Included in the passing of the Tax Cuts and Jobs Act (TCJA) in 2017 was a “revenue raiser” that would require research and development (R&D) expenditures to be capitalized and amortized, rather than immediately deducted, for years starting after December 31, 2021.
What Does This Change Mean For My Business?
Starting in 2022, it will be essential for companies to keep track of where their R&D expenditures occur, as the amortization period for U.S.-based and non-U.S.-based expenditures differ. The amortization period for R&D expenditures performed inside the U.S is 5 years, whereas R&D expenditures performed outside the U.S. is 15 years. It’s important to note that software development costs are specifically included as R&D expenditures under Section 174(c)(3) and, therefore, will be subject to the same mandatory amortization periods of either 5 or 15 years. Companies that have not historically claimed the R&D tax credit could still be subject to these capitalization rules as other costs like software development also fall within the Section 174 bucket.
The TCJA states that this change to R&D capitalization is a change in a method of accounting, even though it’s being mandated. The IRS has yet to issue guidance on whether this will be an automatic change or if a filing of Form 3115 will be required.
The example below shows a company that annually incurs $1M of qualified U.S.-based R&D expenditures, which starting in 2022, are now required to be amortized over 5 years using the half-year depreciation convention.
| Year | Amortization Period | Total 2022 R&D Expenditures | Allowable 2022 R&D Expenditures by Year | NET Add-Back (if $1M R&D Expenditures incurred Each Year) | |
| 2022 | Year 1 | $1,000,000 | $100,000 | $900,000 | |
| 2023 | Year 2 | $200,000 | $700,000 | ||
| 2024 | Year 3 | $200,000 | $500,000 | ||
| 2025 | Year 4 | $200,000 | $300,000 | ||
| 2026 | Year 5 | $200,000 | $100,000 | ||
| 2027 | Year 6 | $100,000 | – | ||
| TOTAL | $1,000,000 |
Legislative action is required to change the treatment of R&D expenditures for tax years beginning after December 31, 2021. The delay of the effective date to capitalize R&D expenditures has broad bipartisan support, and taxpayers remain hopeful that Congress will be able to enact a bill that will allow for uninterrupted expensing treatment of Section 174 costs, at least for the next few taxable years. In the meantime, taxpayers should start considering the implication of Section 174 rules as currently enacted.
Anders CPAs + Advisors can help you prepare for these significant tax law changes. Please contact your Anders advisor to discuss how this will impact your business.
