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New Rule Requiring Capitalization of R&D Expenses

By Kenneth H. Bridges, CPA, PFS December 2022

Historically, “research and experimentation” expenditures have enjoyed very favorable tax treatment.  You can elect to deduct such expenses immediately (or capitalize and amortize if more beneficial), the expenses are not subject to the general rules requiring capitalization of start-up expenses, and you can also receive Federal and state tax credits for the expenses.

In an effort to pay for the tax cuts included in the Tax Cuts and Jobs Act legislation enacted in late 2017, Congress included a provision that could be a ticking time bomb for early-stage technology companies.  This provision, scheduled to take effect for 2022, requires that R&D expenses be capitalized and amortized over 5 years (15 years for research conducted outside the U.S.) rather than deducted immediately.  This could result in a situation whereby taxable income (and the tax thereon) greatly exceeds net cash flow.

Legislation has been proposed (but not yet enacted), which would repeal or defer the capitalization rule.  Hopefully, such legislation will be enacted and made retroactive. If not, companies may need to reconsider what they classify as R&D expenses versus normal ongoing operating expenses and whether the resulting R&D tax credit(s), if any, are sufficient to offset the tax on the additional income from capitalization.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.