With Build Back Better Legislation Stalled, Tax Changes Are Here for R&D Expenditures

The Trump administration’s Tax Cuts and Jobs Act of 2017 (TCJA) brought about the most sweeping update to the U.S. tax code since the 1986 tax reform enacted under President Reagan. Significantly lowering business and individual tax rates, the TCJA was widely viewed as favorable for taxpayers, including companies claiming the research and development (R&D) tax credit. The TCJA kept the R&D tax credit permanent, while eliminating most other corporate tax credits and incentives in exchange for lower tax rates.

However, included in the TCJA was a change to the treatment of certain deductions starting with the tax year beginning after December 31, 2021. Pre-TCJA, taxpayers had the option of immediately expensing R&D expenditures or electing to treat these expenditures as deferred expenses and amortizing the costs over a period of not less than 60 months, beginning with the month that the taxpayer first realizes benefits from those expenditures. This beneficial treatment allowed taxpayers to either utilize the deductions in the current year, or to defer them depending on their individual facts and circumstances. In addition, taxpayers were given the option to amortize over 10 years certain expenditures that otherwise were deductible.

For tax years beginning after December 31, 2021, the TCJA eliminated the taxpayer option to deduct current R&D expenditures. Taxpayers are now required to charge these expenditures to a capital account and amortize them over five years. This change requires the extended amortization even in cases of a retired, abandoned, or disposed of property for which specified research or experimental expenditures were paid or incurred, thereby denying an immediate deduction in those circumstances. Furthermore, for foreign research expenses, the new treatment requires the amortization period to be extended to 15 years.

The new treatment also adversely affects taxpayers that utilize special tax provisions permitting either the expensing of software development costs or amortization of the costs over 36 months. The new rule states that any amount paid or incurred in connection with the development of software shall be treated as a research or experimental expenditure, forcing it into the five-year amortization period.

The stalled Build Back Better Act (BBBA) does contain a provision to modify these onerous changes enacted by the TCJA. Although the BBBA is not likely to pass, there is much optimism among technology companies and practitioners that Congress will create a workaround, eliminating or significantly delaying implementation of the new requirements. Until such hopes come to fruition, however, taxpayers need to weigh their options and prepare themselves in case the current law does indeed remain effective for the 2022 tax year.

Anchin tax professionals can help uncertain taxpayers successfully navigate through the evolving legislative terrain. If you have questions about the current laws concerning the R&D tax credit or proposed changes to the TCJA, please contact Yair Holtzman, Partner and Leader of the R&D Tax Credits & Incentives group, and Chemicals and Life Sciences industry groups, or your Anchin Relationship Partner.