To the relief of companies with significant research activities, the Congress extended and expanded the research and development ("R&D") tax credit as one of its last acts before adjourning in December. The R&D tax credit was included in the "Tax Relief and Health Care Act of 2006," which President Bush signed into law on December 20, 2006. Completion of this legislation brought to a close more than a year of intense lobbying efforts by much of the business community, as the fate of the popular R&D tax credit became entangled in the volatile political environment surrounding the 2006 congressional elections.

The R&D tax credit, which equals 20 percent of the amount of the taxpayer's qualified research expenses (in excess of base amount), is a temporary credit -- and the failure by Congress to take action had caused the credit to expire on December 31, 2005. As a result, taxpayers that incurred qualified research expenses in 2006 could not be certain that they would be able to claim the credit with respect to these expenditures. The legislation that was signed into law in December extended the credit for two years -- retroactively for 2006 and prospectively for 2007. In addition, the legislation also created an alternative and elective method for calculating the amount of the R&D credit, which allows taxpayers to calculate the credit based on the taxpayer's average qualified expenses for the three preceding years. In general, this new component of the R&D credit will benefit more mature companies that have been conducting significant research and development activities for many years (and therefore suffer from a substantial base amount under the primary method for computing the credit). Younger companies (and others with a smaller base amount) that benefit more from using the primary method of computing their R&D credit will be permitted to continue calculating their credit using that method.

The R&D credit enjoys widespread bi-partisan support -- in fact, the new Senate Finance Committee Chairman Max Baucus of Montana has already introduced legislation in 2007 to further increase the R&D credit and make it permanent. However, making the credit permanent faces at least one significant hurdle -- and that is the revenue cost to the Federal government. It is believed that a permanent R&D credit could cost the Federal government up to $200 billion in revenue (over ten years). Given the current budget deficit situation, it appears unlikely that the R&D credit will be made permanent in the absence of significant reform of the income tax system.