ACA and Tax Coalition Partners Make Capitol Hill Visits

By: Pat Gouhin, Chief Executive Officer

I just returned from another trip to Washington, DC where I teamed up with our tax coalition partners; National Venture Capital Association (NVCA) , Biotechnology Innovation Organization (BIO) and Advanced Medical Technology Association (AdvaMed).  We conducted a series of congressional visits with key representatives from the tax writing Senate Committee on Finance and House Committee on Ways and Means. We also met with the Assistant to the President for Financial Policy on the National Economic Council.  This coalition, started by ACA over four years ago by Public Policy Chairman David Verrill, brings a consistent voice to US tax policy that impacts investors and entrepreneurs. It is managed by ACA’s consultants at GrayRobinson.

Coalition team members Cameron Arterton, Vice President, Tax Policy for BIO,
Patrick Gouhin, ACA CEO, and Chris McCannell, Senior Government Affairs Consultant for
GrayRobinson, on the steps of the Old Executive Office Building looking at the White House

Our visit was timed with legislation being drafted by Senator Maggie Hassan (D-NH) a new member of the Senate Finance Committee, to build support for her legislation on the R&D Tax Credit Expansion Act. This legislation recognizes that refundable tax credits are vital for new and small businesses that are not yet profitable enough to have income tax liability. Currently, the refundable credit is capped at $250,000 and cannot exceed a business’ Social Security payroll taxes, which are 6.2% of wages. Further, a small business is only eligible for the refundable credit if its gross receipts are less than $5 million. The new legislation proposes to double the refundable R&D credit by increasing the refund cap from $250,000 to $500,000, to simplify and expand the refundability of the R&D credit to cover all payroll taxes paid by businesses and also extends the refundable R&D credit to more small businesses by increasing the eligibility cap to $10 million in receipts from $5 million in receipts.  ACA, along with our coalition are working with Senator Hassan to find a lead Republican to make the legislation bi-partisan. I have reached out to my Junior Senator Thom Tillis (R-NC) and hope that he joins Senator Hassan in this key endeavor.

This same legislation recognizes that startups commonly choose to take the “alternative simplified” R&D credit instead of the traditional R&D credit. The traditional credit covers 20% of a business’ current-year R&D spending that is above the greater of its historical average or half its current-year R&D spending, while the simplified credit only covers 14% of current-year R&D spending that is above half of its previous three-year average. The refundable R&D credit is available to startups through the first five years of profitability but the design of the simplified R&D credit limits incentives for startups in these first years of business. This limits the incentive provided by the R&D credit to new startups that are quickly scaling up research budgets. Senator Hassan’s legislation equalizes the simplified R&D credit favored by startups with the traditional credit by increasing the alternative credit rate from 14% to 20% for new and small businesses that are eligible for the refundable credit. It also expands the simplified R&D credit for new startups and provides greater flexibility in the first five years of business.

During our visits we also reaffirmed our past position on Section 41 Payroll R&D Credit that aligns closely with Senator Hassan’s legislation. We strongly supported the Protecting American’s from Tax Hikes Act (PATH) Act’s reform to the R&D credit that allowed pre-revenue innovators to take a portion of their R&D credit against their payroll tax obligation which was an important recognition that income tax credits do not yet benefit pre-revenue companies. Congress made a great start in encouraging the growth of more innovative American companies when the payroll R&D credit was created as part of the PATH Act. But the size restrictions associated with the provision leave many startups unable to access the benefits of the payroll R&D credit. A typical startup will still be quite early in the process of development when the size/age limits eliminate their ability to benefit from the payroll R&D credit. Meanwhile, their pre-revenue nature prevents them from taking advantage of the traditional R&D credit. This creates a strange dichotomy where startup companies cannot access the benefits of the R&D credit when they need it the most. As global competition for innovative entrepreneurship continues to increase, a number of other countries, including Canada, Spain, France, and Britain, have created various forms of a refundable R&D credit. We believe that our proposed improvements to the payroll R&D credit will provide a fair and material benefit for American entrepreneurs and represent a strong step forward in shoring up our startup leadership on the world stage.

Secondly, we talked about enhancements to Section 1202 of the tax code which gives investors in qualified small business stock in companies valued under $50 million a 100% exemption on capital gains if the stock is held for five years or more. ACA has always led on this issue and we take full credit for it becoming permanent when President Obama signed the PATH Act into law in 2015.  Reflecting that valuations haven’t changed since the early 1980’s when Section 1202 was added to the code, we support increasing the cap to $100 million. We also support either through regulations at the IRS or through legislation, a clear tracking document where the entrepreneur and the investor attest to understanding that the company qualifies for 1202 and will be able to claim 1202 after an appropriate liquidity event. This form, which we envision as one page, can be filed with the IRS and with the Reg D documents to provide additional certainty to the investor, and their heirs, that the investment qualified under 1202 even in the original entrepreneur has left the company. We believe formalizing the 1202 process will give added incentives to investors and entrepreneurs to take advantage of this transformative part of the tax code.

Thirdly, we held multiple meetings looking at Section 382 NOL Safe Harbor. Tax rules relating to the treatment of losses can unintentionally punish start-ups for investing in the growth of their companies. The rules, in Section 382 of the tax code, were written in the mid-1980s with the intent of preventing the strategy of companies acquiring failing firms with enormous losses on their books for the sole purpose of using the tax losses to offset other unrelated income.  This is also known as loss trafficking. While we recognize the importance of preventing abusive loss trafficking, the excessive application of these rules has created an impediment for startups which depend on invested capital and often accumulate net operating losses (NOLs) as a result of substantial R&D expenditures and rapid hiring.  Under Section 382, accepting these critical equity investments can limit a startup’s ability to utilize NOLs in the future. Thus, Section 382 discourages investments in innovation and works at cross purposes with tax policy that generally seeks to encourage R&D such as the R&D credit.  We believe, and communicated that, Congress can foster economic growth and job creation without creating a new tax expenditure, simply by modernizing the rules in the code to stop penalizing startups for investing in job creation and innovation. The solution lies within a safe harbor from Section 382 NOL limitations for startups going through viable fundraising rounds and ownership changes. We proposed specific changes that would allow loss limitation rules to still be able to accomplish the objective without preventing tax abuse but avoid the unintended consequences of discouraging investment in innovation and job creation.

We are close to having  Finance Committee Senators Pat Roberts (R-KS), Rob Portman (R-OH) and Robert Menendez (D-NJ) introducing this legislation which would be a win for angel investors.

Finally, we met with The Honorable Rebekah Jurata, Assistant to the President for Economic Policy at the National Economic Council. Rebekah is a good friend of ACA, and was previously House Financial Services Committee Chairman Jeb Hensarling’s (R-TX) Securities Counsel where she ran point on the HALOS Act.  Rebekah offered to help coordinate a meeting with ACA, and key board members along with our coalition partners with Deputy Treasury Secretary Justin Muzinich, to talk about our issues surrounding implementation of H.R. 1 the Tax Cut and Jobs Act (TCJA) especially 1202 and Opportunity Zones. Rebekah also reassured ACA that she and the White House are in close coordination with the United States Securities and Exchange Commission on ways the SEC can expand capital formation through rule-making or guidance.  We used her offer as an opportunity to emphasize that we believe Chair Clayton and the Commission have the authority to exempt demo days from general solicitation, instead of having to pass the HALOS Act in Congress. We will continue to work with the Rebekah and the White House to see if this can be accomplished.

ACA CEO meets with Congressman Brian Higgins (D-NY).
Rep. Higgins is a member of the tax writing House Ways and Means Committee.

While influencing legislation can be a long and slow process, I am happy to report that our voice was heard. I would be remiss to not share a few challenges. The wounds from the passage of H.R. 1, the Tax Cut and Jobs Act in the last Congress remain raw with some key Democrats. While House Dems, especially the moderate New Dems and Blue Dogs appreciated our pro-growth, pro-job message, and folks like Senators Hassan and Menendez are rolling up their sleeves for innovation, the Senate Finance Committee Democratic staff (Senator Ron Wyden D-OR) was incredibly skeptical of the value of additional tax cuts. The staff clearly stated that while issues like expanding the Earned Income Tax Credit, Child Care Tax Credit and other middle-class initiatives are unaddressed that Ranking Member Wyden is not likely to support additional tax cuts even for an industry as innovative and worthy as the early stage ecosystem.  As we continue to refine our messaging, especially among Senate Democrats , we will need to highlight the impact of angel investors on job creation, economic growth and how our investments bring diversity and economic opportunity to the broadest group of people. We will need to convince a skeptical audience.

We pledged our ongoing support to provide subject matter expertise and guidance in the future.  I believe our offer was received positively as our elected officials continue to tackle challenging and complex issues that have significant impact to multiple stakeholders.