Updated August 20, 2024
Certain recent changes to tax code Section 174 may negatively affect companies that have research and development (R&D) expenses.
Here’s the basic problem: If in 2023 you spent $1M to make $1.2M then you have $200K of profit. If we lived in a perfect world, you would only be taxed in 2023 on the $200K.
Unfortunately, we don’t live in a perfect world. Beginning in 2023, domestic R&D expenses paid or incurred in a tax year are effectively taken over six tax periods.
More precisely, the expenses are taken over a five-year period, but all R&D expenses for a year are treated as having been paid or incurred in the middle of the year, meaning a taxpayer gets a six-month deduction in the first year, annual deductions over the next four years, and a six-month deduction in year six.
This means if $1,000,000 domestic R&D expenses are paid or incurred in 2023, there would be a $100,000 deduction in 2023, a $200,000 deduction in each of 2024, 2025, 2026, 2027, and $100,000 in 2028.
The issue is even more pronounced for research conducted outside of the U.S., Puerto Rico, or a U.S. possession. R&D expenditures related to such foreign research are deductible over a 15-year period, taken effectively over 16 tax years. See the chart below.
And while an expense not taken this year but in a future one can provide a benefit that would not otherwise be available in the future year,[1] that is cold comfort for growing businesses that may be cash strapped now.
While there previously has been momentum to delay the application of the five-year period for domestic research and development costs until taxable years beginning after December 31, 2025, the Senate in August 2024 voted against legislation to this effect.
The below chart illustrates the schedule over which $1M of R&D expense incurred in 2023 (Year 1) would be taken over time and the value of the tax deduction assuming the C corporation otherwise has taxable income.
|
Year |
Five-year Amortization (domestic) |
Fifteen-year Amortization (foreign) |
|||
|
|
Deduction |
Additional Taxes/ (Tax Savings) Compared to Immediate Expense |
Deduction |
Additional Taxes/ (Tax Savings) Compared to Immediate Expense |
Additional Taxes/ (Tax Savings) Compared to Five-year Amortization |
|
1 |
$100,000 |
$189,000 |
~$33,333 |
$203,000 |
$14,000 |
|
2 |
$200,000 |
($42,000) |
~$66,666 |
($14,000) |
$28,000 |
|
3 |
$200,000 |
($42,000) |
~$66,666 |
($14,000) |
$28,000 |
|
4 |
$200,000 |
($42,000) |
~$66,666 |
($14,000) |
$28,000 |
|
5 |
$200,000 |
($42,000) |
~$66,666 |
($14,000) |
$28,000 |
|
6 |
$100,000 |
($21,000) |
~$66,666 |
($14,000) |
$7,000 |
|
7 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
8 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
9 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
10 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
11 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
12 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
13 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
14 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
15 |
|
|
~$66,666 |
($14,000) |
($14,000) |
|
16 |
|
|
~$33,333 |
($7,000) |
($7,000) |
[1] And, of course, time value of money considerations, tax rate changes, and other factors can impact the utility of deferred expenses.
Chase Manderino frequently advises regarding corporate tax matters. For additional information, please contact chase@mbakertaxlaw.com.