Businesses have historically had the option of treating research and development expenses as either currently deductible or as capital costs to be amortized over time. The Tax Cuts and Jobs Act (the “TCJA”), signed into law at the end of 2017, eliminated the current deduction option. Under the TCJA, domestic R&D expenses must be amortized over five years and foreign R&D expenses are amortized over 15 years, beginning with tax years that start after December 31, 2021.
The Build Back Better Act would have delayed this change until 2026. Although that bill passed the U.S. House of Representatives, it stalled in the Senate. As a result, R&D expenses are now subject to capitalization and amortization, rather than current expensing. There is a lot of pressure on Congress to delay or repeal the changes to R&D expensing, but the difficulty of passing a tax bill in an election year has many feeling skeptical.
Businesses that are involved in software development may be particularly impacted. The TCJA changes to Code Sec. 174 (the section covering R&D expenses) clarify that any software development activity counts as an R&D expense. Accordingly, many software development companies may see a large part of their payroll expense go from a current tax deduction to a 5- or 15-year spread-out deduction.
Many expect that the TCJA changes to R&D expenses will be reversed or at least delayed. But as we near the halfway point of 2022 and nothing has happened yet, businesses should be prepared for the effects of these changes on their 2022 taxes.