Companies engaged in research and development (R&D) activities in the United States have benefited from the ability to fully deduct their R&D costs, for tax purposes, on an annual basis since 1954. This favorable tax treatment has presumably been based on public policy to foster innovation and advancement by U.S. companies.
The historic deductibility of R&D costs, however, has changed. The Tax Cuts and Jobs Act enacted in 2017 contained a provision whereby beginning January 1, 2022, costs incurred for R&D activities will no longer be immediately deductible. Instead, the costs will have to be capitalized and amortized over 5 or 15 years. Costs related to research activities performed in the U.S. will be recovered over a 5-year amortization period, while those related to research activities performed outside the U.S. will be recovered over a 15-year period. As a result of this treatment, there may be significant timing differences between when a company incurs and pays for these expenses and the ultimate deductibility for tax purposes. These differences will likely result in increased taxable income.
While this change will have a negative impact, the following items are things that companies can do during 2022 to try and lessen the impact:
- Review the classification of costs, ensuring that only appropriate costs are categorized for research and development.
- Ensure that the R&D done by foreign subsidiaries appropriately adheres to transfer pricing policies.
- Ensure the company is taking maximum advantage of other R&D allowable tax incentives, including the research tax credit.
- As new agreements with contract research organizations are drafted, review milestones and payment terms for potential timing benefits.
- Consult with your tax advisor early in the year to estimate the impact of this provision on your 2022 taxable income.
While there have been several bills introduced in Congress, including the currently stalled “Build Back Better Act”, which would reverse this change, as of today, no legislation has passed. Pending the passage of additional legislation, these changes, which are currently effective, will cause significant changes in 2022 tax reporting. For calendar year companies, these changes may impact the first quarter estimated tax payment due on April 15, 2022.