New Bill Pending in Congress Could Improve the R&D Credit and Make Other Tax Code Changes

Businesses are able to take advantage of numerous tax credits that incentivize certain activities. The research and development (R&D) credit, for example, allows companies to claim a tax credit for expenses related to improving existing products or services or developing new ones. The Tax Cuts and Jobs Act of 2017, however, interferes with this credit by requiring taxpayers to capitalize certain R&D costs. HR 3938 is a new bill pending in Congress, also known as the Build It in America Act (BIAA). It would amend the Internal Revenue Code (IRC) to delay the impact of the capitalization rule. The bill would extend two other important tax deductions, The Business Interest Deductions and 100% Bonus Depreciation, and modify the Clean Vehicle Credit. It would also, however, repeal several tax credits related to clean energy. While the future of this bill is uncertain, it’s helpful to note what tax law changes are being proposed by members of congress. Read on to learn more about the potential impact of the BIAA.

Improvements to the R&D Credit and Deductions
Title I of the BIAA, entitled “Investment in America,” modifies the rules for deducting R&D expenses. This could allow more businesses to take advantage of the R&D credit.

What Is the R&D Credit?
Section 41 of the IRC allows taxpayers to claim a credit equal to a portion of their expenses related to both in-house and contract research expenses. This may include wages paid to employees, fees paid to contractors, supply costs and expenses related to the use of computer equipment.

How Does the § 174 Capitalization Rule Affect the R&D Credit?
Beginning with the tax year 2022, Section 174 of the IRC bars certain taxpayers from claiming a deduction for certain research expenses during the year in which they incur them. Instead, they must capitalize and then amortize those expenses for a five-year period. The amortization period is 15 years for foreign research costs.

The § 174 capitalization rule applies to corporations and most other types of business entities. It can interfere with their ability to claim the R&D credit.

How Would the BIAA Affect Businesses’ R&D Activities?
The BIAA, as currently drafted, would delay the implementation of the § 174 capitalization rule until January 1, 2026. It would add a new section to the IRC, § 174A, that temporarily allows deductions of research expenses as they are incurred. This could facilitate the use of the R&D credit.

Our Recommendation:
Section 174 relief is unlikely to happen before the September 15, 2023 extended business tax filing deadline; therefore, we recommend clients capitalize their R&D expenses and go ahead and file their 2022 tax returns to comply with current law. We will keep you updated if and when relief comes.

Other Tax Deduction Extensions
Title I of the BIAA would also extend two other deductions, The business interest and 100% bonus depreciation deductions.

Limitations On The Business Interest Deduction
The IRC limits the amount of interest that businesses may deduct in a single tax year to a percentage of their “adjusted taxable income” (ATI). Beginning in 2022, businesses include allowances for depreciation, amortization, and depletion when calculating ATI, which results in a lower interest deduction. The BIAA would allow those deductions to be added back through January 1, 2026.

Extension of the 100% Bonus Depreciation Rule
Section 168(k) of the IRC allows taxpayers to take deductions of large percentages of the cost of certain property as depreciation expenses during the year they acquired the property. The BIAA would allow a 100% deduction through 2026 or, for certain items, 2027. Under current law, the percentage drops from 100% to 80% for 2023, and continues to drop until it’s eliminated starting in 2027.

Repeal or Modification of Certain Tax Credits
Title III of the BIAA, entitled “Repeal of Special Interest Tax Provisions,” would modify one tax credit program and eliminate several others.

Modifications to the Clean Vehicle Credit
The BIAA would not change the amount of the Clean Vehicle Credit found in § 30D of the IRC. It would, however, make numerous changes to the eligibility criteria, such as the following:

• It removes the requirement that a vehicle’s “final assembly…occurs within North America.”
• It removes the requirement that a vehicle come from a “qualifying manufacturer” and substitutes the term “manufacturer,” as defined by the EPA under Title II of the Clean Air Act.
•  It reduces the minimum battery capacity requirement from seven kilowatt-hours to four.
•  It establishes new critical minerals requirements.
• It repeals the credit for two- or three-wheeled plug-in electric vehicles.

Repeal of Other Tax Credits
Title III would repeal four tax credit programs altogether. All four of the credits were created by the Inflation Reduction Act (IRA) of 2022:

• The Clean Electricity Production Credit, § 45Y of the IRC
• The Clean Electricity Investment Credit, § 48E of the IRC
• The Previously-Owned Clean Vehicle Credit, § 25E of the IRC
• The Qualified Commercial Clean Vehicle Credit, § 45W of the IRC

Find Out More
Business tax credits can be complicated, and the landscape is often changing as Congress and the IRS modify laws and regulations. A knowledgeable and skilled tax professional can help your business identify the best available tax strategy.

If you have any questions or would like additional information, please contact DMJPS.