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Decoding the new IRC section 174 provisions – What it means for business

A substantial amount of research and development (R&D) is necessary for the United States to be one of the world’s top innovation hubs. However, the amount spent on R&D varies significantly from year to year and influences a company’s profitability across various industries, including technology, healthcare, consumer discretionary, energy, and industrial sectors. Therefore, taxpayers were urged to adopt an expense deduction structure to reduce the financial strain that R&D costs placed on them.

Research and experimental costs (also known as “R&E expenditures”) could be written off, capitalized, and amortized by taxpayers under the previous tax code, IRC Section 174. However, to increase short-term federal tax income, the Tax Cuts and Jobs Act (TCJA) fundamentally alters how R&E spending under IRC section 174 is taxed.

R&E expenses for tax years will no longer be deductible by taxpayers beginning after December 31, 2021, due to the changes. Instead, all R&E costs, which are costs in the experimental or laboratory sense borne by taxpayers during their trade or company, must now be capitalized and amortized. The approach will be followed whether the taxpayer is claiming the R&D credit and regardless of whether these charges qualify for the credit.

Congress has debated whether to delay the capitalization of IRC Section 174 expenditures. However, the revised IRC Section 174 is now in effect as of the tax year 2022. Therefore, to calculate their projected taxes for the tax year 2022, taxpayers should take into account the impact of changes to the deductibility of R&E expenditures.