Late last year, Congress passed and President Biden signed into law the Consolidated Appropriations Act of 2023. This bill included funding for the federal government for 2023 but left out the much-anticipated tax extenders. One of the most anticipated was a delay in the Section 174 amortization requirement. With the extenders not passing, many taxpayers are asking, “What now”?
First, it’s essential to understand what Section 174 includes: It details how taxpayers are to handle research expenditures. Prior to the Tax Cuts and Jobs Act of 2017, taxpayers had the option of amortizing these expenses over five years or immediately deducting them. As a budgetary tool, the TCJA removed the ability to immediately deduct expenses and inserted the amortization requirement starting in 2022. The expectation by most policy experts was that this requirement would not come to fruition. Multiple bipartisan bills have included relief for this change, but none have passed. This means most taxpayers need to move forward with the current law as it is written.
There has been some confusion surrounding the change and how it interacts with the Section 41 research tax credit. Despite industry confusion, not all Section 174 expenses are Section 41 expenses, but all Section 41 expenses are 174. To simplify how it works, claiming the R&D tax credit does not increase or create Section 174 expenses. Simply forgoing the R&D tax credit for 2022 would not eliminate the amortization requirement. Taxpayers may have Section 174 expenses that do not qualify for Section 41. Additionally, the Section 41 tax credit is an incremental credit, meaning that only costs exceeding a baseline amount each year qualify. Taxpayers not exceeding this baseline amount will still need to amortize all Section 174 expenses.
The tax credit can be used to offset the financial impact caused by this new amortization requirement. While the tax credit is not enough to offset 100% of the change from this law, forgoing the tax credit will unfortunately make tax liability worse, not better. Taxpayers can also review other parts of the Tax Code for planning opportunities to offset some of the increased liability. Reviewing depreciation expenditures, energy upgrades done in prior years, and other tax-saving strategies could help reduce the negative financial impact of this new tax change.
While many members of Congress are still considering ways to fix this portion of the Tax Code, taxpayers need to begin planning for the law as it is currently written. Unfortunately, there is no shortcut around this amortization requirement. While many taxpayers equate the Section 41 tax credit with Section 174, eliminating the tax credit does not reduce the amortization burden. Taxpayers who do not claim the R&D credit will still be required to amortize Section 174 expenses. As taxpayers and preparers move into the 2022 filing season, this unforeseen consequence of the TCJA will lead to difficult conversations.
