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What Impact Will 2022 Changes to R&D Expenses Have on Technology Companies?

Few sectors benefit more from the R&D tax credit than the tech industry — for many people, it’s synonymous with the very idea of innovation, and it’s responsible for many of the most important advances over recent years. However, things are changing, and the way tech companies can report R&D expenses is set to change in the 2022 tax year.

Here’s what to expect:

TCJA and tax credits

In 2015, the PATH Act confirmed the R&D tax credit would be a permanent fixture and introduced a payroll tax benefit for newer businesses that may not be eligible for the tax credit. Then, in 2017, the Tax Cuts and Jobs Act (TCJA came along). Many tax incentives were removed, but the tax credit remained — with a few amendments.

Beginning in the tax year following December 31, 2021, the TCJA changed how a few deductions worked. Instead of companies having the choice of expensing R&D costs straightaway or amortizing them over a period of five years or more, they were given only one option: Amortizing over five years.

This policy reduced flexibility and limited tax-effectiveness since taxpayers could no longer tailor their treatment of tax credits to their own unique circumstances. It applies to costs that could previously have been amortized over three years, such as website development, and abandoned property that was previously eligible for an immediate deduction.

Plus, specific types of expenses face additional rules. For instance, credits for foreign R&D (such as payments to foreign contractors) must now take place over an amortization period lasting 15 years.

These changes could also impact book to tax timing differences since the policy won’t change how R&D costs should be included on financial statements, meaning that deferred tax provisions may be impacted.

An example of the changes

To make this clearer, let’s look at an example of how tax credits will work under the latest changes.

Say there’s a SaaS startup that operates remotely and has a team of employees, freelancers, and contractors working from various states in the US that spends annually $500,000 on R&D expenses that qualify for tax credits. Previously (in 2020 and 2021), the company would have been able to choose between using this $500,000 as expenses straightaway or amortizing it over a period of five years or more.

Starting in 2022, the startup wouldn’t have the option of making it an immediate deduction. Instead, it can only amortize over five years. In other words, it could claim $50,000 in 2022, $100,000 a year between 2023 and 2026, then $50,000 in 2027.

What does the future hold?

Not everyone is happy with the changes outlined above, and Congress has already attempted to overturn the amendments through the Build Back Better Act and other proposals. However, so far, nothing has worked.

A potential upcoming attempt is the America COMPETES Act, which may act on a bipartisan but non-binding Senate vote on the topic. Due to the innovation and positivity surrounding technology firms, many politicians are keen to overturn the tax changes.

Yet for now, businesses in the technology sector will have to get their heads around the new legislation and ensure they’re prepared for the upcoming tax years.