Posted by Jeffrey Feingold on 11.11.22

While the Tax Cuts and Job Act of 2018 (TCJA) will have a profound impact on taxpayers filing their 2022 tax returns, the new law change should not have the same impact on the manner in which the taxpayer will compute the R&D tax credit.

Starting in 2022, the TCJA requires all IRC Section 174 R&D expenses to be capitalized and amortized over a period of not less than 60 months. Broadly stated, a Section 174 expense is a research and experimental (R&E) cost incurred with the connection of research costs in the experimental or laboratory sense, intended to discover information that would eliminate technical uncertainty concerning the development or improvement of a product or process.  Previously this was an election the taxpayer could take, and either capitalize the Section 174 R&E amounts or expense the full amount in the year incurred. And depending on the tax position, most taxpayers have typically expensed rather than amortized the Section 174 amounts, to reduce their tax burden.  But under TCJA, this is no longer an election and instead, requires all taxpayers to capitalize and amortize these R & E costs.  Therefore, this new requirement will clearly drive up the taxpayer’s tax liability dramatically.

While the TCJA will have a huge impact on the tax liability of R&E filers, the only language that speaks directly to the R&D tax credit and IRC Section 41 is a confirming amendment to IRC Section 280C. This confirming amendment states that if the amount of the research credit determined for the taxable year exceeds the amount allowable as a Section 174 amortization expense deduction for the taxable year, the amount chargeable to a capital account for the taxable year for such expenses, shall be reduced by the amount of the excess. Stated differently, if the amount of the current year credit amount is less than the amount of the current year amortized Section 174 expense, then there is no issue.  And if by some happenstance that the current year net credit is somehow MORE than the 174 amortization, then the excess must be subtracted from the amount capitalized. But because the Section 41 R&D credit amount is always lower than the amount of Section 174 deduction, this would most likely never be an issue, and the full R&D tax credit should be allowed.

As such, the R&D credit has not been significantly impacted by the amortization requirement under the TCJA. Clearly the TCJA’s focus is more on the taxable income calculation through Section 174 R & E costs, not the R&D tax credit.  If anything, taxpayers should actively pursue and file the Section 41 R&D tax credit as a means of helping mitigate the higher taxable income brought about by the mandatory amortization rules of the TCJA.  

Please contact Tax Point Advisors if you want to learn more about the implications of the TCJA and the R&D tax credit and how it may affect your company.