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Changes to Tax Treatment of R&D Costs on the Horizon

While the Tax Cuts and Jobs Act (“TCJA”) is nearly four years old, some of the key provisions of the legislation have not yet taken effect.  Among these provisions are the changes to Section 174 of the tax code, which covers the deductibility of research and development expenditures.  Companies that operate within the manufacturing industry should begin to familiarize themselves with the changes that will be enacted when this provision takes effect for tax years beginning after December 31, 2021, specifically, the limitation around the immediate expensing of research and development (R&D) costs.

Prior to the TCJA, companies had the option of expensing R&D costs immediately or deferring and amortizing these expenditures over a minimum five year period beginning in the month that the company first realized an economic benefit from the expenditures.  Once the changes to Section 174 take effect, companies who have R&D expenditures will not be allowed to deduct these expenses in the tax year they are incurred.  Instead, companies will be required to charge these expenditures to a capital account and amortize them over a five-year period beginning at the midpoint of the year in which the R&D expenditures were paid or incurred.  For companies with foreign related R&D expenditures, the provisions are even more restrictive, requiring companies to amortize foreign R&D expenditures over a fifteen-year period.  The restrictions around the immediate deductions of these expenses could have a significant impact on companies who operate in industries that see heavy expenditures on R&D, such as manufacturing.

Manufacturers need to understand the limitations imposed by the TCJA, and will need to work with their CPA’s well in advance of the end of the 2022 tax year to plan for the impact it will have on taxable income.  Further, companies should be aware that these changes will impact other areas within their tax and reporting functions.  The changes will result in additional timing differences between GAAP and tax reporting and will impact the amount of R&D tax credits the Company is entitled to. While Congress has introduced legislation in early 2021 which would eliminate the changes to section 174, companies should not rely on this legislation getting passed given the current political environment.  If you would like to better understand the changes to Section 174 and how it will impact your organization, contact your TBC Advisor.

By: Gary Domermuth, CPA, Manager