Research and development (R&D) tax breaks are a set of tax breaks designed to attract companies with high research expenditures to the United States. They’ve been around for 70 years, but the Tax Cuts and Jobs Act (TCJA) in 2017 changed the way they can be taxed.
As of tax year 2022, R&D expenses can no longer be expensed in the first year of service, but those costs must be written off more than 5 years in domestic research and 15 years in foreign research. This is known as “capitalizing” those expenses. This capitalization or depreciation requirement can be especially inconvenient for startups, which can incur most of their R&D costs in their first year of operation. This can make it difficult for startups to make up for those losses in their first year and make them wait for the equivalent of a lifetime in startup years.
R&D costs include all costs associated with research and experimentation associated with a trade or business, such as pursuing a new patent registration and associated costs, materials, drawings and salaries. In short, R&D expenses can be a big part of a startup’s overhead.
At the risk of sounding corny, call your lawmakers.
Earlier this year there were signs of bipartisan support for a withdrawal of the requirement and a return to spending for the first year, but rising inflation may have put a damper on those initiatives. The perception is that the R&D tax breaks mainly benefit large companies, and the political picture of huge tax cuts for companies like Intel and Lockheed Martin could be a bridge too far for lawmakers. Tax year 2022 flies by, various high-profile bills have come and gone, and there are no eminent signs of a withdrawal in the making.
Preparing to write off R&D expenses
If Congress repeals the write-off requirement, well and good. Still, there are some things we can do now to prepare for the possibility of the rule coming into effect.
Hire a tax professional first if you haven’t already. If that’s your CFO, fine; if not, start talking to a tax attorney now – avoid one-click stores that promise to deliver you your credits because they won’t be there when you get checked. If the law remains unchanged, from March the estimated tax payments will have to be made without the first year R&D deduction and with amortization.