Changes to the tax treatment of research expenditures had a big impact on many manufacturers ’ tax bills . For calendar-year taxpayers , the impact date is Sept . 15 , 2023 , which was a change that took effect for 2022 under the Tax Cuts and Jobs Act ( TCJA ). It requires businesses to capitalize research and experimental ( R & E ) expenditures under IRS Section 174 and amortize them over five years ( 15 years for research conducted outside the United States ). Previously , businesses had the option to immediately deduct these expenditures . Given the potential impact of these lost deductions , manufacturers should conduct a study of their research expenditures and consider strategies for reducing their tax bills .
Changes to the tax treatment of research expenditures had a big impact on many manufacturers ’ tax bills . For calendar-year taxpayers , the impact date is Sept . 15 , 2023 , which was a change that took effect for 2022 under the Tax Cuts and Jobs Act ( TCJA ). It requires businesses to capitalize research and experimental ( R & E ) expenditures under IRS Section 174 and amortize them over five years ( 15 years for research conducted outside the United States ). Previously , businesses had the option to immediately deduct these expenditures . Given the potential impact of these lost deductions , manufacturers should conduct a study of their research expenditures and consider strategies for reducing their tax bills .
Revisit the R & D Credit
One potential tax-saving option is to determine whether R & E expenditures qualify for the credit under Section 41 for “ increasing research activities ” ( commonly referred to as the R & D credit ). Tax credits are generally more valuable than tax deductions . While both save taxes , tax deductions lower your taxable income , but tax credits reduce your tax bill dollar for dollar .
Note , the Inflation Reduction Act ( IRA ) of 2022 expanded the ability of start-up businesses to use R & D credits to offset payroll tax liability . The TCJA allowed start-ups — generally defined as companies less than five years old and have less than $ 5 million in gross receipts — to claim R & D credits against up to $ 250,000 in Social Security tax liability . The IRA allows these businesses to claim up to an additional $ 250,000 against their Medicare tax liability .
Keep in mind , not all R & E expenditures will qualify for the R & D credit . Section 174 applies to a broad range of expenditures , including both direct and indirect R & E expenses . In contrast , Section 41 is generally limited to only direct expenses .
Analyze Your R & E Expenditures
Another option is to conduct a study of your R & E expenditures to determine whether any of them can be properly reclassified as deductible business expenses under Section 162 . Prior to the TCJA ’ s 2022 change , businesses didn ’ t need to worry too much about whether expenses were deductible under Section 174 or Section 162 , because the tax treatment was essentially the same . Now , however , determining the proper classification of expenses can mean the difference between capitalizing them or deducting them immediately .
As you review these expenses , keep in mind that under the TCJA , to be eligible for the R & D credit , an expense must be treated as an R & E expenditure pursuant to Section 174 . So , it ’ s important to weigh the potential benefits of reclassifying R & E expenses as deductible business expenses against the potential loss of R & D credits .
Consider Purchasing Software
Another significant change made by the TCJA was to change the tax treatment of software development costs . Previously , taxpayers had the option of deducting these costs as they were paid or incurred .
Now , however , software development costs are treated as R & E expenditures required to be capitalized and amortized under Section 174 . A potential strategy for softening the tax blow of this change is to purchase software , which is deductible immediately as a business expense , rather than to develop it in-house .
Stay Tuned
The requirement to capitalize and amortize R & E costs can have a significant tax impact on certain manufacturers . Work with a tax advisor to help you navigate through the current rules and ensure you ’ re claiming this credit appropriately . Contact our manufacturing CPAs today to obtain assistance . ■
Issue 2 | 2023 VIEWpoint 7