Beginning in 2022, the federal research tax credit must be amortized. Some lawmakers are pushing back with bills to reverse course before amortization starts.

By Jamie Overberg

For over 60 years, businesses in the United States have been able to immediately deduct R&D expenses in the year those expenses were incurred. Beginning in 2022, certain expenses will need to be amortized and policymakers are waking up to the detrimental impact this pending change will have on U.S. innovation.

The Tax Cuts and Jobs Act (TCJA) of 2017 had a revenue-raising provision to begin amortizing research and development costs beginning in 2022, including software development costs. The deduction is to be spread out over five years for activities on U.S. soil, or 15 years for activities undertaken outside the U.S.

Throwing out the long-standing, immediate deductibility of R&D expenses will diminish the value of R&D credits. Amoritization reduces the after-tax cash flow for R&D activities and drives down the rate of return on R&D investment, causing private sector R&D investments to become more expensive and resulting in harmful outcomes, according to the R&D Coalition, a coalition of more than 65 member companies and associations in all 50 states.

The harmful impact will be felt in job losses and a decrease in global competition. Opponents highlight several far-reaching implications as well on foreign tax credit calculations and foreign earnings.

What’s at issue

Several bills are before Congress that would delay or repeal changes in §174 rules, which are at the heart of the amortization issue. Taxpayers currently have the option under §174(a) to immediately expense R&D costs. Alternatively, taxpayers under §174(b) can elect to treat these costs as deferred expenses and amortize the costs over a period of not less than 60 months,  beginning with the month that the taxpayer first realizes benefits from those expenditures. 

The current law allows taxpayers to plan whether they want to use deductions in the current year or defer them based on facts and circumstances. Additional provisions allow taxpayers to amortize over 10 years expenses that might otherwise be tagged as deductible under §174(a). 

Breaking it down, wages, supplies, outside contract and leased computer costs are eligible for research tax credit while organization costs associated with the project can be capitalized. According to the Tax Foundation, forcing businesses to amortize new R&D costs would be a tax hike of $100 to $120 billion over the next decade.

Congress deliberates

Unless Congress acts to reverse provisions in TCJA, taxpayers will lose the current year deductibility for wages, supplies, outside contract and leased computer costs beginning in 2022. TCJA legislation would require taxpayers to charge these expenses to a capital account and spread out the amortization over five or 15 years.

Congress is considering bills to protect the R&D tax provision. Both the American Innovation and R&D Competitiveness Act of 2021 (H.R. 1304) and the American Innovation and Jobs Act (S. 749) would stop the TCJA amortization provisions from going into effect. Both have bipartisan support as a growing number of politicians weigh in on the importance of encouraging American innovation, manufacturing and competitiveness.

Either way the chips may fall on this issue, tax departments need to be prepared. First, communicate the potential impact amortization will have to your company’s effective tax rate to upper management. Discuss potential changes with the accounting department and determine what mechanisms are already in place or need to be implemented to capture the costs that will need to be capitalized. 

TaxOps has assisted many taxpayers in the capitalization arena.  Please reach out to us for any guidance you may need. 

 Jamie Overberg, a partner at TaxOps Minimization, has been observing the hard sciences at work on U.S. soil at innovative companies, engineering firms, and government entities for over 20 years as she executes, manages, and writes about all aspects of R&D credits. She can be reached directly at joverberg@taxops.com.

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