Beginning in 2022, research & development (R&D) expenses receive new tax treatment.

Historically, the government has provided multiple tax incentives to companies performing research and development activities under the premise that this is good for economic growth. The government has generally allowed companies to both immediately expense R&D costs and receive tax credits related to these activities. Due to the law changes within the 2017 Tax Cuts and Jobs Act (TCJA), the treatment of research activities will change in 2022.

Starting in 2022 businesses can no longer deduct R&D expenses all in one year. The new rules require costs to be capitalized over a five or fifteen year period for expenses associated with research conducted outside of the U.S..

What does this mean? Taxpayers who have traditionally claimed R&D expenses can expect more taxable income starting in 2022. Higher taxable income means higher tax payments.

Let’s look at an example:

Company A has R&D product development resulting in $100,000 of R&D expenses. Prior to 2022, Company A would recognize and deduct 100% of the costs in the year incurred. Now in 2022, the $100,000 of expenses must be amortized over 5 years, resulting in only a $20,000 per year deduction. This example defers $80,000 of expenses until future years and inherently creates higher taxable income in 2022.

The good news is that the research activities tax credit is still available. In the scenario above, Company A may also qualify for the increasing research tax credit totaling a percentage of R&D expenses. In this example, $100,000 of qualified R&D expenditures would result in approximately $6,000 of tax credits to Company A. TCJA did not change the timing or nature of the R&D tax credit. Unfortunately, the extra 2022 tax relating to the deferral of the deduction will be much greater than the 2022 tax credit.

Industries such as construction, engineering, manufacturing, agricultural production, or breweries may be doing some form of qualified research and development.

The five-year deferral of research expenses is not optional.  These mandatory capitalization rules and the R&D tax credits are complex to analyze, calculate and document. If you have questions about whether your business qualifies for the R&D tax credit or has capitalization requirements, please reach out to your KT advisor.