The Tax Cuts and Jobs Act (TCJA) introduced a delayed but impactful change to the treatment of research and experimentation (R&E) expenses under Internal Revenue Code (IRC) Section 174. Since its implementation in 2022, this change has created financial challenges for many manufacturers, particularly small and medium-sized businesses.
Let’s explore how the new tax rules work, their implications, and potential strategies to reduce the burden on your bottom line.
Understanding the New Rules
Before 2022, businesses could deduct R&E expenses in the year they were incurred or amortize them over at least five years. Software development costs had even more flexible options, including immediate expensing or shorter amortization periods.
Under the updated rules:
- Specified R&E costs must be amortized over five years for domestic expenses or 15 years for foreign expenses.
- Software development costs are now classified under Section 174 and are subject to the same treatment.
These changes have significantly increased tax liabilities, even causing some manufacturers to face taxable income during loss years. This shift has strained cash flow, leading to layoffs or the need for external financing.
The U.S. policy contrasts sharply with countries like China, which incentivize R&E through generous deductions, such as 200% of eligible expenses. This disparity risks discouraging innovation within the United States.
Strategies to Minimize Impact
While the new rules present challenges, manufacturers can explore several strategies to mitigate the financial strain:
1. Claim the Research Tax Credit
Many manufacturers overlook the R&D credit, assuming they don’t qualify. However, if your business develops new products, processes, or techniques, you might be eligible.
- The credit generally equals 20% of qualified research expenses exceeding a base amount.
- Eligible expenses include wages, supplies, and certain contract research costs.
- Consider retroactively claiming the credit if past activities qualify.
2. Leverage Accelerated Depreciation
A cost segregation study could help identify assets eligible for shorter depreciation periods, potentially allowing for substantial tax savings through bonus depreciation or adjustments to prior years’ claims.
3. Reevaluate R&E Expenses
Review your R&E expenditures to determine if any qualify as ordinary business expenses under Section 162, which can be deducted immediately.
Looking Ahead
Legislative changes may be on the horizon. Earlier this year, the House of Representatives passed a bill to temporarily reinstate immediate expensing for R&E costs. However, the measure stalled in the Senate. A more comprehensive tax overhaul is expected in 2025, as many TCJA provisions are set to expire. Until then, manufacturers should remain proactive in addressing these challenges.
©2026