In Dec. 22, 2017, President Trump signed the Tax Cuts and Job Act of 2017 (TCJA) into law. This legislation provided the most sweeping changes to the U.S. tax code since The Tax Reform Act of 1986.
AIA is learning that the new requirements are having a significant impact on firms and is doing all it can to remedy the issue. AIA continues to work with business groups and others to revise the new law and get it statutorily corrected (and made retroactive).
In 2017, the Tax Cuts and Jobs Act (TCJA) amended Section 174 to require taxpayers to capitalize and amortize R&E expenditures for tax years beginning after December 31, 2021. The changes require taxpayers to amortize domestic expenditures over five years and foreign expenditures over 15 years, with amortization for the beginning to the midpoint of the taxable year in which the expenditure is paid or incurred.
In the case of retired, abandoned, or disposed property with respect to which specified R&E expenditures are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period. Prior to the TCJA, taxpayers could choose to either deduct Section 174 expenses, capitalize the expenditures, and amortize them over five years, or elect a 10-year amortization of expenditures under IRC Section 59(e).
The TCJA also changed the term “research or experimental expenditures” in Section 174(a) to “specified research or experimental expenditures.” Section 174(b) defines this term as “research or experimental expenditures which are paid or incurred by the taxpayer during the taxable year in connection with the taxpayer’s trade or business.” As part of the Tax Cuts and Jobs Act, a notable change in the tax law occurred for research and development (R&D) costs. Although this change was passed in 2017, it did not take effect until tax years beginning on or after January 1, 2022.
Lookback (Prior to 2023):
Previously, for tax years beginning on or before December 31, 2021 (2021 calendar years and earlier), R&D expenses could generally be deducted as incurred for tax purposes. Currently, for tax years beginning on or after January 1, 2022 (2022 calendar years and later), R&D costs must be capitalized and amortized. The amortization period is generally five years for U.S.-based R&D, and 15 years for foreign R&D. If you are deducting R&D expenses for your financial statements, this new capitalization requirement will result in an unfavorable book/tax difference in 2022. Note that these capitalization rules apply regardless of if you claim an R&D tax credit. The R&D asset that is capitalized is deemed placed in service halfway through the year and follows straight-line depreciation.
New Law’s Effect on R&D Tax Credit
The TCJA made a conforming amendment to Section 41(d)(1)(A) to define “qualified research” as research “with respect to which expenditures may be treated as specified research or experimental expenditures under section 174.” Previously, taxpayers were able to claim Section 41 tax credit for expenditures that either qualified under Section 174 or were deducted under IRC Section 162 as “ordinary and necessary” business expenses. Now, with the change in the definition of “qualified research,” taxpayers must classify those expenses under Section 174 to receive the Section 41 credit. This change will require a greater focus on validating Section 41 expenditures claimed as “specified research or experimental expenditures” under Section 174.
The TCJA also made a conforming amendment to IRC Section 280C, which prevents a double benefit by disallowing deductions for the portion of otherwise deductible qualified research expenses equal to the amount of the credit determined under Section 41(a). For amounts paid or incurred in tax years beginning after December 31, 2021, Section 280C(c) provides that no deduction is allowed for that portion of qualified research expenses otherwise allowable as a deduction for the tax year that is equal to the amount of the credit determined under Section 41(a). This results in a dollar-for-dollar increase in taxable income for the amount of credit to be claimed.
Change in Accounting Method
The change to amortization constitutes a change of accounting method for taxpayers that previously deducted R&E expenditures. The change will be made on a “cutoff basis,” as only expenses for tax years beginning after December 31, 2021, must be amortized. Taxpayers will not be required to make an IRC Section 481 adjustment. The IRS has yet to release new procedural guidance specifically addressing how taxpayers must comply with the new rule, and it is unclear at this time whether taxpayers will be required to file an Application for Change in Method of Accounting (Form 3115).
AIA’s Most Recent Engagement on the Issue:
This change stifles innovation and is not being well received. In December 2022, AIA sent a letter to the Hill calling on them to address the issue. Unfortunately, the 2022 year-end deal that had been crafted by Congress to correct the issue fell through. AIA also issued a memo and action alert on March 7 to all AIA members, calling on Congress to take immediate action on the R&D issue. That message was sent to you directly from AIA’s Government Advocacy Committee Chair Kevin Holland, FAIA. Please feel free to redistribute it to your members.
Since then, a bipartisan bill to address the issue was reintroduced in the Senate (and a House bill was introduced): the Senate bill is the American Innovation and Jobs Act (S. 866) and the House bill number is not yet available. The bill reintroduction is a good first step, but there is much more to do, so member action could make a dramatic difference in helping our progress to get this fixed.
- If you have not already, please write your Members of Congress (using our Action Alert) to ensure action on the issue and co-sponsorship of the new House and Senate bills (S.866/House: TBD).
- AIA continues to seek stories from members/firms affected by the policy change & who could be featured in an op-ed. If interested, please send the information to Sarah Dodge (email@example.com) for follow-up.
- AIA is doing targeted outreach to House Ways and Means Committee members: Full Committee – House Committee on Ways and Means and to Senate Finance Committee Members: Membership | About | The United States Senate Committee on Finance. They are critical to making this correction happen. Virginia has a policymaker on this list. Consider reaching out to Mark R. Warner.