R&D Expenses: What’s Over the Horizon – Deductions or Amortization?

Written By Brady Bryan and Justin DiLauro

Over the last several weeks, we at BRAYN have fielded a number of questions on what 2022 holds for the R&D tax credit and treatment of expenses. The back story on this is that when the R&D tax credit (IRC Sect. 41) was made permanent in 2017, there were compromises made on the expenses to comply with budgetary requirements. So while the R&D tax credit was made permanent, the expense treatment can was kicked down the road for 5 years. Now the fifth year is upon us.

Our general take is not one of concern because the issue was originally created (in our opinion) entirely for Congressional Budgetary reasons, the failure to fix would likely have significant negative economic consequences, and the fix has bi-partisan support.

To elaborate further on the mechanics, by claiming an R&D Tax Credit with a Form 6765, one is also effectively classifying the identified qualified research expenses as Section 174 R&D Expenditures, even though these expenses are typically reported within other more general deduction categories (e.g. Officer Comp, Salaries & Wages, etc). The reason is Section 41 (the R&D Tax Credit Code Section) incorporates Section 174 by reference – the effect is all Section 41 Expenses are viewed as automatically Section 174 Expenses.

The issue starting in 2022 is, Section 174 Expenses must be amortized over 5 years. So, by claiming an R&D Tax Credit, a taxpayer will automatically (and temporarily) lose 80% of the corresponding 174 expenses in year 1. Over a 5 year period, it should theoretically even out, but it would significantly detrimental in year 1 if you play that math out. Again, the only reason we believe this happened is when the R&D Tax Credit was made permanent, the Congressional Budgetary Office (CBO) was required to “score” the Bill over a ten (10) year period. Meaning, that lawmakers made the last 5 years of the window (starting with 2022) more favorable to the government, so the Bill they were trying to pass into Law would look cheaper to the public.

There are billions of R&D Tax Credits claimed annually, most by publicly-traded companies, so a failure to fix this amortization issue by Q1 Filings could be significantly detrimental to the economy (if not their stock prices), and the inclusion of the fix in all recent bills would indicate that lawmakers know this but don’t want to talk about it. I would say it is likely that the “fix” (kick the can down the road for 4 years) will be tacked onto to whatever next Bill can make it through.

Most assuredly, we believe the fix will happen before any 2022 filings next year. This also does not affect carryforwards into 2022.

Feel free to contact us for additional questions.

By Brady Bryan (brady@brayn.com) & Justin DiLauro (justin@brayn.com).

IRS Circular 230 Disclosure – To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Posted in