Significant Tax Law Changes for Research and Development Costs are on the Horizon

For years companies enjoyed immediate tax benefits for their investment in research and development activities. In addition to great incentives, like R&D tax credits, companies currently have the option to capitalize or expense these costs, as incurred, under IRC Section 174. Barring the passage of any tax law changes, such as the ill-fated “Build Back Better Act”, this tax-saving opportunity is scheduled to face significant changes, starting in 2022.

What’s Changing

As a result of the Tax Cuts and Jobs Act of 2017, companies will be required to capitalize all their R&D costs, including software development costs, for tax years beginning after December 31, 2021. Companies can no longer deduct these costs when incurred but will instead amortize these costs over 5 or 15 years, creating a substantial prolonging of their tax benefits. The capitalization of these costs may create significant timing differences between the cash flow of a company and its taxable income.

How Will This Impact Me?

All costs associated with R&D activities performed within the US will be capitalized and amortized over five years, while foreign R&D activities will be capitalized and amortized over 15 years.

Companies should review how the capitalization of these costs will impact their taxable income to determine if this will trigger any cash requirements to fund tax liabilities. Those with foreign operations should also review how this impacts the calculation of items such as their foreign tax credits (FTC), determination of effectively connected income, and the foreign-derived intangible income deduction (FDII). Additionally, certain companies should be mindful of any impacts on their accounting for income taxes (ASC 740) as this may have financial statement implications.

What Can I Do?

Companies should consider the following opportunities:

  1. Review available net operating losses (NOLs) and tax credits that can be used to offset any potential tax exposure
  2. Review their ability to claim R&D tax credits as part of the R&D expenses they’re incurring
  3. Review their accounting policies to assess the accuracy of costs being classified as R&D costs
  4. Review transfer pricing agreements to maximize tax efficiencies for foreign R&D activities
  5. Review favorable accounting method changes that may help accelerate expenses or defer income

Author: Robert Traester, CPA, MST | [email protected]

Contact Us

Companies interested in learning more about these tax law changes and respective tax planning opportunities should contact a member of Withum’s professional team.