Current Section 174 Amortization Rules Prevent Help for Struggling Illinois Farmers
Struggling Illinois farmers are looking for help in coping with recent environmental changes that is putting their livelihood at stake. The long-standing R&D tax credit would normally be one viable option in the search for relief. However, the current Section 174 amortization rules actually disincentivize Illinois farmers from claiming the R&D tax credit to help recoup the costs associated with addressing this issue. The current rules would very likely result in a higher federal tax bill.
The current Section 174 amortization rules went into effect 1/1/2022. These rules require any business expenses that could be considered research or experimental costs be amortized over five years instead of being immediately deductible in the tax year they were incurred. The IRS has stated that this would be the case regardless of whether the taxpayer was claiming the R&D tax credit or not. This requirement to amortize these expenses can result in a significant increase in a taxpayer’s taxable income followed by a jump in their tax bill. All because, in the case of Illinois farmers, they incurred costs in trying to improve crop yield and crop hardiness. Farmers are already operating under extremely tight profit margins and any effort that may take away from the bottom line can seem not worth the risk. Efforts in evaluating the effectiveness of alternative tilling practices, fertilizers, soil amendments or crop rotation programs take time as well as precious farmland if test plots are utilized.
The R&D tax credit was designed to incentivize companies to continuously improve upon their existing practices and benefit from the costs incurred associated with those efforts. However, the current Section 174 amortization rules go completely contrary to that intent and can punish companies in the form of higher tax bills. Illinois farmers will be looking for ways to prevent their current struggles in the future but, under the current rules, will likely find that they cannot afford it due to the higher tax bill they will be facing due to their efforts potentially being considered as research expenses.
At ABGi, we have been fighting for American businesses and the repeal of the current Section 174 amortization rules. Lawmakers need to realize how much of a negative impact these rules have on American businesses including American farmers. Illinois Senators Richard Durbin and Tammy Duckworth must take a stand with Illinois farmers. The most readily available and effective way is for them to become a cosponsor of the American Innovation and Jobs Act of 2023 (S. 866) which seeks to repeal these harmful new rules.
Why is everyone talking about Section 174 amortization?
The new Section 174 amortization rules that went into effect January 1st, 2022 has left many with questions regarding what the new rules mean and how does it impact them. Below is information related to the most common questions we have assisted both companies and CPAs with. Should you have any additional questions or would like further clarification, please do not hesitate to reach out to us as we are more than happy to discuss with you.
Does Section 174 amortization apply to me?
Yes – if you have expenses considered to be research and development even if you are not claiming the R&D tax credit. If your company does not perform any R&D activity, then you may not have Section 174 expenses.
What is an R&D expense?
The definition of an R&D expense has evolved over time. No longer is R&D considered to be activity performed in a research lab, or costs associated with developing a patent. There are many definitions of what may be considered an R&D expense – we suggest you consult with a tax professional and a specialty R&D tax incentive team such as ABGi to understand the costs within your company and how they impact your tax liability.
How does this change to amortization of R&D expenses affect the R&D tax credit amount?
The very short answer is that it doesn’t. The R&D tax credit sits under a separate section of the tax code – Section 41. There has been no change to the calculation of, the expenses that qualify, or the eligibility to receive the R&D tax credit. With that said, we are awaiting guidance from the IRS to determine the true effects of Section 174 amortization. This includes more specific guidance concerning how the Section 174 amortization rules affect 280C elections on timely filed returns that include an R&D tax credit claim.
What has the IRS said about Section 174 amortization?
Very little. In late December of 2022, they issued Rev. Proc 2023-11 (Rev. Proc 2023-11) which updated the earlier issuance of Rev. Proc 2023-08. However, a key area that lacks any definitive guidance is how to classify expenses between Section 162 and Section 174 and we do not expect that guidance until later in 2023.
My R&D tax credit provider says to not worry about Section 174 amortization – that is will go away – should I be worried?
Section 174 amortization is the current law. While there are various Congressional vehicles in place to overturn the law, none are in a position to become law in the very near future. The question comes down to timing – if Section 174 amortization does go away – the question is when? Will it be in time for all calendar year 2022 filers to not have to amortize? This uncertainty is placing many taxpayers between a rock and a hard place. Should you file now under the current Section 174 amortization rules and the resulting increased tax liability? And if the current Section 174 rules are removed after you filed, taxpayers need to also consider the time and cost to then amend that return and amount of time it will take to receive their tax refund. Because of Congressional recesses around the Fourth of July and in August, the timing to affect returns due in September and October will be tight. ABGi is closely monitoring the status of current legislation that will remove the Section 174 amortization rules. You may use the following link for the latest updates from Congress. You can also find an easy-to-use guide regarding contacting your congressional office to voice your concern. (Click here)
If I never taken the R&D tax credit before, I don’t have to amortize, correct?
This is not true and is a very common misconception. As Section 174 and Section 41 (the R&D Credit) are separate, the IRS has stated it will analyze the expenditures a company incurs to determine if any are considered R&D and should be amortized. Just because you have never claimed a credit for these types of expenses, does not mean you do not have them in the eyes of the IRS.
What types of expenses are included in Section 174?
Without definitive guidance from the IRS, we do not know the final answer. What we do know is that any expense that qualifies as a research expense under Section 41 when calculating the R&D credit will be considered a Section 174 expense and should be amortized. We also know certain other expenses that are not included in the calculation of the R&D credit should be amortized as well. Those include legal fees for filing patents, overhead costs on R&D facilities and the 35% of contractor research costs that cannot be included in the Section 41 calculation. For a current list of all known expenses that qualify as 174 expenses, please see our Accounting page.
How much do I need to amortize for my 2022 tax filing?
Per the rules, all domestically incurred R&D expenses must be amortized over five years. Expenses for R&D incurred internationally must be amortized over 15 years. But, because of a mid-year convention in 2022, all 2022 expenses can only use 10% of the expense for deduction purposes.
Should we be using the 280c election in the calculation fo our R&D credit?
Again, without definitive guidance, the answer to this question is still somewhat unclear and depends on your specific tax situation. Section 280C says that taxpayers must reduce their deductions by the gross credit amounts. But, there is a provision that says you do not need to reduce your deductions, so long as you take a reduced credit. The technical answer lies within Section 280C(c) and it now says that you have to reduce the amount charged to a capital account only if the gross R&D credit exceeds the amount of the allowable research deduction. With the new rules, we do not see many instances where a taxpayer would elect to reduce the credit.
What industries does this affect?
While this is not an industry-by-industry rule, the IRS explicitly stated to ABGi they expect Manufacturers and Software companies to have Section 174 expenses. Does that mean only Manufacturers and Software companies have to amortize? No – as we know from the tens of thousands of R&D tax credit studies ABGi employees have performed, a wide-range of companies from various industries may have qualified R&D activity.
What happens if Section 174 amortization doesn’t “go away”?
If it doesn’t “go away” and the current rules stay in place, American businesses may see extreme increases in their 2022 tax liability. After approximately the third year, the amortization should start to balance out (a company will be on the back side of amortizing 2022 expenses) and the taxes payable could begin leveling out for future years. We are advising all ABGi clients to keep detailed records of what is being captured as Section 174 expenses. A company will need to amortize the expenses over the entire six-year (remember mid-year convention!) period. Even if an employee leaves the company in the future, the past wages paid to that employee that were being amortized should still be amortized through the entire six-year period.
What is curently being done to get rid of Section 174 amortization?
Both the House and the Senate had bills introduced in the spring of 2022 to eliminate the current law. Click here for current information regarding the status of the bills, current co-sponsors and if you do not see your congressional representative listed as a co-sponsor, information regarding how to contact their office and express your concern.
What can I do to push a repeal forward?
Call your government representative. Call the offices of your local Congressperson and Senators. Click here for information on how to do so. ABGi will walk you through who to contact, who to ask for in the office, and what to say. Letters can also be sent, but know that calling the office is the best way to go on record. If you should have any questions regarding reaching out, please do not hesitate to contact us as we are happy to help