The Tax Cuts and Jobs Act (TCJA) has had enormous, far-reaching consequences on many tax issues. One often-overlooked change currently looming on the horizon is the five-year amortization of R&D expenses that went into effect as of January 1st, 2022.
What is R&D Amortization?
Until this year, companies could deduct their R&D expenses each year. They could also capitalize their R&D expenses and write them off (or amortize them) over at least five years. This is how Congress subsidized R&D in the 1950s. One of the revenue-raising provisions of 2017's Tax Cuts and Jobs Acts eliminated \ R&D expensing starting in 2022. Domestic R&D now must be amortized over five years and foreign R&D over 15 years.
What does amortization look like?
Let's use some round numbers to illustrate the concept. Say we had a $100,000 R&D spend in both 2021 and 2022. In 2021, we deducted the entire $100,000 R&D spend, a tax savings of $21,000 using the 21% corporate tax rate. In 2022, we would deduct only $10,000 of the R&D spend. (Even though it is called five-year amortization, the amortization period stretches out over six years. The first and sixth years get 10% deductions.) Our tax savings would go down by $18,900!
What happens if I forgo the R&D tax credit?
Over the last year, many people have sought ways to overcome this issue. Some non-tax professionals have suggested that companies stop taking the R&D tax credit. Until Congress fixes the amortization problem, forgoing the credit could be an audit red flag. The law does not say that R&D expenses qualified for the tax credit should be amortized; it says R&D expenses must be amortized. This applies regardless of whether or not you take the credit.
Should I take the credit if I haven't taken the credit previously?
The answer is a resounding yes! With this change, the credit is now even more valuable. Until Congress fixes this, companies must amortize expenses. The credit still stands ready to lessen the tax hit of the switch to amortization. While losing the ability to deduct these expenses at 100% is lost, let's remember that a deduction reduces taxable income, but a tax credit directly reduces tax liability. If the end result of reducing the deduction is an increase in taxable income, then generation of a tax credit immediately lessens the impact of that loss.
Where do we go from here?
Luckily, industry professionals, government officials, and most politicians agree that the TCJA's treatment of section 174 expenses was a mistake that needs to be fixed. There have been multiple proposals to either A) eliminate the amortization, or B) kick the can down the road. There has been bipartisan support for both of these options however, like most legislative changes, the process is slow and tumultuous one.
Common Challenges When Claiming R&D Tax Credits
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What Happens to Unused R&D Tax Credits?
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