Articles & Alerts

Written by: Marlen Ziskin

The technology industry is one of the largest industries that benefits from the Research & Development (R&D) tax credit, due to its significant investment in forward-looking technologies and advancement. The PATH Act of 2015 made the R&D credit permanent while also providing for a payroll tax benefit for early-stage businesses that would often not be able to benefit from the R&D income tax credit. In 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) kept the R&D tax credit permanent while eliminating many other tax credits and incentives.

However, included in the TCJA was a change to the treatment of certain deductions starting with the tax year beginning after December 31, 2021. Pre-TCJA, taxpayers had the option of immediately expensing R&D expenditures or electing to amortize the costs over a period of at least 5 years. This allowed taxpayers to either utilize the deductions immediately, or to defer them depending on whichever was most beneficial based on their own circumstances. For tax years beginning after December 31, 2021, the TCJA eliminates this taxpayer option and requires taxpayers to capitalize these R&D expenditures and amortize them over 5 years. Furthermore, for foreign research expenses (e.g., foreign contractors performing R&D services), the new rules require a 15-year amortization period. These rules apply to traditional R&D expenses as well as software and website development costs, which may have previously been capitalized and amortized over a 3-year period. The required extended amortization periods apply even in cases of a retired, abandoned, or disposed of R&D property, thereby denying an immediate deduction in those circumstances.

This change in tax treatment could have considerable ramifications for companies with losses that have significant spend on both R&D and software development, potentially turning net losses into taxable income subject to income tax. Additionally, companies with profit that have historically benefited from the immediate expensing of these costs may have an even larger income tax bill if not planned for properly.

Example:

A tech start-up develops a new SaaS platform using employees and contractors located in the U.S. over the 2020 – 2022 timeframe, spending $500,000 in qualifying R&D costs each year. In 2020 and 2021, the taxpayer had the option to either immediately expense or amortize over 60 months (or more) the $500,000 in annual R&D costs. However, in 2022, the company is required to capitalize and amortize the $500,000 R&D costs over 60 months. Instead of being able to claim a $500,000 immediate deduction in 2022, the company can only claim amortization costs of $50,000 in 2022, and then claim $100,000 in 2023 – 2026 and $50,000 in 2027.

It is important to keep in mind that these changes do not impact the accounting treatment of R&D-related costs for financial statement reporting purposes in accordance with GAAP, potentially causing significant book to tax timing differences that will impact deferred tax provisions.

Though there have been several attempts by Congress to stall these onerous changes, most recently under the Build Back Better Act, none of these attempts have been successful. It does appear that there is bipartisan support to defer or eliminate this change based on a recent non-binding vote across the Senate, which may surface within the America COMPETES Act of 2022. Although the fate of the COMPETES Act is uncertain, there is much optimism among technology companies and practitioners that Congress will create a workaround, eliminating or significantly delaying implementation of the new requirements. Until such hopes come to fruition, however, taxpayers need to weigh their options and prepare themselves in case the current law does indeed remain in effect for tax years beginning after December 31, 2021.

Anchin tax professionals can help you successfully navigate these complex requirements and evolving legislative terrain. Please reach out to
Chris Noble, Leader of Anchin’s Technology Group, Yair Holtzman, Leader of Anchin’s R&D Tax Credits Group, or your Anchin Relationship Partner to discuss how to plan for these new changes.