Tax-Deductible R&D Costs: Congress Considers a Lifeline

By Stanley Rose March 31, 2023

In a previous article, we shared that a taxpayer-unfriendly change was fast approaching that would impact businesses that incurred research and development costs. The change was set in motion with 2017 legislation, but its switch was flipped on in a manner that it first impacted 2022 tax returns. These changes come with somewhat vague and subjective guidance, and were widely panned, even by members of Congress. Practitioners and taxpayers alike were hopeful that Congress would reverse the change before it had to be dealt with on 2022 tax returns. However, we are in the middle of the 2022 filing season, with many impacted returns or extensions filed by March 15 or due soon in mid-April, and the fix has not been provided. A tangible hint of hope, though, materialized a few days ago, when two U.S. senators reintroduced a bill that could undo the mess.

Background

The change that impacts 2022 returns (unless legislation reverses it) is best explained with a bit of context. For many years, a credit (the R&D credit offered under Internal Revenue Code Section 41) has been available for certain research costs, subject to complex computations, and applicable to a somewhat narrow and specific portion of research costs. A credit is more potent than a deduction, because it reduces tax dollar for dollar, rather than merely reducing the pool of net income subject to tax. That credit, for reasons that escape any good explanation, was offered for a year or two at a time, after which the credit expired; only to have Congress renew it for another sorry year or two at a time. It often was renewed retroactively as part of partisan budget negotiations, which in turn required those taxpayers who wanted the credit to obtain it only by filing amended returns. To tax practitioners and their clients, Congress’ treatment of the R&D credit as a hacky sack was maddening, but it finally ended in 2015 when the credit was given permanent status.

Taxpayers celebrating the 2015 move were disappointed to find that in 2017, Congress passed a less welcome change – the one we are dealing with now. Under longstanding rules, most R&D costs were eligible to be deducted for tax purposes in the year incurred, like many other expenses. This has been true for entities that claimed the R&D credit as well as those that did not. The 2017 Tax Cuts and Jobs Act, though, stated that beginning with 2022 returns, the credit remained viable, but the typically much larger pool of R&D costs that always have been currently deductible instead would have to be capitalized and then amortized over a 5 year or 15 year period, respectively, depending on whether the costs were domestic or foreign. In other words, the amount of the deduction wasn’t necessarily changed, but the timing of the deduction is now badly disconnected from the timing of the actual cost outlay. The rule also reaches deep into entities that never have utilized the R&D credit, because the amortization requirement captures a much broader pool of accounts and types of costs than the narrow set of outlays that qualify for the credit.

Because the requirement to amortize the costs was so widely panned, and because multiple members of Congress assured that they wanted to undo what they had done, many interested parties were hopeful that in the quiet incubation period between 2017 and 2022, Congress would reverse the capitalization requirement. But half a decade later, neck-deep in 2022 tax returns, here we wait.

A glimmer of hope

Senators Maggie Hassan (D-NH) and Todd Young (R-IN) reintroduced this month a bill previously floated in 2021 that would allow continued deduction of R&D costs, without any risk to the permanent status of the credit. (In fact, it would expand the use of the credit in a number of ways.) This is proposed legislation, and many such things fall to the cutting room floor without materializing into law. But laws that do come to life start like this, and this represents some action (not just words) that many of us have been awaiting.

What to do

There are many taxpayers, including many of our clients, who are impacted by the 2017/2022 law change, and the natural question is: what do they do now? Unfortunately it seems like the best path is to (1) extend any potentially impacted returns (or file them knowing they may need to be amended), and (2) with any computations of tax due with returns or extensions, assume the existing law – unwelcome as it is – will survive in its current form.

With a little luck, we will have final answers before extended tax returns are due, which for most filers is the 15^th of either September or October. If anything meaningful develops between now and then, we will share it with you. In the meantime, capitalization of these costs is the law, and until and unless it is unraveled, this ugly sweater must be worn.

For more information, please contact Stan Rose or your BNN tax advisor at 800.244.7444.