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The House Ways and Means Committee is considering changes to how Vermont defines taxable income for businesses that invest in research and development. Vermont companies spend millions of dollars each year on R&D across advanced manufacturing, software, biotechnology, and applied research. The tax treatment of those investments directly influences capital allocation, hiring decisions, and long-term competitiveness.

The proposal contains two interdependent components that must be evaluated together. In combination, these changes could materially shape Vermont’s innovation climate, affecting how growth-stage and capital-intensive firms evaluate future investment in the state.

What the Bill Does

The draft legislation makes two significant changes.

First, it adds back federal Section 174 deductions for research and experimental expenses. That means Vermont would not allow businesses to deduct their R&D expenses when calculating state taxable income.

Unlike other areas of the tax code, such as bonus depreciation, the draft does not restore those expenses through state level amortization. As written, R&D costs would not be deductible for Vermont tax purposes.

Second, the bill increases Vermont’s R&D tax credit from 27 percent to 75 percent of the federal R&D credit. That is a substantial increase and would make Vermont’s credit one of the most generous in the country.

These two provisions must be understood together.

What This Means in Practice

There are two primary ways states can treat R&D spending.

One approach is deductibility. Businesses subtract their R&D expenses from taxable income, just like wages, rent, or other operating costs.

Another approach is relying more heavily on tax credits, which apply only to businesses that calculate and qualify for the federal R&D credit and have sufficient tax liability to use it.

Under the existing draft, Vermont would move away from deductibility and rely more heavily on the expanded credit.

For Businesses That Claim the Federal R&D Credit

Businesses that calculate and claim the federal R&D credit would see a larger Vermont credit under the proposed 75 percent rate.

However, because the deduction would no longer be allowed, the total state tax benefit may be smaller than under a system that includes both deductibility and a credit. The outcome depends on each firm’s cost structure and federal credit calculation.

For Businesses That Incur R&D Expenses but Do Not Claim the Credit

Not all businesses that invest in R&D claim the federal credit. Some may not meet the qualification thresholds. Others may not calculate it due to complexity or cost.

Under the draft language, those businesses would lose deductibility of R&D expenses and would not receive the benefit of the credit increase. For those firms, the proposal would result in higher Vermont taxable income.

For Early Stage and Growing Firms

Firms in a loss position or early growth stage often rely on deductions to build net operating losses that can offset future income.

If R&D expenses are permanently disallowed for Vermont purposes, those costs would not be recoverable at the state level, which may affect long term planning and investment decisions.

Timing Versus Permanence

A key distinction in this debate is whether Vermont intends to delay deductibility or eliminate it.

If Vermont required R&D expenses to be amortized over several years, businesses would still recover their costs over time. That is a timing adjustment.

Under the existing draft, there is no amortization restoration. As written, the policy would permanently disallow deduction of R&D expenses at the state level.

That structural difference has meaningful economic implications.

Where the Opportunity and the Risk Sit

The increase to a 75 percent R&D credit is significant. If structured correctly, it could position Vermont as a strong competitor for innovation-based investment.

The risk lies in how the deduction and credit interact. If the credit expansion is paired with preserved cost recovery, the proposal could strengthen Vermont’s competitiveness while maintaining revenue balance. If deductibility is permanently removed, the policy becomes more uneven. Some firms would benefit from the higher credit. Others would see a durable increase in state taxable income.

The Bottom Line

This proposal is not simply about increasing a tax credit. It is about how Vermont defines taxable income for businesses that invest in research and development. Understanding whether the policy preserves deductibility or permanently eliminates it is essential to evaluating its impact.

The Vermont Chamber will continue to work with lawmakers to ensure that tax policy advances affordability, predictability, and long-term competitiveness while avoiding unintended consequences for the businesses that power Vermont’s economy.

Lawmakers on the House Ways and Means Committee confronted a reality that Vermont businesses are already living with. Federal tax changes and trade disruptions are creating uncertainty that businesses cannot control, while Vermont’s selective conformity framework puts state policymakers in a position to either reduce that strain or add to it. As federal pressures build, the conformity debate this session is less about following Washington and more about how Vermont chooses to support its own economy.

Federal tax changes are rarely neutral for states. Vermont does not conform automatically to the federal tax code. Changes that affect the calculation of federal taxable income generally flow through unless the state explicitly decouples, while provisions that occur below the line or are structured differently often require affirmative legislative action. As a result, conformity decisions are not passive. They are deliberate policy choices that shape whether Vermont’s tax system reflects current economic conditions or introduces added cost and complexity for employers already navigating uncertainty.

In periods of stability, these decisions matter. In periods of disruption, they matter more.

What Federal Conformity Means for Vermont Businesses

To ground the discussion in real world application, the Committee heard detailed testimony from Mike Hackett, Partner and Tax Practice Leader at Gallagher Flynn and Company. Hackett walked lawmakers through how key provisions of H.R. 1 operate across business types and why conformity decisions have tangible consequences for Vermont employers.

He emphasized that when Vermont decouples from federal tax treatment, the impact is not abstract. It shows up as additional calculations, higher professional fees, and increased compliance complexity for businesses simply trying to follow the law. In an already challenging operating environment, that added friction can influence whether businesses invest, expand, or delay decisions.

From there, the testimony focused on several provisions with broad relevance across Vermont’s economy.

Research and Experimental Expenditures

One of the most significant provisions discussed was the restoration of current deductibility for domestic research and development expenses. Hackett explained that prior capitalization requirements created a disconnect between taxable income and actual business economics, forcing companies to pay tax on income they never truly realized.

These impacts extend well beyond traditional research-intensive industries. Vermont employers rely on R&D spending for process improvements, engineering, compliance driven innovation, and product development across manufacturing, construction, software, and research driven fields. Allowing these costs to be deducted when incurred improves cash flow and supports reinvestment at a time when margins are under pressure.

Business Interest Deductions

H.R. 1 also restores the calculation of interest deduction limits to a framework used prior to 2022. Vermont has historically conformed to this approach. Hackett noted that decoupling here would be a meaningful departure for the state, immediately limiting businesses’ ability to deduct ordinary financing costs while also requiring separate state and federal calculations.

In an environment of higher interest rates and rising capital costs, interest deductibility directly affects access to capital and the feasibility of investment across sectors. Maintaining alignment here helps avoid layering additional cost and complexity onto routine business financing decisions.

Expensing of Depreciable Business Assets

Updates to federal expensing limits, particularly under Section 179, reflect inflation and rising equipment costs. Vermont already conforms to these rules. Hackett cautioned that failing to update conformity would leave outdated thresholds in place while prices continue to rise, requiring businesses to track separate depreciation systems without changing behavior in a productive way.

Enhanced expensing provisions support investment in the physical backbone of Vermont’s economy, including manufacturing equipment, construction machinery, agricultural assets, technology systems, and hospitality infrastructure.

An Unintended Small Business Consequence

Hackett also highlighted a technical but important issue affecting small businesses that amended federal returns related to prior R&D capitalization rules. Without state action, some Vermont businesses could permanently lose the ability to deduct legitimate expenses for Vermont tax purposes. Those dollars were spent, but the deductions disappear under current state law.

This outcome was never intended by federal policy and disproportionately affects small employers managing tight cash flow, underscoring how technical conformity decisions can have very real consequences.

Conformity as a Vermont Decision

What emerged clearly from the hearing is that conformity is not an endorsement of federal policy. It is a Vermont decision about how much friction the state is willing to layer onto businesses already absorbing external shocks.

When federal actions introduce volatility, state policy choices can either amplify that uncertainty or help stabilize operations. In this context, conforming to key federal provisions can reduce compliance costs, improve predictability, and support continued investment in Vermont’s economy.

The Bottom Line

This week’s testimony underscored that Vermont’s tax decisions this session will be shaped less by ideology and more by whether the state uses the tools it controls to respond to forces it does not.

Federal policy may be driving uncertainty, but Vermont has choices. Conformity decisions that prioritize predictability, simplicity, and investment give businesses the clarity they need to navigate disruption and continue contributing to Vermont’s economy.

The Vermont Chamber will continue to engage lawmakers with data-informed analysis and real-world context to ensure tax policy supports affordability, predictability, and long-term economic resilience for businesses across the state.