Failure to Repeal R&D Expenditure Capitalization Requirements Spoils CHIPS and Science Act

The Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act was signed into law by President Joe Biden in August 2022, containing $280 billion in funding designed to boost the domestic manufacture of semiconductor products. The package contains billions of dollars allocated to improve domestic chip capabilities and a new program to incentivize research and development (R&D) in advanced computer technology.

Despite numerous benefits, the glaring component of the legislation for manufacturers and trade organizations is the fact that it did not repeal IRC Section 174 R&D expenditure capitalization requirements contained in the Tax Cuts and Jobs Act of 2017 (TCJA). To refresh your memory, TCJA eliminated the ability for companies to deduct R&D expenses in the year they are incurred, and are effective for tax years beginning in 2022, which could be a major barrier to investment in critical R&D activities.

As with any major legislation, there are pros and cons, and more details on the items contained within the CHIPS and Science Act can be found in our previous article.

Background on IRC Section 174

The ability to claim a deduction for what the Tax Code considers “research and experimental” (R&E) expenditures has been included in the U.S. tax policy since 1954, when Congress created Section 174, allowing a deduction for these expenditures as a current business expense in the year expenses were incurred. Section 174 defines these expenditures as costs related to the development or improvement of a product which can include: direct expenses such as salaries, supplies, and materials; operating costs; patent expenses; and the costs of hiring outside contractors or engineering organizations to conduct research. Within this section of the tax code was also an option to capitalize and amortize R&E expenditures over a period of five years, starting from when the company first received economic benefit from them. The other option was a write-off of R&E costs over 10 years from the time the costs were incurred.

Enter the Tax Cuts and Jobs Act of 2017, which eliminated the ability to deduct R&E costs in the current year. Starting in tax year 2022, costs incurred for domestic research must be capitalized and amortized over a five-year period starting with the midpoint of the year they were incurred. Costs for research conducted outside of the U.S. must be amortized over 15 years.

How will this impact your business?

Barring changes by Congress, companies with significant R&D investments may see a significant increase in taxable income on their 2022 returns, coupled with an increased administrative responsibility to comply with the new amortization requirements.

As companies hope for congressional intervention delaying or repealing altogether the TCJA changes as some sort of year-end tax extenders legislation, they must identify a method for tracking expenditures and where research takes place, which are now subject to amortization.

Many companies may already track R&D costs to utilize Section 41 R&D tax credit, but the requirements for Section 174 amortization are more far-reaching and further guidance does not exist to clarify or further define requirements. It may be worthwhile to shift the location of some research projects to qualify for the shorter domestic R&D expenses amortization.

Our experienced R&D tax credit specialists have been assisting clients with successful R&D credit claims and are aware of all new regulations. As companies continue to urge Congress to restore same-year expensing, your business must be prepared to meet the necessary requirements in order to utilize R&D incentives.