Section 174 Expensing
For over 60 years, the U.S. tax code has reflected the value of research and development investments to our nation’s economy. The Internal Revenue Code (IRC) of 1954 included Section 174, which gave businesses the option of deducting “research and experimentation” expenses either in the same taxable year in which they occur or amortized over a period of up to 60 months. In the ensuing decades, few changes were made to this provision of the tax code other than the addition of Section 174(e) in 1989, which limited the deductibility of expenses to those that are “reasonable under the circumstances.” And, at various points, the IRS has enacted regulations mostly to specify what types of expenditures businesses can deduct under Section 174.
Congress substantially amended Section 174 for the first time in over six decades with passage of the Tax Cuts and Jobs Act (TCJA) in 2017. Starting in 2022, the tax code will no longer allow companies to expense all qualified Section 174 expenditures in the year they are incurred. Instead, they will be required to amortize any such deductions over five years for domestic expenditures or over 15 years for expenses incurred offshore.
This is a dramatic shift in the tax treatment of business investments in research and innovation, and it will leave the United States with a system unlike any other in the industrialized world. By diminishing the near-term value of R&D expenditures, the TCJA will reduce incentives for companies to invest in the development of new products, ultimately hurting consumers and businesses alike. For these reasons, the R&D Coalition is committed to working with Congress to restore the longstanding tax treatment of R&D investments under Section 174.
R&D Tax Credit
The Research and Experimentation Tax Credit, in Section 41 of the IRC, was enacted as part of the Economic Recovery and Tax Act of 1981 and was initially set to expire at the end of 1985. However, after recognizing the value of this additional innovation incentive, Congress extended the credit 15 times between 1985 and 2015, when it was made permanent as part of the Protecting Americans from Tax Hikes (PATH) Act, which also significantly enhanced the ability of small businesses to claim more of the credit.
The original R&D Tax Credit was a dollar-for-dollar reduction in tax liability equal to 20 percent of a company’s current-year research and development expenditures that exceeded their historical base average. However, calculating base spending amounts was a complicated proposition for companies seeking to claim the credit. So, Congress eventually added the Alternative Simplified Credit (ASC), which is a 14 percent credit that companies can apply to qualified expenditures that exceed 50 percent of their average expenditures over the previous three years. In other words, both the original credit and ASC are available to companies that increase their qualified expenditures over time, not to such expenditures generally.
Members of the R&D Coalition believe that both Sections 41 and 174 are necessary to properly reinforce the value of investments in research and innovation and encourage these types of investments. As such, the coalition is committed to ensuring that both provisions continue to provide ample incentives for small and large businesses alike.