a tenth of that amount.
That obviously leaves American startups at a serious disadvantage, and it’s becoming a major threat to U.S. dominance in high-tech industries. We’re already seeing some startups choose to relocate from Silicon Valley to Canadian tech hubs in Toronto, Montreal, and Vancouver, and with the shift to remote working and unfriendly U.S. immigration policies likely to further weaken U.S. innovation hubs, there’s a real chance that Canada’s thriving tech scene will fill the vacuum.
To arrest that trend and ensure the continuing dominance of American tech companies in coming years, Congress needs to step up. American startups need the additional R&D credits enabled by H.R. 7766, but they need much more, too. To spur American innovation, create jobs, and revitalize our economy, it’s time to create a level playing field, and make sure that R&D incentives are accessible to all businesses—and not just highly profitable corporate juggernauts like Amazon.
This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.
Lloyed Lobo is the co-founder and president of R&D tax credit software company, Boast.AI, that is building the future of tax credit recovery with artificial intelligence to help companies get larger returns without the manual work and audit risk.