R&D Tax Credit / R&D Expenses – Changes in New Tax Bill December 2017

The R&D tax credit was preserved in the final tax bill, known as the Tax Cuts and Jobs Act, thus retaining this important tax credit for businesses to continue to incentivize retaining R&D and tech jobs in the U.S.

The Conference Committee also eliminated the alternative minimum tax (AMT) for corporations such that businesses can still use the R&D credit and are not limited by AMT. This would have been a problem in the House version of the bill, which retained the corporate AMT. With the corporate tax rate at 21% and the AMT rate at 20%, many companies would fall into AMT and would not be able to use the R&D credit. Congress fixed this issue by eliminating the corporate level AMT.

One fund raising measure added (in order to pay for the tax overhaul), effective as of 2022, companies now have to amortize R&D expenditures over a 5 year period, and a 15 year period for foreign R&D costs. This will have a significant impact on current year income as companies cannot deduct R&D costs in the current year (starting for tax years after 12/31/2021). For example, many of the largest companies in the U.S. spend several billion on R&D costs each year and have historically written off these costs in the current year. Income will increase and thus tax liability for companies who now only get to deduct 20% of these costs in the current year and have to amortize these costs over 5 years, or 15 years in the case of foreign R&D expenditures. The tax policy here was likely that the lower corporate tax rate of 21% (and even lower if the company claims the R&D credit), will result still in lower corporate taxes even with eliminating currently deducting R&D costs.

Congress also specified that all costs associated with software development shall be deemed R&D costs. This should eliminate disputes with the IRS on what costs are treated as R&D vs. other costs associated with software development. The IRS will likely issue additional guidance, perhaps amending guidance provided in Rev. Proc. 2000-50 addressing the tax treatment of software costs. Notably, 2000-50 only considered the costs of writing machine readable code as software development costs eligible for 174 treatment. Now under the new tax bill, ‘all costs in connection’ with software development are treated as R&D costs. Historically the big issue with software development was whether a company could expense software development costs vs. amortize such costs. The new tax bill, by explicitly stating that software costs fall within the new amortization rules, means that these costs are also subject to the 5 year/15 year amortization rules effective after 12/31/2021.

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