TCJA and the R&D Tax Credit: Experimental Expenditure Changes

Written By: Tanya Donnelly, Senior R&D Tax Manager

The Research and Development (“R&D”) Tax Credit is set to undergo changes in 2022 due to the Tax Cuts and Jobs Act of 2017 (“TCJA”). Up to the end of 2021, businesses have been able to immediately deduct R&D expenses. This is due to Internal Revenue Code (“IRC”) § 174, Research and experimental expenditures, which has allowed businesses to either deduct eligible R&D expenses in the current year or amortize the expenses. However due to TCJA, beginning in 2022, businesses will no longer have a choice and will not be able to immediately deduct the full cost of R&D expenditures in the year the expenses are incurred. Instead, it requires businesses to amortize the R&D costs over 5 years, and for research performed outside of the U.S., the amortization period would be 15 years.

This change from immediately expensing to amortization will affect how businesses claim certain qualified research expenditures (QREs) for the Federal R&D Tax credit. Businesses will want to create a yearly schedule to track their R&D expenses broken down over the five year or fifteen-year amortization period. This will affect the expenses that can be used each year towards the R&D credit. Further, this could potentially affect some state R&D tax credits that follow the federal regulations for R&D expenses and the R&D tax credit.

Aside from the impact on the Federal R&D tax credit, these changes have other significant tax impacts on businesses. Below is an example of the potential impact.

 Currently  IRC § 174Under TCJA amortization Domestic R&DUnder TCJA amortization Foreign R&D
R&D Expenditures$15 MIL$15 MIL$15 MIL
Amount deducted$15 MIL$3 MIL$1 MIL
Tax Rate21%21%21%
Tax Benefit/Savings due to Deduction$3,150,000$630,000$210,000
Estimated R&D Credit$1,000,000  $200,000*$0 (not in US)
Total Tax Benefit$4,150,000$830,000$210,000

 *Some companies will not generate a credit due to the significant QRE reduction as compared to prior years.

However, these changes are not set in stone. The Build Back Better (BBB) Act includes language to delay the amortization rule until after 2025. At this time, the BBB Act’s passage is delayed with the Senate looking to vote on its passage in the beginning of 2022. Geoff Garber, a partner with BRAYN Consulting, noted that “the R&D tax credit continues to have bipartisan support as one of the most powerful job creating tax benefits. We expect that Congress will fix the R&D expense amortization issue before it causes significant issues for businesses.”

Below is some of the additional legislation that has been introduced during 2021 that relates to the R&D Tax Credit and expenditures:

  • The American Innovation and R&D Competitiveness Act of 2021
    • Would eliminate the five-year amortization requirement scheduled to begin in 2022, thus allowing continued expensing in the taxable years in which they are incurred.
  • American Innovation and Jobs Act
    • Would expand deductibility for research expenses to allow immediate expensing and allow amortization over a period of 60 months for other types of expenses
    • Would increase maximum amount eligible for qualified small businesses
  • Furthering Our Recovery with American Research & Development Act (FORWARD Act)
    • Expands eligibility of qualified small businesses to claim the Payroll Tax Offset
    • Increase the amount of the payroll tax offset

We encourage anyone that currently deducts R&D expenses under IRC § 174 to reach out to their R&D provider as soon as possible to discuss strategies to navigate these changes. As you know, this change is on the heels of the IRS’ new guidance to amending returns to claim the Federal R&D Tax Credit, which you can read about by clicking here. As always, we will continue to monitor Congress and pending legislation and keep you updated as we learn more.

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