Research & Experimentation Costs Under TCJA
- Amber Langston
- Sep 12, 2024
- 3 min read
This blog post may be a little more spicy than most because it involves yet another change caused by the Tax Cuts and Jobs Act. A little background about me, I began tax preparation in 2017. Then the Tax Cuts and Jobs Act was passed and I had to completely relearn how to do my job. In addition to that, many tax preparers who were going to retire, retired early just so they wouldn’t have to deal with the changes to the tax code. And I am still trying to teach clients how the TCJA affects their taxes on at least a weekly basis. And yet, the TCJA is still making changes to tax laws, some of which, like Section 174, have been in place for 50 years.
Prior to the TCJA, under Section 174, businesses who invested in research and experimentation could choose to either expense those payments in the year they were incurred or capitalize and amortize R&E over a period of 60 months or more. Obviously, most established businesses chose to take the deduction, but for newer companies, being able to choose when to make those deductions was very helpful. Section 174 was put in place to encourage businesses to invest in research and experimentation. This also provided an excellent opportunity for tax planning.
Effective 1/1/2022 businesses are now required to capitalize and amortize all R&E expenses over a 60 month period. Not only do they no longer have a choice about how long to amortize those expenses, but they have to use a mid-year convention, which means the first year the expenses are incurred, a business will only get to deduct half the amortization cost for that year. Furthermore, any costs related to R&E that are incurred outside of the US must use a 15-year life for the amortization of those costs. Love that for us.
Unfortunately, there is not a lot of guidance on what qualifies as a R&E expenditure. Since businesses always had a choice on whether to expense or capitalize those costs, the IRS didn’t see a need to define what was R&E, and allowed businesses to use their discretion. The IRS was also certain that this part of the TCJA would be reversed. After all, the TCJA was passed in 2018 and the changes to Section 174 didn’t go into effect until 2022, so Congress had 4 years to do something about a law that produced no benefit to the economy. In fact when the drafters of the TCJA were asked why they were making such drastic changes to a 50 year old statute, they could not provide a legitimate reason.
So for now we are stuck with the new Section 174 statute under TCJA, which means many companies may decrease their research and experimentation during a time when we need to increase those business functions the most. Developing new and innovative ways for companies to run efficiently and improving technology is the only way the American economy can stay competitive. And since there is a 15 year amortization period requirement for expenses incurred in foreign companies, our economy may become further isolated from the rest of the world. Hopefully, most companies will see the competitive benefit of R&E when faced with the new financial and tax challenges those expenses will now carry.
The good news is that companies participating in research and experimentation still qualify for R&E tax credits because the TCJA failed to address it. There is also still a good chance that Congress will repeal this portion of the TCJA. I am not a fan of retroactive tax law changes, but in this case, I would make an exception. The Tax Cuts and Jobs Act is also set to sunset in 2025, which will reverse the new Section 174 as well as many other changes to the tax code. I’ll have to learn how to do my job again, like many other preparers, but it will allow for more tax planning opportunities. There are still plenty of available tax planning opportunities with research and experimentation expenditures. If you are thinking about investing in your business processes, always consult a tax professional to make sure you have the appropriate documentation and expenses are deducted correctly.
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