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Potential Relief from the R&D Amortization Requirements?

A bill that would repeal the requirement to capitalize and amortize IRC Section 174 (Research and Development) expenses has been reintroduced in Congress. Yes – reintroduced – as in Congress had the opportunity previously to make this go away and chose to leave us hanging in the 2022 season finale.

For those of you just joining us, here’s a recap of seasons 1 and 2.

Season 1 – the Tax Cuts and Jobs Act, the most revolutionary income tax bill since the 1980s, passed by the narrowest of margins in 2017. There were many headlines in the bill, none of which included a little-known provision that would require all R&D and software development costs incurred after the 2021 tax year to be capitalized and amortized over five years (for domestic costs) and 15 years (for foreign costs).

You may be thinking, big deal? It’s just a deferral of an expense, you’ll get it eventually. Why shouldn’t these wildly profitable tech companies have to front load some of their tax liabilities? While you’d be correct in thinking that it may not be a big deal for a wildly profitable tech company, for every one of them there are hundreds of smaller tech companies that are currently trapped in a cash flow nightmare. Imagine the following scenario:

Small tech startup sells $1,000,000 of software and pays their 15 employees a total of $1,000,000 to develop said software. Break even, right? Cash flow neutral? Wrong. The $1,000,000 of expenses shrinks to $100,000 (I know – not five years – just trust me) in year one. That means taxable income of $900,000 and a potential tax liability in excess of $300,000 for a company whose cash is all gone… and it only gets worse in years 2, 3, and 4. The light at the end of the tunnel doesn’t begin to appear until year 5.

Season 2 – in 2021, someone in Congress is reminded that they still need to make this problem go away. The result is a bill that’s sponsored by a Democratic Senator, along with 35 Senate cosponsors – 18 Republicans and 17 Democrats. That’s a perfect 50/50 split over 70% of the Senate. But in a perfect replica of a James Bond scene where the villain leaves the room assuming Bond’s demise is certain due to the hastily tied knot securing him to the pole in the water with man-eating sharks; the bill escaped passage.

So, we’re now in Season 3 – this is real. The best-case scenario is that companies responsible for the advancement of technology in our country will have potentially 30% less cash to invest in continued research and development, and we continue to fall behind the rest of the world. Worst case scenario, businesses close because they can’t pay their taxes.

This is a serious issue that will trickle down very quickly to every single one of us. Congress needs to get this done, and they need to get it done now.

Please contact us if you have questions about the information outlined above, our seasoned and experienced tax professionals are here to help. You can also learn more about our Tax services by visiting our website.

About the Author

Mark Heath

Mark is a Partner with McKonly & Asbury. Serving as Director of Tax Services, he brings a wealth of experience in federal, state, and international income as well as franchise tax issues for both publicly and privately held corporatio… Read more

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