The preservation of the research and development (R&D) credit in the Tax Cuts and Jobs Act (TCJA or the Act) is favorable for companies investing in innovation. Also, starting in 2018, companies will get a larger tax benefit from the R&D credit when making the reduced (or net) credit election because of the reduction of the corporate tax rate. In 2018, when the corporate tax rate drops to 21 percent, the net credit will be 79 percent (100 percent minus 21 percent corporate tax rate) instead of 65 percent (100 percent minus 35 percent corporate tax rate). Therefore, even with the same amount of qualified expenditures as prior years, the tax benefit of the R&D credit in 2018 inherently increases due to the corporate tax rate reduction.
Amortization of R&D expenditures
Under prior law, taxpayers could elect to deduct the amount of R&D expenditures paid or incurred in connection with the trade or business or choose to forgo the deduction and amortize the expenditures over the useful life of the research, but in no case over a period of less than 60 months. Under the new law, for amounts paid or incurred in taxable years beginning after Dec. 31, 2021, R&D expenditures are required to be capitalized and amortized over 60 months, or if the research is conducted outside of the U.S., 15 years.
Software development versus purchased software
Also beginning in 2022, R&D expenditures will include expenditures for software development. Previously, Rev. Proc. 2000-50 generally permitted taxpayers to treat software development costs as deductible section 174 costs whether or not the cost otherwise met the section 174 requirement as a rule of administrative convenience. The new law terminates this rule and now requires capitalization of the software development costs otherwise eligible for expensing under Rev. Proc. 2000-50.
Companies planning on developing software in the next few years should consider incurring these costs prior to 2022, as it may be more advantageous to deduct those costs in the year incurred versus being subject to the five-year amortization period.
Regardless of the change in the timing of the R&D amortization deduction, qualified research or experimental expenditures will continue to be eligible for R&D tax credits, providing tax savings to companies investing in new or improved products or processes.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.