As the end of another calendar year approaches many companies are beginning to shift their focus to year-end planning. As the dust continues to settle on the changes implemented under the Tax Cuts and Jobs Act (TCJA) most taxpayers have familiarized themselves with the new tax landscape. However, there is an additional change, part of the TCJA which does not go into effect until 2022, that could have a significant impact if you are a system integrator, engineering firm or manufacturer claiming the Research & Experimental Tax Credit, commonly known as the “R&D” tax credit.
Research & Experimentation Expenses Incurred Prior to December 31, 2021
Currently, if a taxpayer incurs research and experimentation expenses they have the option of either:
- Expensing them in the tax year paid or incurred, or
- Capitalizing the expenses and amortizing them over a period of at least 60 months, beginning when the benefit of the activity is first realized
System integrators, engineering firms and manufacturers claiming the R&D tax credit would typically opt to deduct the expenses related to qualifying research activities in the period incurred. This gives them the benefit of both deducting the expense in the current year, as well as claiming the tax credit in the same period.
Research & Experimentation Expenses Incurred After December 31, 2021
Effective for tax years beginning after December 31, 2021 the TCJA changed the tax treatment for research and experimentation expenses. Companies will no longer be able to deduct the expenses in the current year. Depending on whether the expenses are incurred in the US or overseas, businesses will be required to capitalize the expenditures and amortize them over a five-year period, or in a 15-year period, respectively. While taxpayers would still be able claim the tax credit in the current year, the fact that the underlying expenses used to claim the credit would need to be capitalized could make claiming the credit prohibitive to many companies.
What Should Businesses Do Next?
The change in the tax code represents the most significant change to the R&D tax credit since making it permanent in 2015. While 2022 may seem a long way off, companies currently claiming the credit, or considering claiming the credit, should do the following:
- If you are currently claiming the credit, check with your tax advisor to understand the impact this change may have on your business if it were to go into effect January 1, 2022. Since the credit became permanent, many companies engaged in qualifying activities have come to rely on the credit as part of their annual tax planning strategy. If claiming the credit no longer makes financial sense then long-range plans should be adjusted to reflect this fact.
- If your company has been considering the credit but has never discussed it with your tax advisor, it’s prudent to seek professional advice sooner than later. If your company engages in qualifying research activities you can still deduct the expenses and claim the credit until January 1, 2022 as well as potentially amending prior tax returns.
- Finally, continue to monitor this topic as a number of groups and associations are lobbying congress to change the law to allow for the expensing of research and experimentation costs in the current year. Since this change is not scheduled to go into effect for two years it is possible that the law can still be changed, but unlikely that anything will happen any time soon.
If you are considering the R&D tax credit, or currently claim the credit but are unsure about the impact that this change will have on your tax return, Clayton & McKervey can help you understand your options and create a strategy to utilize the credit to its fullest potential. If interested in sharing your concerns regarding legislation, please contact your local representative.