Effective for tax years after December 31, 2021, companies that have research and development expenditures will be required to amortize their R&D costs instead of deducting them in the current year. So, what is the impact – an increased tax bill beginning in 2022.
Many tax industry professionals who have written “Blogs” on this topic think this will discourage companies from spending R&D because it will raise the cost of investment and reduce economic output.
Why Did the Rule Change?
Prior to the TCJA, companies had a choice to deduct R&D expenses in the current year, capitalize the expenditures, and amortize them over five years or elect a 10-year amortization of expenditures.
The Tax Cuts and Jobs Act (TCJA) passed in 2017 resulted in an amendment to Internal Revenue Code Section 174 requiring companies to capitalize and amortize R&D expenditures for tax years after December 31, 2021. The amortization period for domestic R&D expenditures is five years as a result of the change. Companies that pay for research and development conducted outside the US are required to amortize Section 174 expenses over a 15-year period. There is no longer an option to deduct the entire amount of the R&D expenditure in the current year.
So, What Does This Mean?
A company with domestic research and development costs of $500,000 in CY 2022 could previously take a full deduction of $500,000, thereby reducing taxable income. As a result of the change, the company will have to amortize the costs over five years and therefore will only be able to take a deduction of $100,000 in CY 2022 (or one-fifth of the expenditures) resulting in increased taxable income and an increased tax bill.
This new tax law change of amortizing R&D costs vs. full expensing will result in delays in recovering research and development costs, will overstate income, and increase income taxes.
What is the Impact on Government Cost Accounting?
Manufacturing and Technology companies are likely to be the hardest hit, particularly if they have internally developed software. For government cost accounting purposes, contractors will continue to record the expense in the year incurred in accordance with FAR 31.205-18 Independent Research and Development and Bid and Proposal Costs and CAS 420 Accounting for Independent Research and Development Costs. As such, IR&D will be reported as revenue, yet for financial and tax purposes, only one-fifth of the cost will be deductible, thereby increasing federal taxes. As a reminder, federal taxes are an unallowable expense on government contracts under FAR 31.205-41 Taxes.
Takeaways
Contractors should coordinate with their tax experts sooner than later to ensure they are aware of the tax rules for tax years beginning after December 31, 2021. Contractors should perform a reconciliation with the differences between government cost accounting, financial, and tax records to assist in responding to any audit questions.
Redstone Government Consultants are a team of the most senior industry veterans and the brightest new talent in the industry. Many have held senior government positions including leadership roles in the DCAA. Our new talents bring significant accounting and software experience along with fresh perspectives, inspiration and energy to our team. Through our leadership and combined experience, we provide a unique perspective, bringing both government and contractor proficiencies to bear and ensuring rock-solid government compliance for our clients.
Lynne is a Director with Redstone Government Consulting, Inc. providing government contract consulting services to our clients primarily related to Commercial Item Determinations and support, Cost Accounting Standards, DFARS Business System Audits, Proposals, and Incurred Cost. Prior to joining Redstone Government Consulting, Lynne served in several capacities with DCAA and DCMA for over 35 years. Professional Experience Lynne began her career working with DCAA in the Honeywell Resident Office, Clearwater, FL in 1984. Lynne’s experience included various positions which involved conducting or reviewing forward proposals or rate audits, financial capability audits, progress payments, accounting and estimating systems, cost accounting standards, claims and disclosure statement reviews. She is an expert in FAR, DFARS, CAS and testified as an expert witness. Lynne assisted in drafting the commercial item guidance for DCAA Headquarters. Lynne was assigned as a Regional Technical Specialist where she provided guidance to 20 field offices on highly complex or technical issues relative to forward pricing, financial capability or progress payment issues. As an Assistant for Quality, she was involved in reviewing and ensuring audit reports were in compliance with policy and GAGAS as well as made NASBA certified presentations to the staff including but not limited to billing reviews, CAS, unallowable cost and progress payments. To enhance her experience in government contracting, Lynne accepted a position with DCMA in 2015 as part of the newly organized DCMA Cadre of Experts in the Commercial Item Group. This included performing reviews of prime contractor’s assertions and/or commercial item determinations as well as performing price analyses. Lynne was a project lead and later became a lead analyst where she engaged with the buying commands on requests and reviewed price analysis reviews performed by a team of 5 analysts. She also assisted the DCMA CPSR team relative to commercial items and co-instructed the Commercial Item Training presented to DCMA. Education Lynne earned a Bachelor of Science Degree in Accounting from the University of Central Florida. Certifications State of Florida Certified Public Accountant State of Alabama Certified Public Accountant Defense Acquisition Workforce Improvement Act (DAWIA) Level III- Auditing DAWIA Level III – Contracting