Manufacturers across the country noticed a steep increase in their tax bill in 2022 due to one primary factor; Section 174 Capitalization. Beginning in 2022, taxpayers were required to capitalize their Research and Development (R&D) costs as defined under Section 174 and amortize those costs (5-year amortization for domestic R&D and 15-year amortization for international R&D). This was a big change compared to historical treatment that allowed for immediate deductibility of development cost, so much so that the new requirement has presented substantial challenges to innovative companies whose goals are to push domestic growth. So how are companies able to navigate the new rules and remain competitive?
Timing
The new Section 174 rules themselves present a timing difference. The year two impact will be approximately a 70% add-back of domestic R&D cost to taxable income, and year three will be even less at 50%. By year six, the impact of the Section 174 add-back will be largely neutral to taxpayers (without considering R&D tax credits).
R&D Tax Credits
One of the best ways to mitigate the impact of Section 174 is through R&D credits. Many costs considered in Section 174 are also eligible for the R&D tax credit. When factoring in Federal and State tax credits, this credit can often exceed 10% of the total R&D spend.
Renewable Energy Credits for Corporate Taxpayers
The Inflation Reduction Act of 2022 created an opportunity to allow certain tax credits to be transferable. In particular, there is an opportunity for corporate taxpayers to acquire certain Renewable Energy credits, often for less than the value of the credit itself. While opportunities in this area are limited in 2023, there will be more availability to acquire these credits for corporate taxpayers with significant tax liabilities in 2024 and beyond.
GBQ is here to help companies navigate an ever-changing tax landscape. Please contact Jeff Waldeck jwaldeck@gbq.com with any questions on how we can help.
