Question: Didn’t the Tax Cuts and Jobs Act (TCJA) fix all the big tax issues relating to R&D?

Answer: No. While the TCJA maintained the permanent R&D credit, in some very important respects, the TCJA created long-term challenges for encouraging R&D. Ultimately, while the new tax law included some good news for R&D-heavy industries, it also included some very troubling news.

The good news: The TCJA kept in place the permanent R&D Tax Credit. It also lowered the corporate tax rate from 35 percent to 21 percent, which effectively increased the value of the credit for those companies that can claim it.

The bad news: The TCJA also changed how businesses can expense R&D under Section 174. Beginning in 2022, companies will be required to amortize their R&D expenses over five years for domestic expenses and 15 years for expenses incurred outside the United States. In other words, instead of deducting R&D expenses in the year in which they are incurred, companies will have to spread out their deductions over a five- or 15-year period, depending on the where the spending took place. This is a dramatic shift from current law. By requiring amortization of expensing, the TCJA will significantly diminish the near-term value of R&D investments. The R&D coalition is committed to working with Congress to repeal this change to Section 174.

Additionally, from 2018 to 2025, R&D Tax Credits will have no bearing on a company’s liability under the TCJA’s Base Erosion and Anti-Avoidance Tax (BEAT).  However, starting in 2026, the BEAT calculation will require businesses to “add back” any claimed R&D Tax Credits. At that point, every dollar a company claims under the R&D Tax Credit will potentially increase its BEAT liability, negating much, if not all, of the benefit. 

Question: If the R&D Tax Credit is permanent, why do companies still need immediate expensing of R&D costs?

Answer: The R&D Tax Credit and expensing under Section 174 serve two different purposes. The R&D Tax Credit is a partial dollar-for-dollar credit for qualified expenses, focused mostly on incentivizing companies to increase their year-to-year R&D spending. This is a jobs-based credit, so it goes directly to incentivizing a strong U.S. workforce. Separately, Section 174 allows companies to deduct all qualified R&D expenses from their taxable income. This encourages companies to continue to increase investments in R&D. While the two incentives are interconnected, they do not overlap – expenditures claimed for the purposes of the R&D Tax Credit cannot be expensed under Section 174. Together, these provisions help American businesses compete and conduct R&D here at home.

Question: Even if the changes to Section 174 take away some of the preferential tax treatment for R&D, isn’t the U.S. tax system still relatively generous to companies who make those investments?

Answer: The United States faces fierce worldwide competition for R&D investments. While the U.S. still leads the world in R&D spending, its overall share of global investments has been on the decline, dropping from around 37 percent in 2001 to roughly 25 percent in 2017. However, that increased competition and declining share of investment has not been reflected in our tax code. In 2016, the R&D Tax Credit left the U.S. ranked at number 25 among industrialized countries in terms of R&D incentives. The new amortization rule, while technically not part of that calculation, will not add to our tax code’s generosity. Indeed, it would make the U.S. an outlier as no other industrialized country handles deductions for R&D expenses in this manner.