Major changes to the U.S. tax code, first introduced in the 2017 Tax Cuts and Jobs Act (TCJA), are now coming into force. Startups and software companies are feeling the impact of these new regulations.
One of the most significant changes for founders is the new capitalization and amortization rules under IRC Section 174 (S174). These rules now limit deductions for all research and experimental (R&E) expenses incurred in the 2022 calendar year.
Many in the private sector had hoped, lobbied, and advocated for lawmakers to delay or stop the new S174 requirements from taking effect as of December 31, 2021. However, a turbulent political climate and multiple election cycles stalled any progress for those opposed to the TCJA.
A bipartisan bill—the American Innovation and Jobs Act (AIJA)—was reintroduced on March 16 by Senators Maggie Hassan (D-NH) and Todd Young (R-IN). This bill aims to reverse the S174 changes and expand R&D tax incentives, with a focus on innovative startups and small businesses.
Restoring R&E deductions and expanding R&D tax credit eligibility
When the AIJA was first proposed in 2020, it included provisions to double the credit limit for startups using the payroll tax offset (from $250,000 to $500,000, with a goal of $750,000 over ten years). It also raised the eligibility threshold for companies that can use social security tax credits from $5 million to $15 million in gross receipts.
However, the most urgent part of the AIJA—then and now—has been reversing the S174 changes. Restoring this key R&E tax deduction is crucial, as it has supported innovation and private sector competitiveness for nearly 70 years.
The lack of action to reverse the S174 changes has caused frustration across industries. The National Association of Manufacturers estimates that their sector alone could lose over 60,000 jobs and see output drop by more than $31 billion for the 2022 tax year. As a result, the U.S. is now one of only two developed countries that require amortization of R&D expenses (the other being Belgium).
What’s even more concerning is that China now offers a 200 percent 'super deduction' for R&D to its manufacturers—20 times what’s currently available to U.S. businesses. This has been a major concern for Republican lawmakers working on the bipartisan bill, as Senator Young has emphasized in his latest push for the AIJA.
“Supporting research and development here in the United States is essential for creating high-quality jobs and keeping our country competitive with global rivals, especially China,” Senator Young said in his official statement. “If we want to outcompete and out-innovate the Chinese Communist Party, we need to pass this legislation as soon as possible.”
“When American companies invest in research and development to create new products and technologies, it drives our economy, creates jobs, and helps us compete globally,” Senator Hassan said in a statement to the press. “Our bipartisan bill will help more startups and businesses invest in R&D, and ensure they can fully deduct research and development expenses each year. I urge my colleagues on both sides of the aisle to support this bill and help drive innovation.”
While the reintroduction of the AIJA is the best opportunity for startups to avoid much higher tax bills this year and beyond, businesses can still benefit from existing R&D tax credits to help reduce their new tax burden.
To learn how your team can develop an R&D Capital Strategy that accounts for the new Section 174 requirements, existing R&D tax credits, and how to plan for the year ahead, join our weekly #InnovatorsLive event on LinkedIn every Friday at 12pm ET/9am PT.
