Tax Day has come and gone this year, and there were still no changes to the controversial Section 174 amortization and capitalization rule, which essentially prevented many startups from claiming any R&D expenses they incurred in 2022.
As a result, innovative startups across the United States are now facing much higher tax bills this year, forcing many to look for new sources of non-dilutive capital to recover expenses that, until now, were typically covered by the federal government.
There’s still hope, though, for businesses affected by Section 174 this year—they may be able to recover some of these credits for 2022 and beyond. While previous bills have already been introduced (and reintroduced) in the Senate, bipartisan lawmakers in the House of Representatives are following suit—and are already working with union and private sector groups to build support—as they draft their own version of the bill focused on 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 proposed in 2021 by Reps. John Larson (D-CT) and Ron Estes (R-KS). The updated bill would roll back parts of the 2017 Tax Cuts and Jobs Act (TCJA) and specifically encourage more federal investment in R&D.
Connecting Section 174 repeal to job creation
In the short term, the American Innovation and R&D Competitiveness Act is designed to help businesses that are feeling the impact of the Section 174 capitalization and amortization rules right now. This includes eliminating the requirement to amortize R&D expenses over five years starting in 2022.
The bill’s language also references broader, recent initiatives like the Inflation Reduction Act (IRA) and CHIPS Act, both passed in the past year to boost United States competitiveness in emerging cleantech sectors and strengthen domestic manufacturing.
“Research and development are essential for creating good-paying jobs across the country, especially as we rebuild our economy after the pandemic,” Rep. Larson said in a statement promoting the bill. “Rep. Estes and I came together on this legislation to make sure the R&D tax deduction does what it’s supposed to do: support American businesses and workers as they develop the technologies of tomorrow.”
“More R&D here at home means more jobs now and in the future,” Estes added. “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 many colleagues on both sides of the aisle who want to see this bill passed.”
Where the U.S. is falling behind, China is stepping up
The Section 174 amendment was included in the TCJA to offset major tax deductions elsewhere in the bill—mainly, a 21 percent cut to the corporate tax rate and a 20 percent deduction for certain unincorporated businesses.
While this was a welcome tax break for established corporations and some wealthy individuals, the law fundamentally changed how the country supports startups—and innovation as a whole.
For example, the United States now offers only about one-third of the R&D tax incentives that China does. In fact, China now lets some companies deduct 75-100 percent of their R&D costs through a new “super deduction” as it strengthens its base of small and medium-sized tech companies.
Studies show Section 174 should be repealed now
Beyond watching what other countries are doing, the United States government would do well to follow the advice of domestic analyst groups, who have found clear, positive results from reversing the Section 174 amortization and capitalization rules.
For example, a 2021 estimate from the Tax Foundation found that restoring immediate deductibility would boost U.S. GDP by about 0.1 percent, raise wages by nearly 0.1 percent, and create around 19,500 jobs.
Along the same lines, a 2022 estimate from the Tax Foundation found that the manufacturing sector’s total tax liability would exceed $31 billion in 2023 because of Section 174.
While partisan disagreements—like the expanded Child Care tax credit included in the Senate bill, which is regularly challenged by Republicans—could slow down efforts to repeal Section 174, there are still ways for startups in the United States to optimize their R&D and streamline their tax filings to maximize their claims.
To learn more about how your team can build an R&D Capital Strategy that takes into account the new Section 174 requirements, R&D tax credits in general, and how to plan for the year ahead, schedule a call with our team today.
