R&D Tax Credit Amortization: Maximize Your Tax Savings

Research and development tax credits are useful tools for businesses investing in innovation long term, providing financial incentives for companies that engage in activities that are aimed at developing new products or processes that help their respective field in the long term. On top of reducing your overall tax liability, the financial boost that you get can encourage further innovation and growth over time, allowing your company to gain more notoriety.

In this article, we will take a closer look at the essential aspects of research tax credit amortization, what you should know, and what amortization actually is.

What is R&D Tax Credits Amortization?

Amortization of research and development tax credits is the process of spreading out the benefits of these credits over multiple years. This practice is often used in accounting and can provide several financial benefits for businesses.

The purpose of this practice is to improve the financial gain and economic growth that the tax credits have. By spreading out the credit over this period, usually over a span of five years, businesses can smooth their taxable income, leading to much more predictable financial outcomes.

The benefits of research and development tax credits include improved cash flow, ongoing financial support, and assistance in long-term tax strategy. This can be very beneficial for businesses that are looking to increase their financial performance long term.

When looking at amortization, rather than immediate expensing, amortization allows businesses to claim the entirety of the research tax credit against their overall tax liability in the year that they are incurred.

Spreading recognition over multiple years will assist in your financial planning by creating a more predictable experience. By amortizing your credits, businesses can plan their finances and support innovation efforts.

How was R&D Tax Credits Treated Previously?

Section 174, passed in 1954, was the beginning of specific tax provisions for research and development expenses. Section 174 allowed businesses to deduct the expenses they incurred or to amortize these expenses over a period of 60 months or more.

Now, we have a more modern research tax credit system, created in 1981 and made permanent by the Protecting Americans from Tax Hikes (PATH) Act in 2015.

Before 2022, businesses had the option to immediately expense their research and development costs, taking the full deduction in the year that the expenses were actually incurred. This provided the benefit of being upfront, which would lower tax burdens in the short term for the business claiming it.

The Tax Cuts and Jobs Act of 2017 changed this, requiring businesses to amortize their research expenses over five years, aiming to standardize the treatment of these costs and align them with better long-term accounting principles.

Changes Introduced by the Tax Cuts and Jobs Act (TCJA)

One of the biggest changes initiated by the Tax Cuts and Jobs Act of 2017 was the amortization requirement, taking away the immediate tax benefits that businesses were able to claim. The amortization period actually depends on whether you’re performing domestic or international research.

The application of the mid-year convention is another big change that was introduced by the TCJA, as businesses are required to treat expenses that are for research and development as if they were incurred at the midpoint of the taxable year. This means that for the first year, only half of the original amortization amount can be deducted, with the remaining half being distributed over the following years.

These changes introduced by the Tax Cuts and Jobs Act began after December 31st of 2021, which means that the new amortization rule would be applicable for these research and development expenses from January 1st, 2022 onwards.

CHIPS and Science Act of 2022

The CHIPS and Science Act of 2022 introduced an update to this by deferring the requirement placed by the Tax Cuts and Jobs Act of 2017. This means that the mandatory amortization of research and development expenses, initially set for that Dec 31st start date, has actually been deterred for four years.

This changes the effective date to December 31st 2025, meaning that businesses have additional time to adjust their planning and strategies to plan for the upcoming changes.

Impact of Section 174 Changes on R&D Tax Credits

The requirement to amortize research and development expenses can potentially increase business tax liabilities in the short term. This is because businesses can no longer take immediate deductions, and their taxable income might be higher, leading to increased tax payments.

The IRS has provided a lot of guidance on implementing these changes through various notices, such as Notice 2023-63 and Notice 2024-12. These offer detailed explanations on how businesses should approach the new amortization requirements under the new section, as it’s important for ensuring compliance and understanding the nuance of the new guidelines.

4 Advantages of R&D Tax Credit Amortization

While the advantage of instantly being able to claim your research expenses is gone, amortization offers plenty of benefits in the long run for businesses. By spreading these expenses over the years, businesses can get four key benefits:

1. Improved Cash Flow Management

One of the primary benefits of research and development tax credit amortization is improved cash flow management through the years. This is because the financial strain of larger tax reductions ar one time can eat into the profitability and cash flow of businesses. This approach allows for predictability so that you can plan accordingly.

2. Enhanced Long-Term Tax Planning

Amortizing research and development expenses also allows for long-term tax credits. By better forecasting future tax obligations, businesses can make more informed strategic decisions and maximize the amount of return they get in subsequent years.

3. GAAP Alignment

Aligning with generally accepted accounting principles is an important part of this amortization requirement. Proper accounting and reporting of these benefits make compliance more likely over longer periods while supporting investor confidence and transparency.

4. Potential to Generate Deferred Tax Assets (DTAs)

The potential to accumulate deferred tax assets is a benefit of amortizing research and development expenses over time, as they offset future tax liabilities. By creating these DTAs, companies can use their investments in research to further reduce their tax burden for the following years.

How to Calculate R&D Tax Credit Amortization?

Calculating research and development tax credit amortization involves several steps to ensure accurate allocation and compliance with tax regulations.

The first step is to determine the appropriate amortization period that you should use for your research expenses. According to the TCJA 2017, businesses must amortize domestic expenses over 5 years, while foreign research expenses must be amortized over 15 years.

Once this is determined, the next step is to allocate the tax credit across that period, which is found by dividing the credit evenly over the amortization period.

It’s important to account for any changes in qualified research expenses or credit amounts in subsequent years. This is because you would have to adjust your amortization schedule for your own strategic interests and to ensure your financial records remain accurate.

The mid-year convention is the application method for amortization, under this convention, businesses apply a 10% deduction in year 1, 20% in years 2 through 5, and 10% on year 6. This approach is the most even over the specified amortization period, which provides balance to the tax credit.

It’s important to address changes if a research and development project is abandoned or if asset dispositions have begun. The remaining unamortized expenses should be written off in the year the project was abandoned.

Amortize R&D Tax Credits with Professional Help

Looking through the complexities of research and development tax credits can be a challenging thing, especially for people without a lot of experience in claiming these tax benefits. Our expert CPA consultants can provide you with the guidance that you need to get the most out of your tax credits while still getting the most out of your benefit programs.

Stop navigating these complex systems alone, hire a CPA at TaxCredits.com and secure the financial benefits that your business deserves.

FAQs

Can R&D costs be amortized?

Yes! R&D Costs can be amortized by spreading out the expenses associated with research and development over a specified period instead of deducting them in the year that you incurred them.

What is the amortization period for Section 174?

The amortization period for expenses for domestic research is five years, and the period for expenses for foreign research is fifteen years.

How long can R&D tax credit be carried forward?

This depends on whether you’re going into state tax credits or solely federal tax credits. For the federal, it can generally be carried forward for up to 20 years.

What are the new R&D amortization rules?

The new amortization rules mandate changes to how businesses handle the amortization of research and development expenses, requiring mandatory amortization, mid-year conventions, and effective dates.

How does R&D amortization work?

Research and development amortization refers to the process of spreading out your deduction of research and development expenses against your overall tax liability. This is different than the original method, which would require a deduction in the year the expenses were incurred.

How many years back can you claim R&D tax credits?

For the federal R&D tax credits, you can claim research and development tax credits three years back from the date you file an amended return, though this has changed throughout the years. For state credits, it depends on where you’re located.

What is the 25/25 rule for R&D credit?

The 25/25 rule for the research and development tax credit limits the amount of credit a business can use to offset the overall liability. The research and development tax credit can offset up to 25% of the taxpayer’s net regular tax liability above 25,000. For any over than limit, it can be used to reduce the excess amount by 25%.