At the start of 2022, companies were notified that they must amortize their R&D expenses over five years. This is in contrast to past years when they were able to immediately deduct research and development expenses from their taxable income. The United States government created this delay in amortization to raise federal tax, but only in the short term.
As Congress members try to reimagine the future of the R&D tax credit, there are many different options to consider. One of the proposed options, which was originally part of the House’s Build Back Better Act, would be to delay the R&D amortization until 2026. In this scenario, the four-year delay would be around $233 billion cheaper than canceling amortization altogether. However, there would still be no long-term economic growth. In fact, if amortization was canceled altogether it would reduce federal revenue by $213 billion from years 2022 to 2031. Based on research, this would increase long-term GDP and American incomes by 0.1%.
On the flip side of this, if Congress decides to delay amortization until 2026, it would raise GDP by $11.2 billion over ten years with no benefit to long-run economic growth and or American incomes. There are other options on the table as well. The proposed delays of amortization could span between 1 to 3 years and these would also slightly increase revenue, but again, with no long-term benefit to American incomes or revenue.
Compared to complete and permanent cancellation of amortization, a 4-year delay would somewhat increase revenue within the 10-year budget window depending on the timing. By this we mean, if a temporary tax policy was proposed, it wouldn’t affect long-run GDP because there would be no long-term incentives. A temporary tax policy can often influence variables involved with investment decisions. The major variable of concern here would be timing as a temporary increase in investments could only see a drop-off later. This would not be a long-term solution, because a temporary tax policy would not change long-run after-tax return on investments; Therefore, there would be no long-term effect on the economy affected. A temporary delay could also risk R&D expensing being viewed as a “tax extender,” which could affect how the tax credit is viewed by businesses who are considering investment decisions.
Although delaying the amortization of R&D until 2026 may seem to be the best option, other options could push for economic growth and stability of the tax credit. This could be achieved by canceling the upcoming amortization of research and development expenses permanently.
Importance of Timing on R&D Deductions vs Impact on Revenue
Originally included in the Tax Cuts and Jobs Act (TCJA), amortization of R&D expenditures was initially meant to offset the switch from fully expensing R&D costs to five-year amortization. In the process of this switch, the five-year amortization temporarily limited the amount of deductions businesses can take which would in turn increase baseline revenue. Delaying the switch to amortization also delays higher revenue which acts counterintuitively to its creation in the first place.
Here’s where it can get a bit tricky. If the delay passes, businesses would continue taking their immediate deductions, as we do now, from 2022-2026. The immediate deduction for businesses will reduce their taxable income and tax liability reported to the IRS. This will lower federal revenue. However, between 2027 and 2031, businesses start the amortization deductions process which will increase taxable income and tax liability in turn raising federal revenue.
In 2021, all research and development expenses were fully deductible. Under the current law, in 2022, only one-fifth of the investment is deductible. For example, if $100 is invested in research and development projects, only $20 would be deductible. This pattern continues each year as new investments are made. The 2022 deductions continue until 2026, at this point total deductions each year would level off.
In this situation, more deductions would be allowed if the delay of amortization was until 2026, decreasing federal revenue. After the amortization begins in 2026, the same phase-in of deductions would occur over a five-year period which would increase federal revenue.
In conclusion, both of these scenarios would result in the same effect on annual revenues, but from the federal budget point of view, it is a shift in the timing of deductions. A lot can change with the legislation of the R&D tax credit and it can be difficult to constantly stay up-to-date. Our experts at National Tax Group are here to help! If you have any questions or want to get a free assessment of benefits, contact us today.