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New Rules for Treatment of R&D Costs Could Impact Technology Companies

By: Daniel Larson

Certain provisions of the Tax Cuts and Jobs Act (TCJA) could have a significant impact on technology companies in 2022.

Here’s what technology companies need to know about an amendment to Section 174 of the tax code that can affect taxable net income.

First, though let's look back at the TCJA and why we're talking about this change years after it was signed into law.

Background of TCJA

Singed into law in 2017, the TCJA contained a number of significant changes to the previous tax code. However, not all of the changes went into immediate effect. The TCJA established timelines as to when certain provisions of the law would go into effect.

The amendment of Section 174 is one of the changes that takes effect for companies in 2022. This new amendment will significantly affect the way companies treat research and experimentation expenses. This could ultimately have a big impact on technology companies, especially software development companies.

Potential Impact of the Amendment of Section 174

Section 174 expenses include both direct and indirect research expenses. In the past, under Section 174, companies had the option of deducting research and development expenditures in the year in which the expenses were incurred. This included the cost of developing computer software. The ability to deduct these expenses in the year in which they incurred substantially reduced a company’s taxable income in the year in which they incurred these expenses.

Under the new amendment to Section 174, which takes effect starting in 2022, companies will no longer be able to deduct these expenses on their tax return. Instead, companies will now be required to capitalize research and experimentation expenses and amortize them over a number of years. The amortization period depends on whether the research and experimentation occurred inside or outside of the United States

Beginning in 2022, for research and experimentation that takes place in the U.S., the expenses must be capitalized and amortized over a five-year period. For research and experimentation that takes place outside of the U.S., the expenses must be capitalized and amortized over a 15-year period.

This new amendment could significantly impact the taxable income of technology companies, as they can no longer take the full deduction of research and experimentation expenses in the year in which the expenses are incurred.

What You Should Do Now

You should start planning for change this now, as you might be required to make higher quarterly tax payments throughout 2022.

Additionally, you should review all of your expenses to ensure that you’re correctly identifying all research and experimentation expenses. Failure to fully understand the impact of this amendment could end up being quite costly for your business.

Need Help?

To learn more about how this new amendment might affect your business, contact us here or call 800.899.4623.

Published April 5, 2022

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