Despite lobbying by many Fortune 100 companies and strong bi-partisan support to retain the deductibility of research and development (R&D) costs, 2022 brings an unexpected change for companies in the manufacturing, technology, SaaS, and life sciences industries. Those companies with significant R&D costs, including software development costs, will now be subject to mandatory capitalization, for U.S. tax purposes, as an intangible asset. This can have a significant impact on their 2022 financial statements and cash flows, as they will no longer be allowed to deduct those expenses in the year incurred.
For businesses with multi-national operations, the amortization period is over a five or fifteen-year period, depending on whether the research was conducted in the U.S. or outside the U.S., respectively. This will be treated as an automatic change in accounting method, and will not require a Form 3115. The mandatory capitalization of R&D expenses may also impact other U.S. federal tax computations, including Sec. 163(j) business interest expense limitations, GILTI and foreign tax credits. Another important attribute is that the amortization is not terminated in the case of retirements, abandonment or disposal, but will continue through the full five or fifteen-year period.
Many U.S. tax practitioners had predicted that the mandatory capitalization would be at least postponed, as was initially passed by the House in the Build Better Act (“BBA”) in late 2021. However, the BBA, which included legislation to delay the mandatory capitalization of R&D expenses, has since stalled in the Senate.
Companies now need to start reviewing their Sec. 174 R&D expenses, which includes “all costs incidental to the development or improvement of a product” and consider the impact of mandatory capitalization on their 2022 quarterly provisions and Federal tax estimated payments. There may also be opportunities to amend recent tax returns to capture prior unclaimed R&D tax credits. If you have questions on how this 2022 change affects your business, and to stay updated with any attempted amendments to the law, please contact Namir Hallak at: nhallak@davidson-co.com