The U.S. R&D market’s full attention is directed toward Congress due to the bipartisan tax deal that promises to turn upside down the treatment of domestic Research and Experimental (R&E) expenses under Section 174.
Currently, all domestic R&E expenses from January 1, 2022, are required to be capitalized and amortized over a 5-year period, as per the provisions of the Tax Cut and Jobs Act (TCJA) passed during the Trump Administration in 2017.
This change has significantly impacted U.S. companies’ liquidity by disallowing the full deduction of all R&E expenses incurred in a given year from the total taxable income, as was permitted before the TCJA, resulting in higher tax amounts.
The bipartisan Tax Relief for American Families and Workers Act of 2024 (HR 7024) aims to reinstate pre-TCJA regulations, placing a moratorium on the domestic R&D amortization obligation requirement until the end of 2025, thereby restoring taxpayers’ option to deduct all domestic R&E expenses.
Fast pace in Congress
The Bill HR 7024 swiftly passed in the House with an expressive vote margin (357 in favor and only 70 against) on January 31, 2024, thanks to bipartisan support and negotiations led by congressmen Smith and Wyden. The bill is now awaiting approval in the Senate, where it is expected to pass without major opposition and with minor amendments.
The main obstacle is the Senate Calendar, as Senators will return to their districts during the State Work Period starting on Feb 12 and must reconvene in D.C. on Feb 25. This timeline has dashed hopes of implementing the new regulations before the start of the IRS tax season.
However, due to the rapid progress of negotiations and bipartisan support, it is anticipated that HR 7024 will receive presidential approval before April 15, 2024, the due date of filing a tax return or to request an extension, allowing businesses to deduct all R&E expenses without amending their tax returns. Nevertheless, amidst the anticipation, it’s crucial to acknowledge the lingering uncertainty surrounding the bill’s approval. Despite the optimistic projections, the political landscape remains unpredictable, leaving stakeholders cautiously hopeful yet acutely aware of the potential pitfalls, as well as mindful of all the possibilities.
Strategic tax planning under new regulations
In light of potential presidential sanction without vetoes or major amendments, taxpayers will need to reconsider their tax strategies for the upcoming tax years and, depending on the chosen strategy, amend their 2022 and 2023 tax returns to maximize tax deductions.
With the reinstatement of pre-TCJA regulations for domestic R&E expenditures, businesses would have the option to decide whether to deduct 100% of domestic R&E expenditure or capitalize and amortize these expenses. The former would generate higher cash flow by reducing taxable income through deductions, thereby decreasing tax liability, while the latter would increase company EBITDA due to the treatment of Section 174 expenses.
At last, in the first scenario, businesses would have the option to change the amortization accounted in 2022 and fully deduct the domestic R&E expenses, potentially resulting in a tax refund. Thus, if HR 7024 receives approval, there will be keen anticipation for IRS recommendations and regulations concerning the retroactive application of the domestic R&E expenses deduction, spanning from 2022 to possibly 2023, should the bill not be ratified before April 15th. This underscores the significance of timely legislative action and its implications on tax planning strategies for businesses. In this climate of uncertainty, it is anticipated that numerous requests for extensions to file taxes will arise, as businesses grapple with the evolving legislative landscape and await clarity on the status of HR 7024 before a final decision is made on the format for accounting the domestic R&E amounts.
Businesses are encouraged to stay informed and proactive as the legislative process progresses, in order to assess the potential impact of HR 7024 on their tax strategies. Although the bill offers the potential for boosting innovation and economic growth, its ultimate effects depend on its successful passage through the Senate and subsequent implementation. Therefore, it is crucial for businesses to collaborate with tax professionals and companies and professionals involved in the environment of innovation promotion mechanisms to make well-informed decisions and effectively navigate this dynamic landscape.
By Javan Castro, R&D Tax Analyst.
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