The Tax Cuts and Jobs Act of 2017 has many provisions designed to help businesses grow. However, there is one provision that could be particularly detrimental to businesses in the technology industry.
Under prior law, technology companies were allowed a choice in how to deal with their designated research and development expenses – such expenses could either be fully expensed in the year incurred or capitalized and amortized over a sixty-month period. For these purposes, research and development expenses are defined as costs incurred in the experimental or laboratory sense; related to the development or improvement of a product.
Historically, technology companies would generally take advantage of the ability to immediately deduct these types of expenditures; thereby allowing them to partially or fully eliminate any taxable income from their business. This ability to avoid taxable income – and income taxes payable to Federal and state governments – was, and is, very important to these businesses – particularly in the start-up phase when every penny of investment is targeted at the development of a new product.
Under the new Tax Cuts and Jobs Act, this ability to currently deduct the costs associated with research and development will eventually be lost. Under the new law, research and development expenditures incurred within the United States will be required to be capitalized and amortized over a sixty-month period. In addition, research expenditures attributable to research activities conducted outside of the United States will be required to be capitalized and amortized over a period of fifteen years. This new rule will have a significant impact on cash-flow planning for start-up companies who may need to start projecting for income tax payments a lot sooner than anticipated – particularly those companies that outsource their R&D functions to foreign jurisdictions, such as India.
Fortunately, Congress has given the technology community a relatively long runway to prepare for the implementation of these new rules. According to the new law, the capitalization requirements only apply to research and experimentation expenditures incurred in taxable years beginning after December 31, 2021. Prior to that effective date, technology companies can continue to currently deduct their R&D costs under the old law. However, business owners should plan accordingly with respect to their product development expenditures to ensure that the highest tax benefit is obtained in future years.