Research & Development Expense Capitalization – What Does This Mean for Your Business?
A provision included in the Tax Cuts and Jobs Act of 2017 requiring businesses to capitalize research and development (R&D) expenses went into effect for tax year 2022. Prior to the implementation of this tax provision, businesses could fully deduct R&D expenses incurred during the year. The new rules require the expenses to be capitalized and deducted over a five-year period for R&D expenses incurred within the U.S., or fifteen years for R&D expenses incurred outside the U.S.
Impact of R&D Capitalization Rule
Delayed R&D deductions may mean higher taxable income in 2022. To make it even worse – the capitalization rules require a mid-year convention which means only a tenth of R&D expenses incurred in 2022 will be deductible on a 2022 tax return. The remaining expenses will be deducted over the next four and a half years. Businesses not aware of this change may be surprised to see higher taxable income and higher tax liabilities for 2022. The new rules may cause cash flow issues for some businesses as the full amount spent on R&D expenses in 2022 does not proportionately reduce taxable income.
R&D Tax Credit Still Available
On the bright side, the R&D tax credit is still available to help mitigate some of the pain associated with capitalizing R&D expenses. The R&D tax credit is generally about 6% of qualified R&D expenses incurred during the tax year. It is important to note, while claiming the R&D tax credit is optional, capitalizing R&D expenses is not. If your business elects not to take the R&D tax credit and has R&D expenses on the books, those expenses must still be capitalized.
As with most tax provisions, the rules are complex. Reach out to your tax advisor at Ketel Thorstenson to see how these rules impact your business.