Immediate R&D Expensing Is No More: What Does This Mean for Your Business?

by Tyler Petzel, CPA

The research and development (R&D) tax credit has long served as an incentive for business owners to invest in R&D efforts. Recently, however, one of its most advantageous benefits disappeared. As of January 1, 2022, business owners are no longer able to deduct R&D costs in the year they are incurred. Instead, domestic R&D expenses must be capitalized and amortized over a span of five years. R&D expenses paid to a foreign contractor get the same treatment but must be spread out over 15 years.

Why the change?

The benefit’s elimination can be traced back to the Tax Cuts and Jobs Act (TCJA) of 2017. When it went into effect, it ushered in a provision that would do away with immediate R&D expensing starting in 2022. Although the provision’s purpose was to help balance the federal budget, it has now left many business owners with budgeting problems of their own.
If your business engages in R&D, here’s what you should know about these latest R&D tax credit changes.

Plan on additional taxable income this year.

As I mentioned, U.S.-based R&D expenses must now be capitalized and amortized over five years. So, if you were to end up with $2 million in domestic R&D expenses in 2022, you would no longer be able to deduct this entire amount in one tax year. Instead, you’d have to spread this amount over five years, meaning you’d expense only $400,000 each year. The result: Your annual taxable income would see a significant increase.

Not planning to claim the R&D tax credit? You could still be affected.

One would think that if you weren’t claiming the R&D tax credit, you would be exempt from this change. Unfortunately, this is not the case. Even if you don’t claim the R&D credit, you must still capitalize and amortize your domestic R&D expenses over five years.

Hold out hope for legislative change.

Although both sides of the political aisle wanted to extend the previous tax law, it expired before they could act. Now, to overturn the TCJA provision and revert to the previous law, a new bill must be passed (this legislative change would have to be a rider on another bill). Our hope is that federal lawmakers will eventually make this happen and allow business owners to expense R&D costs retroactively.

Start planning now.

We simply don’t know when or if we’ll see good news for business owners. For now, it’s critical to plan for impacts to your cash flow as soon as possible. As a starting point, consider reviewing your business’ R&D expenses in previous years to gauge your net tax effect, so you aren’t left in a cash-flow crunch. If you have questions about how these R&D tax credit changes could affect your business this year, we’re here to help. Contact us today.