Changes to the federal tax code that threaten innovation, valuable building science research, and firm prosperity, have taken effect. Previously, businesses that incurred qualified research or experimental expenditures could deduct those expenses within that same taxable year. However, the Tax Cuts and Jobs Act of 2017 included a provision that, starting on December 31, 2021, all research and development expenses must be capitalized and amortized over five years (or 15 years for expenses outside the United States). The new revised federal research and development tax credit, which took effect on January 1, 2023, is a significant tax liability increase for architecture firms.
AIA’s Latest Engagement
AIA is actively working with business groups and others to remedy the issue by revising the new law and getting it statutorily corrected (and made retroactive). In December 2022, AIA sent a letter to the Hill calling on congressional leadership to address the issue. Unfortunately, the 2022 year-end deal that had been crafted by Congress to correct the issue fell through.
AIA’s Government Advocacy Committee Chair Kevin Holland, FAIA, issued a message, including an overview of the impact on firms and an action alert, on March 7 to all AIA members. Since then, a bipartisan bill to address the issue was reintroduced in the Senate (S.866 – American Innovation and Jobs Act) and House (H.R.2673 – American Innovation and R&D Competitiveness Act of 2023). The bill reintroduction is a good first step, but there is much more to do, so member action could make a dramatic difference in helping our progress to get this fixed.
AIA has been given a possible fall 2023 date for decisive action. However, until then, members’ advocacy is still needed to get this over the finish line.
Take Action
Does your architecture firm invest in research and development? Reach out to Amal Mahrouki at amahrouki@aiapa.org or 717.236.4055, and we can connect with the national advocacy team to share your story.
If you have not done so yet, please take action by completing the form and hitting send on this action alert to Congress.
Read on for more information, originally published by AIA on April 21, 2023.
Background
In 2017, the Tax Cuts and Jobs Act (TCJA) amended Section 174 to require taxpayers to capitalize and amortize R&E expenditures for tax years beginning after December 31, 2021. The changes require taxpayers to amortize domestic expenditures over five years and foreign expenditures over 15 years, with amortization for the beginning to midpoint of the taxable year in which the expenditure is paid or incurred.
In the case of retired, abandoned, or disposed property with respect to which specified R&E expenditures are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period. Prior to the TCJA, taxpayers could choose to either deduct Section 174 expenses, capitalize the expenditures and amortize them over five years, or elect a 10-year amortization of expenditures under IRC Section 59(e).
The TCJA also changed the term “research or experimental expenditures” in Section 174(a) to “specified research or experimental expenditures.” Section 174(b) defines this term as “research or experimental expenditures which are paid or incurred by the taxpayer during the taxable year in connection with the taxpayer’s trade or business.” As part of the Tax Cuts and Jobs Act, a notable 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.
Lookback
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.
New Law’s Effect on R&D Tax Credit
The TCJA made a conforming amendment to Section 41(d)(1)(A) to define “qualified research” as research “with respect to which expenditures may be treated as specified research or experimental expenditures under section 174.” Previously, taxpayers were able to claim Secon 41 tax credit for expenditures that either qualified under Secon 174 or were deducted under IRC Section 162 as “ordinary and necessary” business expenses. Now, with the change in the definition of “qualified research,” taxpayers must classify those expenses under Section 174 to receive the Section 41 credit. This change will require a greater focus on validating Section 41 expenditures claimed as “specified research or experimental expenditures” under Section 174.
The TCJA also made a conforming amendment to IRC Section 280C, which prevents a double benefit by disallowing deductions for the portion of otherwise deductible qualified research expenses equal to the amount of the credit determined under Section 41(a). For amounts paid or incurred in tax years beginning after December 31, 2021, Section 280C(c) provides that no deduction is allowed for that portion of qualified research expenses otherwise allowable as a deduction for the tax year that is equal to the amount of the credit determined under Section 41(a). This results in a dollar-for-dollar increase in taxable income for the amount of credit to be claimed.
Change in Accounting Method
The change to amortization constitutes a change of accounting method for taxpayers that previously deducted R&E expenditures. The change will be made on a “cutoff basis,” as only expenses for tax years beginning after December 31, 2021, must be amortized. Taxpayers will not be required to make an IRC Section 481 adjustment. The IRS has yet to release new procedural guidance specifically addressing how taxpayers must comply with the new rule, and it is unclear at this time whether taxpayers will be required to file an Application for Change in Method of Accounting (Form 3115).