R&D Expenses and Capitalization: What You Need to Know

4 Minute Read
Posted by Randy Eickhoff on Mar 28, 2022 1:00:00 PM

Acena R&D Expenses and Capitalization - Business Owner Version

For over four decades, business owners across more than 40 industries have leveraged the power of the research and development tax credit to support their innovation and technology operations as well as drive working capital to their bottom lines. However, recent legislation updates are bringing significant changes to how business owners can claim their research and development expenses. 

If you’re running a company that relies on the dollar-for-dollar R&D tax credit, it’s important to understand some of the ways these changes can impact both your business and your profit margins. Knowing about the potential changes on the horizon can give you the insight you’ll need to successfully navigate possible R&D tax credit shifts with your CPA or financial advisor. 

2017 Tax Cuts and Jobs Act Legislation Officially in Effect for 2022 

The Tax Cuts and Jobs Act (TCJA) was passed in 2017 with specific research and development expense provisions. However, the latest R&D legislation didn’t officially go into effect until after December 31, 2021. Under the previous laws, taxpayers with businesses that incurred qualified research or experimental expenditures within a taxable year were allowed as a deduction. 

As of December 31, 2021, that rule changed. The new TCJA laws stipulate that business owners can no longer deduct R&D expenses in the same year they are incurred. The current laws now mandate that all qualifying research and development expenses must be amortized over 60 months. Put simply: rather than being viewed as an expense, qualifying activities are part of R&D Expense Capitalization, where they are considered an investment. These new laws even include software development as an investment that must be amortized over five years. 

What Do the Current R&D Changes Mean for Your Business? 

It’s important to understand how capitalization of research and development costs can impact your business operations. Technically, your CPA or financial advisor could categorize your research and development expenses under Code Section 162, which captures ordinary and necessary business expenses. However, if these expenses are considered ordinary and necessary business expenses under Section 162, they are not eligible to be included as R&D expenses for use in calculating the R&D tax credit. While this would preserve the expense and maintain a lower taxable income, it would also eliminate your R&D tax credit.

New R&D Legislation Can Have Far-Reaching Consequences

Of course, beyond directly impacting your specific business operations, R&D Capitalization can also negatively affect how U.S.-based companies view innovation and technology development moving forward. In its previous version, many organizations failed to reap the benefits of this lucrative deduction simply because they didn’t realize they met the requirements for Qualified Research Expenditures (QREs). The new requirements and regulations may serve to further convolute the process — and discourage business owners from pursuing new innovation altogether, ultimately putting American businesses at a technology disadvantage compared to the rest of the world.   

There is Still a Chance that R&D Capitalization Laws May Change

If you’re struggling to see the silver lining in the new R&D tax legislation, you’re not alone. However, as a taxpayer, it’s critical to know there is some good news about the TCJA R&D tax laws. Congress has recognized how these current changes may impact businesses of every size across the country. As a result, they’ve introduced the Build Back Better Act, which has a specific provision for the research and development expense capitalization. 

The Build Back Better Act won’t eliminate R&D expense capitalization — but it could delay it. According to taxfoundation.org, if passed, the Build Back Better Act would delay the amortization of research and development expenses until after 2025 instead of after 2021. This delay would enable taxpayers to continue to claim their R&D operations as an expense for at least the next three years. 

Act Now to Be Heard on the R&D Tax Credit

At Acena Consulting, our R&D tax experts make it our mission to help CPAs, financial advisors, and business owners understand the changes coming in research and development tax law. However, we recognize that raising awareness is only the first step toward driving change. The best way to delay legislative updates that could negatively impact your business is by contacting your local congressperson directly. 

Still have questions about how R&D expense capitalization laws can cause your taxable income to jump by up to 80%? We can help. Contact Acena Consulting today to connect with an R&D tax professional.

Randy Eickhoff

Randy Eickhoff

Acena Consulting Founder and Partner. Randy is a licensed CPA and has worked with over 200 companies on various tax credits and other government incentives including multinational technology firms as well as small privately held manufacturing, sports, and technology companies.