Section 174 allowed taxpayers to currently deduct ‘research or experimental’ (R&E) expenditures. Taxpayers alternatively could elect to treat R&E as deferred expenses that are deducted ratably over at least 60 months or as capital expenditures that are amortizable over a useful life, if determinable. Taxpayers choosing to deduct R&E expenditures also could annually elect under Section 59(e) to recover the costs over a 10-year period.
The 2017 tax reform act amended Section 174, effective for amounts paid or incurred in tax years beginning after December 31, 2021, to eliminate these options and require taxpayers to charge their R&E expenditures and software development costs (collectively, R&E expenditures) to a capital account. Capitalized costs are required to be amortized over five years (15 years for expenditures attributable to foreign research). Because taxpayers may claim the Section 41 R&E credit only for costs that are eligible to be treated as R&E expenditures under Section 174, it is expected that any amounts treated as qualified research expenditures for purposes of the R&E credit also will be capitalized under amended Section 174.
Legislation is currently under consideration in the Senate that would reinstate on a temporary basis the previous Section 174 treatment of R&E expenditures. The House-passed ‘Build Back Better’ reconciliation bill would defer for four years the effective date of the 2017 capitalization and amortization requirement. If enacted, taxpayers with R&E expenses paid or incurred in tax years beginning before 2026 would continue to have the earlier options.
A change to the Section 163(j) interest deduction limitation also has gone into effect in 2022. For tax years beginning after 2021, taxable income no longer is adjusted for depreciation, amortization, and depletion in arriving at adjusted taxable income (ATI), resulting in lower ATI and potentially a greater interest disallowance. The House-passed Build Back Better bill does not propose to delay or eliminate this change to the computation of ATI.