Current State of Section 174
As discussed in our recent blog, the Tax Cuts and Jobs Act (TCJA) of 2017 included a delayed provision that requires taxpayers to begin capitalizing and amortizing research and experimental (R&E) expenditures under Section 174 for tax years beginning after December 31, 2021. Prior to this provision, taxpayers had the option to deduct R&E costs in connection with the taxpayer’s trade or business during the taxable year incurred. Starting in tax year 2022, R&E costs will need to be capitalized and amortized over a 5-year period for domestic expenses and over a 15-year period for foreign research, beginning with the midpoint of the taxable year in which such expenditures are paid or incurred.
There are currently bills in both the House and Senate that would revert Section 174 to its prior state, allowing current-year deduction of R&E expenditures.
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On April 18, 2023, Congressmen Ron Estes (R-KS) and John Larson (D-CT) introduced the American Innovation and R&D Competitiveness Act of 2023, H.R.2673. The bill has 87 cosponsors, including 44 Democrats and 43 Republicans. When Congressman Estes introduced the bill, he focused his remarks on the need to incentivize businesses to keep research and development work in the United States. The goal of the bill is to make immediate expensing of R&E expenditures a permanent part of the tax code. The bill’s language is limited to reverting Section 174 to the deduction and capitalization options in effect prior to the TCJA as well as conforming amendments to Sections 41 and 280C, which would allow for current-year expensing of Section 174 expenses.
Similarly, there are currently two bills that have been referred to the US Senate Finance Committee that would reinstate the ability under Section 174 to deduct expenses in the current year.
Senator Ted Cruz (R-TX) introduced S.314 in February which would repeal the TJCA changes to Section 174. The bill, entitled Cost Recovery and Expensing Acceleration to Transform the Economy and Jumpstart Opportunities for Businesses and Startups Act or the CREATE JOBS Act, also includes changes to the timing for expensing and depreciating certain property under Section 168.
Senators Maggie Hassan (D-NH) and Todd Young (R-IN) introduced S.866 in March. The bill, entitled The American Innovation and Jobs Act, contains similar provisions as S.314 and H.R.2673 to revert Section 174 to its pre-TCJA state and comes with broad bipartisan support with over 25 cosponsors.
In addition to the Section 174 changes, The American Innovation and Jobs Act includes substantial expansions for Qualified Small Businesses (QSBs) within the Research & Development (R&D) Tax Credit. Senator Hassan previously sponsored legislation that expanded the R&D Tax Credit for QSBs as part of the Inflation Reduction Act, doubling the amount of the R&D Tax Credit that can be allocated towards payroll taxes each year. This new bill would have the following effects for qualifying companies if enacted as written:
- Increase the limit for payroll allocation incrementally from $500,000 in tax years beginning after December 31, 2023, to $750,000 in 2032;
- Extend the eligibility from 5 years to 8 years to elect to apply the R&D Tax Credit towards payroll taxes;
- Change the gross receipts eligibility cutoff from $5 million to $15 million and include a de minimis threshold of $25,000;
- Alter the calculation for the Alternative Simplified Credit to provide a more generous calculation; and
- Alter the QSB credit from a non-refundable to refundable tax credit, allowing qualifying companies to receive the full value of the credit in the current tax year.
How to Plan
While we are encouraged by the bipartisan support shown for H.R.2673 and S.866, the capitalization and amortization requirements remain in effect. As we all continue to watch Congress for updates to Section 174, it is important for taxpayers to discuss the impacts of Section 174 and potential changes with their tax preparers.
In its current state, Section 174 creates an additional tax liability for many taxpayers, making the need for tax credits and supplemental deductions more urgent than ever. Get advice from an expert on how to navigate this new landscape and receive guidance on the incentives potentially available to your unique business