Change in R&D Expenditures Will Raise Tax Liability
Prepare Now
If your company generally benefits from research and development (R&D) expenditures, prepare for a change. Starting this year, R&D costs can no longer be expensed immediately but must be capitalized and amortized over at least five years, due to major tax legislation enacted in 2017. The impact will include higher immediate tax liability for companies with R&D expenditures.
Prepare for a Higher Tax Bill
The Tax Cuts and Jobs Act of 2017 (TCJA) was generally seen as a positive change, cutting the top corporate tax rate to 21% from 35% and making R&D tax credits permanent. However, buried in the legislation was a provision limiting the ability to expense the R&D costs, masked as a revenue recapture measure.
Before TCJA, taxpayers had the choice of either expensing their R&D costs or capitalizing and amortizing them over five years. This allowed taxpayers the option to utilize the deductions in the current year or defer them, depending on their tax planning needs. The first choice – expensing – ended as of December 31, 2021.
The impact of this change will vary depending on the amount of R&D tax credits a company claims and on the company’s tax rate, as well as other variables. Below is an example of the different treatment between the 2022 tax year and previous tax years for a company claiming $100,000 in R&D costs:
Year | Expense Incurred in 2021 | Expense incurred in 2022 |
2021 | Allowable expense $100,000 | |
2022 | Allowable expense $10,000 | |
2023 | Allowable expense $20,000 | |
2024 | Allowable expense $20,000 | |
2025 | Allowable expense $20,000 | |
2026 | Allowable expense $20,000 | |
2027 | Allowable expense $10,000 |
Keep in Mind
If you have relied on R&D expenditures to lower your tax bill, about all you can do is prepare for a higher tax bill and start to develop tax planning strategies to minimize the impact of the new amortization rules. Talk to your tax advisor now. How you book R&D expenses and how you keep records will be critically important in supporting the tax credit going forward. Now is the time to make sure you are doing it right.
Another change in the R&D picture relates to claiming the tax credit on amended tax returns. In recent guidance, the IRS announced it is now requiring more supporting information to take the credit on an amended return.
The good news: there is no change in how your credits are calculated. These changes are prospective and beginning in 2022. They will not impact your 2021 tax return. There are no guarantees, but Congress may repeal these changes in 2022.
To determine the impact of these change on your 2022 cash flow planning, and future tax liabilities, contact your Adams Brown advisor.