Due to the legislative changes created by the Tax Cuts and Jobs Act of 2017 (TCJA), research and development costs (including software development costs) must be capitalized taxable year beginning January 1, 2022. The eligible costs would be deducted over five years if the activities took place in the United States, or over 15 years for non-U.S. activities. Companies should begin to have tax planning conversations around R&D before the new rules take into effect.
What’s the R&D Credit?
The federal research and development tax credit is an incentive available to any business that attempts to develop new, improved, or technologically advanced products or trade processes. In addition to activities such as creating new products or trade processes, the credit may also be available to taxpayers that have improved upon the performance, functionality, reliability, or quality of existing products or trade processes.
How does TCJA changes affect the R&D Credit?
One of the key changes in the TCJA as it relates to the R&D credit was in keeping it permanent. With the introduction of a lower corporate tax rate (35% to 21%) the TCJA’s effects were thought to be very favorable for R&D intensive businesses.
However, within the Act, there was a change to the treatment of tax code Section 174 deductions taxable year beginning after December 31, 2021. Before the TCJA, Section 174 provided taxpayers with the option of immediately expensing R&D expenditures or amortize the costs over a period of not less than 60 months. This had allowed taxpayers planning options to either utilize the deductions in the current year or to defer them depending on their facts and circumstances.
Software development costs also received unfavorable treatment in the TCJA. The updated legislation states that any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure (of which instead of being able to expense under Revenue Procedure 2000-50, will now have to amortized over a five-year period).
What Should You Do?
Taxpayers should begin to develop tax planning strategies to minimize the impact of the new rules. There is still a short window of opportunity to continue to take advantage of the current rules under Section 174(a). To determine what sort of estimated benefit can be realized in taking advantage of the current R&D rules or if there are any questions on the R&D credit, contact us at firstname.lastname@example.org for a free consultation.
Author: Eunice Salinas, Director Tax Credits & Incentives, Hito, LLC