Tax Day came and went this year without any changes to the controversial Section 174 amortization and capitalization rule, which essentially blocked many startups from claiming any R&D expenses incurred during 2022.
As a result, innovative startups across the United States are facing a much higher tax bill this year, forcing many to explore alternative avenues of non-dilutive capital to recoup expenses that historically were covered by the federal government.
There’s still hope, however, that businesses who were impacted by the Section 174 measures this year may be able to recover some of these credits for 2022 and going forward. While previous legislation has already been pitched (and re-pitched) in the Senate, bipartisan counterparts in the House of Representatives are following that lead—and already engaging with union and private sector groups for support—in drafting their own version of the bill aimed squarely at R&D.
The bipartisan American Innovation and R&D Competitiveness Act was reintroduced in the House on April 18—aka Tax Day 2023—after first being floated in 2021 by Reps. John Larson (D-CT) and Ron Estes (R-KS). The revised legislation would repeal tenets of the 2017 Tax Cuts and Jobs Act (TCJA) and specifically promote more federal investment in R&D.
Tying Section 174 repeal to job growth
In the short term, the American Innovation and R&D Competitiveness Act is designed to offer support for businesses that are feeling the brunt of the Section 174 capitalization and amortization rules today. This includes repealing the required amortization of R&D expensing over five years beginning in 2022.
The language of the bill also alludes to broader, recent initiatives like the Inflation Reduction Act (IRA) and CHIPS Act, which were both passed in the past year as measures to boost the US’s competitiveness in emerging cleantech industries while boosting the country’s manufacturing prowess.
“Research and development play an integral role in creating good-paying jobs across the country, especially as we rebuild our economy from the impacts of the pandemic,” Rep. Larson stated in a release promoting the bill. “Rep. Estes and I joined together on this legislation to ensure the R&D tax deduction does what it was designed to do: support American businesses and workers as they develop technologies of the future.”
“More R&D here at home means more jobs now and in the future,” Estes adds. “Rep. Larson and I know that businesses and manufacturers in our districts and across the country need immediate R&D expensing, and we’re joined by a number of our colleagues on both sides of the aisle that want to see this bill passed.”
Where US is lagging, China picks up the slack
The Section 174 amendment was baked into the TCJA to offset significant tax deductions offered elsewhere in the bill—primarily, a 21 percent reduction in the corporate rate and a 20 percent deduction for certain unincorporated businesses.
While this was a welcome tax break for established corporations and certain wealthy individuals, the legislation fundamentally changed the country’s posture toward supporting startups—and innovation broadly.
For instance, the United States now has the dubious distinction of offering almost one third of the R&D tax incentives that China offers. To that end, China now allows some companies to deduct 75-100 percent of their R&D costs through a recently introduced “super deduction” as the nation shores up its base of small- and medium-sized technology enterprises.
Studies support repealing Section 174 immediately
Beyond watching the moves of other nations, the government would be wise to follow the guidance of analyst groups stateside, who have calculated positive, material outcomes from reversing the Section 174 amortization and capitalization rules.
In a 2021 estimate from the Tax Foundation, for instance, restoring immediate deductibility would increase U.S. GDP by about 0.1 percent, increase wages by almost 0.1 percent and create approximately 19,500 jobs.
To that end, a 2022 estimate from the Tax Foundation found that the manufacturing industry’s collective tax liability would exceed $31 billion in 2023 as a result of Section 174.
While there are partisan details in the mix that threaten to hinder the adoption of any measure to repeal Section 174—namely, a expanded Child Care tax credit that has been included within the Senate Bill but regularly contested by Republicans—there are still ways for startups in the United States to optimize their R&D and streamline their tax filing to maximize their claims.
To learn more about how teams can build an R&D Capital Strategy that bears in mind the new requirements around Section 174, R&D tax credits in general, and how to plan for the year ahead, schedule a call with our team today.
