Deducting research and development (R&D) expenditures now looks different for companies, due to changes to Section 174 of the Internal Revenue Code. These changes were enacted as part of 2017’s Tax Cuts and Jobs Act, but only took effect with the 2022 tax year.
Effective for tax years beginning after December 31, 2021, businesses must capitalize and amortize all R&D expenses from the current tax year. Previously, taxpayers have been able to immediately deduct their R&D expenses against taxable income. Keep in mind, the R&D costs mentioned here are much broader than those that qualify for the R&D tax credit.
New R&D capitalization requirements
Instead of deducting R&D expenses in the year incurred, businesses are now required to capitalize and amortize such expenses over a five-year period for U.S.-based research and a 15-year period for offshore research.
For companies regularly conducting research, they would be expected to break out their R&D costs including:
- R&D wages and supplies
- Contracted third-party research
- Software development costs
Two notable exceptions to this rule are expenditures for land or property improvement and exploration expenditures related to mining or drilling. If a capitalized R&D cost is disposed, retired or abandoned, no deduction is allowed for that expenditure.
R&D action items for the 2022 tax year
Starting in 2022, eligible research expenses will need to be identified by taxpayers and amortized over the required period. This treatment applies regardless of whether or not the company takes advantage of research tax credits available under Internal Revenue Code Section 41.
Congress continues to discuss repealing the required amortization requirement or delaying its application to taxpayers. However, in spite of recognized bipartisan support, there has yet to be any sign that a last minute change will be enacted in time for the upcoming tax deadline and companies should prepare to comply with the new rules.
There are a number of questions regarding the application of Section 174 costs and whether certain costs would fall within the new requirements, but guidance from the IRS has been limited so far. While awaiting further clarification, taxpayers should consider the impacts of these changes and how best to comply with the new rules as the impact of the Section 174 definitions appear to be far reaching based on the current landscape.
For companies with significant investment toward research and development, a credit claim under Section 41 may be a viable strategy to help offset increases to taxable income due to changes in the expense treatment under Section 174.
RKL’s R&D team is here to help companies navigate these changes and how they apply given the uncertainty surrounding Section 174 treatment. We have extensive experience helping companies identify research expenses and implement repeatable strategies. Contact your RKL advisor or use the form below to start the conversation.
