Research and Development Tax Capitalization Rules: Are You Ready?

As part of the Tax Cuts and Jobs Act, a significant change in the tax law occurred for research and development (R&D) costs. Although this change was passed in 2017, it did not take effect until tax years beginning on or after January 1, 2022.

Previously, for tax years beginning on or before December 31, 2021 (2021 calendar years and earlier), R&D expenses could generally be deducted as incurred for tax purposes.

Currently, for tax years beginning on or after January 1, 2022 (2022 calendar years and later), R&D costs must be capitalized and amortized. 

The amortization period is generally five years for U.S.-based R&D, and 15 years for foreign R&D. If you are deducting R&D expenses for your financial statements, this new capitalization requirement will result in an unfavorable book/tax difference in 2022. Note that these capitalization rules apply regardless of if you claim an R&D tax credit.

The R&D asset that is capitalized is deemed placed in service halfway through the year and follows straight-line depreciation. This means, for R&D expenses incurred in 2022 of $100,000, the deductibility would look like this:

2022: $10,000

2023 through 2026: $20,000

2027: $10,000

As you can see, in 2022 you will have an unfavorable tax adjustment of $90,000 ($100,000 cash spent on R&D less tax deduction of $10,000). This is a timing difference that will eventually become favorable in future years but can affect your cash flows in the short term when making 2022 tax payments. 

Additionally, taxpayers that previously had not been tracking their R&D expenses must now find a way to accurately account for R&D costs in order to follow tax law. If you have not previously been tracking R&D costs, consider having an R&D study done to determine if any of your R&D costs qualify for the R&D tax credit. This credit could help mitigate some of the tax due as a result of the new R&D capitalization rules.

It is no secret that this change stifles innovation and is not very popular. Earlier in 2022, Congress had attempted to delay the implementation of R&D capitalization requirement. Unfortunately, this resolution did not pass. As we approach the close of 2022, Congress is again looking to delay or otherwise change the R&D capitalization requirement. Schneider Downs & Co. will continue to monitor these developments closely and provide updates as needed.

Make sure to account for these R&D capitalization rules when making 2022 tax payments. If you believe you have R&D expenses but have not previously claimed an R&D tax credit, now is a good time to discuss the R&D credit with your tax preparer.

About Schneider Downs Tax Services

Schneider Downs’ tax advisors have experience and expertise in a wide range of industries, including Automotive, Construction, Real Estate, Manufacturing, Energy & Resources, Higher Education, Not-for-profits, Transportation and others. Our industry knowledge and focus ensure the delivery of technical tax strategies that can be implemented as practical business initiatives.  

To learn more, visit our dedicated Tax Services page. 

Questions? Contact Derek J. Godwin, CPA, or a member of your Schneider Downs & Co. service team.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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