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Effective for tax years starting in 2022, there is a policy change that will impact how research and development (R&D) is handled for U.S. tax purposes. Rather than being allowed to deduct those costs immediately, companies are now being told that they must spread those costs out over a period of at least five years.
Unsurprisingly, many companies are not thrilled with that change. It has the potential to hurt manufacturers in a number of different ways, all of which are worth exploring.
In a letter that was sent on November 4, 2022, no less than 178 CFOs – primarily those from some of the biggest names in United States manufacturing, like Ford Motor Company, Lockheed Martin, Boeing, and others – outlined why they believe that these aforementioned new rules would lead to what they call a “competitive disadvantage” for American companies. This would likely lead to job losses, harming their ability to innovate over the next decade.
Their point of view was simple: they were asking the current Congress to switch back to a system that allowed them to immediately deduct their costs regarding R&D as soon as the end of the year.
Until January 1, 2022, businesses could deduct 100% of all expenses directly attributed to R&D in the same year they were incurred. This is a major new expense – the tax liabilities of these companies are about to increase exponentially. This makes it more expensive to invest in advancements that will help innovate various sectors like manufacturing and in the growth of these companies.
One company that is particularly worried about the implications of this change is Miltec UV. However, company leadership believes that an exciting new opportunity is within reach. They have spent years developing new technology for lithium-ion batteries – otherwise known as the rechargeable batteries found in countless devices like your smartphones or tablets. This new technology could potentially be used for next-generation electric vehicles.
Miltec UV has poured at least 11 years of development into manufacturing the electrodes used in these batteries. They’ve spent countless amounts of money on prototyping. Various proof of concepts have been developed to indicate that these microbes can do what the company thinks they can. There has been testing. On top of it all, there is the cost of manufacturing the batteries. Officials agree that they are very close to the point where they can commercialize the batteries and begin to sell them, but with these new rule changes, they will have to pay more taxes than they previously thought they would.
For smaller businesses than Miltec UV, how do you know if you will be affected? The first clue is to look at your financial statements or recent tax return – do you have “R&D expenses”? Or have you claimed the R&D credit in the past? If either of these are true, you will likely be affected by the new law.
But you’ll need to do an even deeper dive. That’s because how R&D expenses are defined for credit purposes differs from expenses affected by the new law. The nuances of the differences are beyond the scope of this article, but needless to say that those companies with significant R&D would benefit from an R&D study to ensure that the least amount of costs are categorized as R&D.
Those companies will also need to look at where the development is performed. Believe it or not, the law is even worse for those with international development costs; these are written off over not a five-year period but a fifteen-year period. Either way, the “half-year” convention determines the write-off.
To summarize the write-off of R&D expenses:
Pre-2022: 100% write-off
2023 and forward – domestic R&D: 10% write-off in year one, 20% in years two through four, 10% in year five
2023 and forward – international R&D: 3.33% write-off in year one, 6.66% in years two through fourteen, 3.33% in year fifteen
Many businesses are hopeful that Congress will reverse these rules. But until then, large and small taxpayers need to address their R&D costs and the effect on 2022 tax liabilities. If you have questions about how these changes to the R&D tax policy will affect your business, please contact Cray Kaiser at (630) 953-4900.