By Jonathan Davis
If your business has substantial R&D expenses in 2022, you may want to do some tax planning to get an estimate of the impact of Internal Revenue Code (IRC) 174. Unless there are any changes in tax legislation, research and development (R&D) expenditures will no longer be eligible for a full deduction in the year incurred.
Starting with tax years ending after December 31, 2021, these expenses will now need to be amortized over five years for domestic R&D. In addition, because tax amortization will use the midyear convention, the year the expenses are incurred will only receive a 10 percent expense deduction. For example, if a business has $100,000 of R&D expenses during 2022, the allowed deduction through amortization expense would only be $10,000. Tax years 2023-2026 would then be allowed a $20,000 amortization expense and the remaining $10,000 would be allowed in 2027. This results in 90 percent, or $90,000 not being deducted until tax years after 2022. Unless a state specifically decouples from this treatment, businesses will not only see an increase in federal taxable income, but also state taxable income.
Businesses will want to examine what expenses they classify as R&D expenses on their books. Only expenses defined under IRC 174 should be included under this category and amortized. There is also additional guidance provided in the regulations about what are includable expenses. As previously mentioned, this is the current tax rule for these expenses. There have been discussions about changing this treatment or postponing it to a future tax year, but time is running out.
Jonathan Davis is a Tax Manager with Weyrich, Cronin & Sorra (WCS), a full-service accounting firm in Hunt Valley, Bel Air and Elkton. Please do not hesitate to call our offices and speak with a CPA about how WCS can help you with these changes.