What A/E/C Companies Need to Know about the Changing Treatment of R&D Expenditures
With the introduction of the Tax Cuts and Jobs Act of 2017 (TCJA), many small and midsize Architecture, Engineering and Construction (A/E/C) businesses were able to start utilizing the Research and Development (R&D) tax credit as an effective method of reducing tax liabilities and receiving immediate cash back savings. The TCJA removed the Alternative Minimum Tax (AMT) restriction on corporations which had long prevented them from utilizing R&D tax credits to offset their tax liability.
However, included in the TCJA was a change to the treatment of certain deductions starting with tax years beginning after December 31, 2021.
But first some background: Pre-TCJA, taxpayers had the option of (1) immediately expensing R&D expenditures, or (2) electing to treat these expenditures as deferred expenses and amortizing the costs over a period of not less than 60 months beginning with the month that the taxpayer first realizes benefits from those expenditures. This beneficial treatment allowed taxpayers to either utilize the deductions in the current year or to defer them depending on their individual circumstances. Yet for tax years beginning after December 31, 2021, the TCJA eliminates this taxpayer option and requires R&D expenditures to be charged to a capital account and amortized over 60 months starting at the midpoint of the year in which the expenditures were paid or incurred, resulting in a potential increase of immediate tax liabilities. The required extended amortization period applies even in cases of a retired, abandoned, or disposed of R&D property thereby denying an immediate deduction in those circumstances. Furthermore, for foreign research expenses, the new treatment requires the amortization period be extended to 15 tax years.
With many taxpayers in the A/E/C industry utilizing the R&D tax credit, companies should consider the implications of the new rule. The following example demonstrates the impact of the law change.
An A/E/C company develops a new modular construction method in the U.S. over the 2020 – 2022 timeframe, spending $2,000,000 in qualifying engineering costs in each year. In addition, the company incurred $500,000 for lawyer patent fees in 2022. In 2020 and 2021, the taxpayer had the option to either immediately expense or amortize over 60 months the $2,000,000 in engineering costs. However, in 2022, the company is forced to amortize the $2,500,000 engineering and attorney costs over 60 months. Accordingly, instead of being able to claim a $2,500,000 expense in 2022 the company can only claim amortization costs of $250,000 in 2022, and then claim $500,000 in 2023 – 2026 and $250,000 in 2027.
During the past year, a legislative proposal in Congress was introduced to modify this onerous change as part of the Build Back Better Act which would have delayed the new provision until tax years beginning after 2025. However, this bill has stalled. While the new law change is in effect, there is much optimism among companies and practitioners that Congress will create a workaround, eliminating or significantly delaying implementation of the new requirements. If and until such hopes come to fruition, A/E/C taxpayers need to weigh their options and prepare themselves in case the current law does indeed remain effective for the 2022 tax year. Anchin tax professionals are specialists in this area and can help taxpayers navigate through the evolving legislative terrain.
If you have questions with respect to this Alert, please contact Phillip Ross, Leader of Anchin’s Architecture & Engineering and Construction Industry groups, Yair Holtzman, Leader of Anchin’s R&D Tax Credits group, Gleb Gorkhover, Senior Manager in Anchin’s R&D Tax Credits group, or your Anchin Relationship Partner.