The Tax Cuts and Jobs Act of 2017 made changes effective in 2022 for the R&D deduction under Section 174 as well as the interaction between that deduction and the R&D credit under Section 41, as provided in Section 280C. Although the changes generally reduce the deduction in the first year by requiring capitalization and amortization over 5 years, they also reduce certain limits on the Section 41 credit.

For years prior to 2022, Section 174 provided a deduction for qualifying R&D expenses. Section 41 provided a credit based on qualifying R&D expenses. However, because both the deduction and the credit arise from the same activities, Section 280C(c) provides a limit on either the credit or the deduction so taxpayers are not double dipping tax benefits from the same R&D expenses.

Beginning in 2022, however, Section 174 has been modified to require capitalization and amortization of qualifying R&D expenses, typically over 5 years. Section 41 continues to provide an R&D credit but has been modified slightly to be consistent with new Section 174. Section 280C(c) was modified to provide a new, less stringent limit. Under the new limit, the Section 174 amortization deduction is not reduced unless the credit amount exceeds the current year amortization deduction. If the credit exceeds the amortization deduction, the deduction is reduced by the excess. That is a significant change because in many years the limit may not apply to either the deduction or the credit.

Although the changes described herein may increase tax liability in the first year, the less stringent limit may result in additional deductions for R&D expenses, albeit over a longer period.

John G. Hodnette is an attorney with Fox Rothschild in Charlotte.

September 21, 2023/by TAX