Tax Code 101: Understanding Section 174 and the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) brought about significant changes to the U.S. tax code, affecting businesses across various industries. Among the key provisions that impact research and development (R&D) activities is Section 174, which deals with the amortization of certain expenses related to intangible assets. Understanding Section 174 is crucial for businesses aiming to optimize their tax positions, especially when it comes to claiming the federal R&D tax credit.
Defining Section 174
Section 174 in the federal tax code tells us which portion of R&D costs incurred during a tax year can be deducted in the tax return for that year. These expenditures are incurred in connection with the taxpayer’s trade or business, which represents R&D costs in the experimental or laboratory sense. This includes costs related to the development or improvement of a product or process.
Broader than the costs under the original Section 41, Section 174 spend includes research after commercial production, costs of obtaining a patent, reverse engineering, research conducted outside of the U.S., and other costs that were not previously considered qualified R&D expenses. Spend that is eligible for the federal R&D tax credit is a subset of Section 174 costs.
How does this impact your business?
There has been a lot of confusion surrounding the changes brought about by the TCJA and whether or not they impact the federal R&D tax credit. Starting in 2022, taxpayers are required to amortize R&D spend over five years. Businesses can deduct only 10% of their spend in the first year for income tax, and the remaining 90% is deducted in subsequent years. Lower deductions generally result in a higher taxable income. While many may think these changes make the federal R&D tax credit not worth the time and effort, in reality, the potential increase in taxable income actually makes tax credits, like the federal R&D tax credit, more valuable!
It is important to note that the calculation of the federal R&D tax credit and how it is applied to a business’s tax obligation has not changed. Furthermore, businesses are required to amortize R&D costs regardless of whether or not they even claim the federal R&D tax credit.
To summarize, while the TCJA brought about some changes to the U.S. tax code, it does not lower the value of the federal R&D tax credit or impact how the tax credit is calculated or applied. The federal R&D tax credit remains an incredibly valuable opportunity for businesses of all sizes to be rewarded for their innovative efforts. TriNet Clarus R+D offers a dedicated team of tax experts and a platform solution that helps businesses to efficiently claim R&D tax credits. TriNet Clarus R+D has unique insight into federal R&D tax credits for businesses. To learn more or schedule a demo, connect with our tax experts today.
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