In this summary, we will cover:

  • The treatment of Research & Development expenditure before and after the new tax laws.
  • The treatment of Research-related expenditure when incurred within and outside the US.
  • The options available for capitalizing and amortizing Research & Development expenses.
  • When the new proposed Research & Development expenditure-related laws take effect.

Takeaways:

    • The new changes in tax laws have left the credit for Research & Development relative the same. This is after the tax credit was made permanent in 2015 in the Protecting Americans against Tax Hikes (PATH) Act.
    • The current law which is bound to change after December 31, 2021, permits taxpayers to elect to expense Research & Development expenditure incurred during a business or trade in the year they were incurred. Alternatively, the expenditure can be amortized over the useful life of the research but for not more than 60 months.
    • Some experts believe that the change in the treatment of Research & Development expenses may bring about a higher taxable income for a business. And subsequently, companies may need to adjust their budgeting and operating expenses to accommodate the increase in taxes.
    • Research expenditure incurred outside the US will be treated differently under the new tax laws. As such, any such expenditure will not qualify as an expense under the R&D tax credit. Such an expense will not be relevant when it comes to offsetting a company’s total tax liability.
    • The new proposed laws will require one to identify and separate Section 174 expenditure that will be amortized. While this may require a more in-depth accounting analysis, isolating the expenses may come in handy when faced with audit defense situations.

Summary

The 2017 US Tax Cuts and Jobs Act (TCJA) (H.R.1) addresses a number of tax issues relating to various industries. The technology industry, in particular, had a lot to ponder over. The sector contains a number of sub-sectors including computer hardware/peripherals, software, cloud/SaaS (Software as a Service), internet/social media, and semiconductor companies.

The recent change in tax laws has seen a major shift in some of the conventional ways of tax operations. Interestingly, the law leaves the credit for Research & Development relatively intact.

The R&D tax credit was made permanent in 2015 in the Protecting Americans against Tax Hikes (PATH) Act.

Research & Development is important to almost every industry—but most of the research going on in the US is mostly due to software development which reflects a major driver of innovation and effectiveness across all aspects of the economy.

Before the new tax proposal on R&D, the law permitted taxpayers to elect to expense Research & Development expenditure incurred during a business or trade in the year they were incurred.

Alternatively, the expenditure could be amortized over the useful life of the research but for not more than 60 months. This legislation is bound to remain the same until the tax year beginning after Dec 31, 2021.

Under the new Tax Cuts and Jobs Act, after December 2021, the immediate deduction of Research & Development expenses such as salaries paid to research staff would be off the menu. The expenses would have to be capitalized and amortized over a period of 5 years.

On the other hand, research expenditure incurred outside the US would face an even longer capitalization and an amortization period of 15 years.

The move to treat the expenditure differently depending on whether it is domestic or foreign is a major change from the way things have been done since 1954.

A good number of companies in the tech industry that are engaged in R&D prefer to write-off research expenses immediately to lower their taxable income.

For some tax experts, the change may bring about a higher taxable income for a business. And subsequently, companies may need to adjust their budgeting and operating expenses to accommodate the increase in taxes.

Businesses faced with higher taxes may opt for planning their cash flows by investing in activities that may reduce tax burdens; and from the look of things, the tax proposal seems to favor companies investing domestically.

Research & Development Prevalence

There’s no doubt that a lot of tech firms spend decent amounts of money in R&D. For instance, firms such as Amazon, Alphabet, Apple, and Microsoft spend billions of dollars on Research & Development alone.

According to FactSet, technology companies are in fact, the leading spenders when it comes to R&D. Here’s an overview of the recent spending on Research & Development by some of the big tech companies as compared to other industries.

Foreign Research & Development Expenditure

As mentioned earlier, research conducted outside the US is treated differently under the new tax laws. As such, any such expenditure will not qualify as an expense under the R&D tax credit. Such an expense will not be relevant when it comes to offsetting a company’s total tax liability.

If this is combined with the 15-year capitalization and amortization period, firms looking to conduct their research outside the US may have to think twice about the financial impact of foreign research and development expenditure.

The R&D write-off provision would be enacted much later as compared to other provisions in the House and Senate Tax Plans. The delayed enactment (until after Dec 2021) is said to give room for reactions from the R&D industry players. Further, the delay will allow for accounting for planned R&D budgets that extend into 2018 and beyond.

Most tech firms budget for three to five-year periods. If a major shift is bound to occur, it was only fair to give such firms sufficient time to adequately prepare for the change.

Moving forward, the changes relating to research expenditure are expected to have most impact for small and medium-sized companies—such firms are those that claim the R&D credit and utilize the Activities Approach in Junction with the Cohan Rule to estimate their expenses.

Under the method, taxpayers would typically group their qualified research expenditure with other expenses without separation. For instance, wages relating to Qualified Research Expenses (QREs) get combined with the rest of the wage expenses.

However, the new proposed laws will require one to identify and separate Section 174 expenditure that will be amortized. While this may require a more in-depth accounting analysis, isolating the expenses may come in handy when faced with audit defense situations.

Moving forward…

Fortunately, companies have a couple of years ahead of them until 2021 to prepare for the change. The IRS is also expected to furnish the key stakeholders in the Research & Development space with further guidance in relation to the new laws.

Need help?

Are you getting confused and unsure of the next step to take about the new tax laws? Feel free to contact us right here. We are here to listen and help you navigate through whatever challenges you may be facing.