Federal research and development (R&D) tax credits encourage research that may not be economically feasible in the short-term, but that supports society in the long-term. Legislation passed in 2017 and effective starting in tax year 2022 changes the time period in which businesses can claim those credits. 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.
R&D tax credits, which were originally established in 1981 as temporary credits, were finally made permanent with the passing of the Protecting Americans From Tax Hikes (PATH) Act in 2015. The PATH Act also significantly broadened the number and size of businesses that can take advantage of this investment tool.
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.
R&D tax credits encourage research that may not be economically feasible in the short-term but that supports society in the long-term. These R&D credits can now be used by more businesses in a broader array of situations. Another very useful resource is the IRS Instructions for Form 6765: Credit for Increasing Research Activities.
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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.
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