R&D amortization impact on SMBs
This year’s Tax Day came and went without any alterations to the controversial Section 174 amortization and capitalization rule, a situation that hindered numerous startups from claiming R&D expenses incurred during 2022.
As a consequence, innovative startups across the United States now face heightened tax obligations this year, compelling many to explore alternative avenues of non-dilutive capital in order to recover costs that were historically covered by federal government support.
Nevertheless, there remains a glimmer of hope for businesses affected by the Section 174 measures this year, as they might have the opportunity to reclaim some of these credits for 2022 and beyond. Although prior legislative proposals have been presented (and re-presented) in the Senate, bipartisan representatives in the House of Representatives are following suit and collaborating with
union and private sector entities to garner support for crafting their own version of a bill focused squarely on R&D.
The bipartisan American Innovation and R&D Competitiveness Act was reintroduced in the House on April 18, coinciding with Tax Day 2023, subsequent to its initial proposal in 2021 by Reps. John Larson (D-CT) and Ron Estes (R-KS). This revised legislation seeks to revoke elements of the 2017 Tax Cuts and Jobs Act (TCJA) and specifically advocates for increased federal investment in R&D.
Linking Section 174 repeal to employment growth, the American Innovation and R&D Competitiveness Act aims to provide immediate assistance to businesses currently grappling with the impact of the Section 174 capitalization and amortization rules. This includes the annulment of the mandatory amortization of R&D expenses over a five-year period starting in 2022.
The language of the bill also makes reference to broader recent initiatives like the Inflation Reduction Act (IRA) and CHIPS Act, both of which were passed within the last year to bolster the United States’ competitiveness in emerging cleantech industries while enhancing the nation’s manufacturing prowess.
Representative Larson emphasized, “Research and development play an integral role in creating good-paying jobs across the country, especially as we rebuild our economy from the impacts of the pandemic.” He further stated, “Rep. Estes and I joined together on this legislation to ensure the R&D tax deduction does what it was designed to do: support American businesses and workers as they
develop technologies of the future.”
Rep. Estes added, “More R&D here at home means more jobs now and in the future. Rep. Larson and I know that businesses and manufacturers in our districts and across the country need immediate R&D expensing, and we’re joined by a number of our colleagues on both sides of the aisle that want to see this bill passed.”
Where the United States is falling short, China is stepping up its efforts. The inclusion of the Section
174 amendment within the TCJA was intended to offset substantial tax deductions introduced elsewhere in the bill, primarily a 21 percent reduction in the corporate tax rate and a 20 percent deduction for specific unincorporated businesses.
While these provisions were welcomed by established corporations and certain affluent individuals, they fundamentally transformed the country’s stance on supporting startups and innovation at large.
For instance, the United States now trails behind, offering only about a third of the R&D tax incentives provided by China. In contrast, China now permits certain companies to deduct 75-100 percent of their R&D costs through a recently introduced “super deduction,” as the nation strengthens its base of small- and medium-sized technology enterprises.
Backing the repeal of Section 174 are studies indicating positive outcomes. Analyst groups in the United States have projected that reversing the Section 174 amortization and capitalization rules could yield favorable, tangible results. In a 2021 estimation by the Tax Foundation, immediate deductibility restoration could raise U.S. GDP by approximately 0.1 percent, increase wages by nearly 0.1 percent, and generate around 19,500 jobs.
Furthermore, a 2022 projection from the Tax Foundation revealed that the manufacturing industry’s cumulative tax liability could surpass $31 billion in 2023 due to Section 174.
While partisan considerations may complicate the adoption of any measures to repeal Section 174—namely, an expanded Child Care tax credit included in the Senate Bill, which has encountered regular opposition from Republicans—startups in the United States still have opportunities to optimize their R&D efforts and streamline their tax filings to maximize their claims.
For more information on developing an R&D Capital Strategy that takes into account the new requirements surrounding Section 174, R&D tax credits in general, and how to plan for the upcoming year, we encourage you to schedule a call with our team today.