Deductions for R&D Expenditures Must Be Taken Across 5 Years Starting in Tax Year 2022
Until January 1, 2022, taxpayers were able to immediately expense expenditures made on research & development activities as defined under Section 174 of the Internal Revenue Code. Absent updated legislation, new requirements will go in to effect this upcoming 2022 tax filing season. The following update was co-authored by ADP subject matter experts, Elizabeth Bowman, Tax Manager, Compliance Solutions/Tax Credits and Brandi Price, Director, Compliance Solutions/Tax Credits.
Currently, for tax purposes, businesses have an option on how to treat R&D expenditures under Internal Revenue Code (IRC) Section 174. IRC Section 174 currently allows taxpayers to either deduct the R&D expenses in the year in which the expenses are incurred, or to defer the expenses and amortize the R&D expenditures over a minimum of 60 months (five years).1 However, under the Tax Cuts and Jobs Act of 2017 (TCJA), a provision was enacted requiring R&D expenses to be capitalized and amortized over five years, eliminating the option to deduct the full expense in the year incurred.2
This change is effective for tax years beginning on or after January 1, 2022. The five-year amortization period could begin in the midpoint of the taxable year in which the expenditures are paid or incurred.
- Review with your tax advisor your current methods of classifying expenditures
- Understand the interplay of defining expenditures under section 174 research and experimental expenditures versus section 162, which provides guidance on ordinary and necessary business expenses, as the amortization treatment may affect your taxable income
- Consider the possible impact of any 59(e) elections regarding extended amortization periods for certain qualifying expenditures. Internal Revenue Code section 59(e) provides a ten-year write off of certain tax preference items. It is unclear how the 59(e) election might be affected by pending legislation.
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1 IRC§ 174 Research and experimental expenditures, applicable for amounts paid or incurred in taxable years beginning before 1/1/2022
2 IRC §174 Amortization of research and experimental expenditures, applicable for amounts paid or incurred for tax years beginning after 12/31/2021.