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A significant change to the U.S. tax code has altered the way businesses account for research and development (R&D) expenses. This change — mandated under Section 174 of the IRS Code and effective since 2022 — has had a ripple effect across various industries. The added financial strain has hit small businesses and tech companies particularly hard, potentially stifling innovation and putting the U.S. at a competitive disadvantage.
Companies Can No Longer Write Off R&D Expenses
Until recent years, Section 147 of the Internal Revenue Code gave companies two options for handling their R&D expenses: They could either expense them entirely in the year they were incurred, or they could amortize them over a five-year period. This flexibility allowed businesses to manage their tax liabilities and optimize their financial planning.
However, a 2022 tax code revision eliminated the option of expensing R&D expenses in full. Instead, all R&D costs must now be amortized over five years, regardless of the company's financial situation or annual R&D expenditure.
The forced amortization requirement has had several negative consequences for businesses. According to Gergely Orosz of The Pragmatic Engineer, the change in R&D expense treatment caught many companies off guard, resulting in unanticipated tax liabilities that can be substantial. This has forced some businesses to delay or cancel R&D projects, restrict hiring, and even consider layoffs.
The Tax Foundation examined how the tax change affected businesses in 2023. “In dollar terms, manufacturing faces the largest tax increase as a result of R&D amortization, at $31.7 billion in 2023, followed by information at $3.7 billion and professional, scientific, and technical services at $2 billion.” The financial strain caused by forced amortization is now discouraging many companies from investing in R&D.
U.S. Companies at a Disadvantage
The Information Technology and Innovation Foundation warned in a 2020 report that this policy would put the U.S. at a major disadvantage compared to other major economies. Being one of the only countries that doesn’t allow expensing of R&D investments means U.S. businesses may lag behind in development compared to their international counterparts.
As R&D Coalition chair Sharon Heck explained to The Register, “The forced amortization of R&D expenses makes the US an outlier with respect to the treatment of R&D. As a result, we are seeing a negative impact on the ability for businesses — particularly small businesses — to invest in R&D.”
Calls for Change to the R&D Tax Code
In response to the negative impact of the R&D amortization requirement, several bills have been introduced in both the House of Representatives and the Senate to restore the pre-2022 option of expensing or amortizing R&D expenses. These bills have received significant support from tech industry leaders and economists, who argue that returning to a more flexible R&D expense policy is crucial for maintaining the US's position as a global innovation leader.
Opponents of the change to the tax code argue that the inability to write off R&D is stifling innovation in U.S. companies. Since the implementation of the new regulations, “the growth rate of R&D spending has slowed dramatically from 6.6 percent on average over the previous five years to less than one-half of 1 percent,” as written in a Newsweek piece. This slowdown in innovation could potentially impact the US's long-term competitiveness in the global tech landscape.
According to the Wall Street Journal, these tax bills hit small businesses especially hard, because they have less borrowing power to cover unexpected expenses. The same article notes that small businesses are the biggest providers of employment in the U.S., potentially causing a domino effect affecting job creation and hiring.
Conclusion
The forced amortization of R&D expenses could prove to be a significant impediment to innovation, especially for small businesses and the tech industry. Reversing this policy and restoring the flexibility to expense or amortize R&D costs would provide tax relief to businesses, encouraging them to continue investing in innovation. By allowing companies to manage their expenses in a way that aligns with their financial needs and strategic priorities, the U.S. could better support small businesses and drive innovation across multiple industries.
Sources
Information Technology and Innovation Foundation
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