Protect American Jobs & Innovation
A change in the tax treatment of research and experimentation (R&E) expenses that went into effect on January 1, 2022, has significantly negative impacts on American employers. While the Tax Cuts and Jobs Act of 2017 (TCJA) essentially lowered taxes for American businesses, the bill also modified Internal Revenue Code (IRC) Section 174 regarding the treatment of R&E expenditures.
The modification requires research expenses to be capitalized and amortized over multiple years (five years for U.S.. based expenses and 15 years for foreign research expenses). As a result, many small- and medium-sized businesses face 2022 tax bills that are four times more expensive on average than in previous years. What is worse is that U.S. companies that are doing the most to keep America at the forefront of innovation are the ones getting hit the hardest by this change in tax treatment. The more significant the investment in R&E, the larger the tax hike in 2022.
While some Members of Congress are aware of the negative impacts of Sect. 174, there was a general belief this issue would “go away.” However, as the implementation date neared, Congress needed to take appropriate action to repeal this legislation, and companies are now faced with significant unplanned expenses.
Senators Hassan (D-NH) and Todd Young (R-IN) recently introduced a bill in the Senate (S.866) that would reverse the TCJA implementation of Sect. 174 allows businesses to fully deduct R&E expenses in the year they are made and expand the refundable research and development (R&D) tax credit.
Congressmen Ron Estes (R-KS) and John Larson (D-CT) have recently reintroduced the American Innovation and R&D Competitiveness Act, which will allow R&D expenses to be deductible in the year they were incurred.
Congress must act now on this legislation, enabling small- and mid-size businesses to continue investing in innovation, saving jobs, and protecting America as the world leader in innovation.
IRC Section 174 Overview and TCJA Implications
Congress passed IRC Section 174 in 1954 to allow for the immediate deduction of expenses related to research and experimental expenditures. The rationale behind this policy was clear — encourage competitive STEM applications and drive innovation within the United States.
For nearly seventy years, this policy remained unchanged – until now. Under the TCJA, U.S.-based research and experimental expenditures must now be amortized and deducted over five years; however, because of how the legislation is written, it turns into a deductible period of 6 years (given the “mid-year convention” in the legislation).
The unintended consequences of amortization are crippling small and mid-sized businesses. Every tax year through 2021, taxpayers could fully deduct all research expenses. Beginning in the tax year 2022, TCJA requires amortizing these expenses. Due to the mid-year convention, taxpayers can only deduct 10% of those expenses for the year they are incurred. As a result, the taxpayer’s ordinary business income increases, exponentially increasing overall tax liability.
This new amortization policy is not only anti-business but also acts anti-worker as these businesses will be forced to cut payroll through layoffs or close their doors. Perhaps most disappointing in this legislation is that the more research and development a US company undertakes, the more detrimental the overall impact. Thus, the unintended consequences will likely result in millions of layoffs of high-quality STEM jobs while punishing small and mid-size companies that invest in U.S. innovation.
