Allowing companies to deduct costs is not a “special corporate tax break”
In 2022, U.S companies engaging in research and development lost the ability to deduct these expenses and are now forced to amortize costs over five years. This is resulting in one of the largest tax increases on businesses in US history as companies lose the ability to deduct 90% of their deductions for R&D wages, supplies, and contractor expenditures in 2022. While there has been bi-partisan support in congress to repeal this requirement (more on that here, and here), lawmakers have continually failed to get the job done.
Many outlets and observers writing about this issue have also failed to frame the problem correctly. Too often the narrative revolves around phrasing like “restoring R&D tax breaks,” or “reinstating corporate tax breaks for research.” This implies that the ability to deduct R&D expenses is some new carve out or shelter for corporations which, of course, is not true.
Thinking of the ability to deduct an R&D expense as a special “tax break” is incorrect. Deducting a wage or contractor expense is not a special privilege or special treatment that is unique for R&D. Offering the ability to deduct R&D wages is not some corporate shelter or special break designed as a hand out. Companies are allowed to deduct salaries of all employees. Whether they be research scientists, salesmen, receptionists, or night janitors. The new law eliminating the ability to deduct R&D costs is more like a special tax penalty that has been levied upon companies that invest in innovation and problem solving.
The law now gives a better “tax break” for companies that hire low skilled labor compared to companies that hire research scientists. If you are a company looking to tackle a problem, whether it be through the invention of a new green technology or the creation of a new software, you are penalized for hiring the engineers and creating the jobs needed to do so. On the other hand, if you avoid the innovation altogether and hire more salespeople or more customer service reps, you are rewarded with a supposed “tax break” and are allowed to fully deduct those salaries.
No other country in the developed world penalizes R&D investments by requiring firms to amortize the deductions. This new law creates phantom income which increases tax bills. Companies are having to pay these tax bills with cash they never actually earned. Many small businesses will have a hard time coming up with the money to pay these additional taxes and are even taking out loans to do so. This is an unprecedented break in how expenses such as supplies, wages, and materials are treated for tax purposes. Failure to fix this law will make the U.S. the most expensive country in the OECD to perform R&D within. This is not a good look for a government that likes to tout its supposed commitment to innovation, especially when countries like China have recently implemented “super deductions” for R&D costs.
Framing the discussion as “restoring a tax break” is a misnomer. It may lead lawmakers to think that voting to restore R&D expensing amounts to some sort of special corporate tax give away. Nothing could be further from the truth. The only thing that is special here is the way innovative companies are being penalized for employing high-skilled R&D personnel compared to their peers in the US and abroad.
Andrew Parrish, EA, MBA
Andrew is a partner at Alternate Tax Solutions and manages the R&D Tax Credit division, advising taxpayers on Section 41 R&D Tax Credits and the new Section 174 amortization rules.