For decades, companies could deduct research and development (R&D) expenses upfront. However, with the changes in the Tax Cuts and Jobs Act (TCJA), this long-standing tax benefit shifted, raising questions about its future.
Let’s dive into what’s changed, what it means for your business, and how you can adapt.
What Changed Under the TCJA?
Beginning in 2022, the TCJA required businesses to amortize their R&D expenses over five years (15 years for foreign expenses) instead of immediately deducting them. This shift is a significant departure from the previous ability to expense R&D costs upfront, making investing in innovation in the short term costlier.
For example:
- Before 2022: A $500,000 R&D expense could be fully deducted in the year it was incurred.
- After 2022: That same expense must now be deducted incrementally, with only a portion eligible in the first year.
What Does This Mean for Businesses?
The change affects cash flow and budgeting for businesses that heavily invest in research, particularly small and medium-sized companies with limited resources. Immediate expensing provided a predictable way to offset R&D costs. Now, businesses face a deferred tax benefit, reducing the near-term incentive to innovate.
Key Impacts Include:
- Higher Taxable Income: Without the full deduction, your taxable income increases, potentially pushing you into a higher tax bracket.
- Reduced Cash Flow: Delayed tax savings may limit funds available for future R&D or other investments.
- Strategic Adjustments: Companies may need to reevaluate their R&D investments or consider other ways to maximize tax benefits.
Legislative Push for Change
The shift to amortization wasn’t intended to be permanent. Many lawmakers and industry groups are advocating for a return to immediate expensing, recognizing its importance for economic growth and global competitiveness.
In 2023, bipartisan efforts to restore R&D expensing gained momentum but were stalled by broader budget negotiations. As lawmakers now set their tax priorities for 2025, optimism remains high for revisiting the issue, with strong support for a proposal to reinstate the provision allowing businesses to immediately deduct specific research and development expenses. However, no changes have been finalized yet.
What Can Businesses Do Now?
While we wait to see if immediate expensing makes a comeback, here are steps you can take to manage the current rules:
- Maximize Other Tax Benefits: Take full advantage of the R&D tax credit, which remains available and can offset payroll taxes or income taxes.
- Plan Strategically: Work with a tax advisor to adjust your budgeting and cash flow projections, accounting for the amortization schedule.
- Leverage State Credits: Many states offer R&D incentives, which can provide additional tax savings.
- Advocate for Change: Join industry groups or coalitions pushing for legislative action to restore immediate expensing.
R&D Tax Credit: A Silver Lining
Despite the amortization rules, the federal R&D tax credit continues to offer a valuable way to offset taxes. To qualify, your business must engage in activities that improve a product, process, or technology through a systematic approach.
Key benefits of the credit include:
- Payroll Tax Offset: Small businesses and startups can apply the credit against payroll taxes, freeing up cash.
- Innovation Support: It’s available for a wide range of industries, from tech startups to manufacturers.
Even with amortization, the R&D tax credit remains a crucial tool for businesses committed to innovation.
What’s Next?
The future of R&D expensing is uncertain, but ongoing conversations in Congress indicate it’s a priority for many lawmakers. Until a resolution is reached, businesses must adapt to the current rules while staying informed about potential changes.
R&D expensing may not be gone for good, but its current absence is a reminder to reassess your tax strategies. By leveraging available credits, planning for amortization, and staying proactive about legislative developments, you can continue to invest in innovation without losing financial stability.
Need help navigating these changes? Our team can guide you through R&D tax planning, helping your business stay competitive and prepared for whatever comes next.
