Companies in many different industries incur research and experimentation expenses. Whether they are developing new software, testing new formulas, or creating a new product line, they look to their CPAs and trusted advisors to guide them on the treatment of R&E expenses.
Currently, there are two allowable methods for the treatment of R&E expenses, one of which is to capitalize and amortize the expenses over the useful life of the research as long as it is between five and ten years. The reasoning behind this method is to take the deductions over time to offset the income being produced by the research.
The second method is to immediately expense the R&E expenses in the year in which they are paid or incurred. The purpose of this method is to take the losses when the cash is spent and, in the case of a C corporation, carry forward any net operating losses to the year in which income exceeds expenses. In the case of a pass-through entity, such as a partnership or S corporation, the losses generated may be able to offset the partner or shareholder’s other income.
With the passage of the Tax Cuts and Jobs Act on December 22, 2017, there are new rules for the treatment of R&E expenses. For amounts paid or incurred for specified research and experimentation in tax years beginning after December 31, 2021, the expenses must be capitalized and amortized over a five-year period. If the research and experimentation is conducted outside of the United States, they must be amortized over 15 years. Specified R&E expenses include all costs incurred in connection with the research and experimentation. They do not include land, depreciable property or depletable property; however, they do include the depreciation or depletion allowances from that property. Exploration expenses for ore or other minerals are also excluded.
The Tax Cuts and Jobs Act did not change the rules for calculating the research and development credit. However, it did change the calculation of the Orphan Drug Credit. Learn more about the R&D Credit and how it can be applied to your business.
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