The 2017 Tax Cuts & Jobs Act featured a major change to how companies can write off expenses. The change went into effect in July 2022, but a lot of companies apparently didn’t get the heads up from their accountants and are now scrambling to pay sky-high tax bills.
Previously tech companies could deduct cash outlays like software engineer salaries as research & development (R&D) expenses in the year incurred, under Section 174 of the Internal Revenue Code. Then Congress and President Trump authorized a five-year amortization period for that tax preference to Big Tech, in part to pay for lower tax rates for individuals and corporations.
For foreign companies and tech workers outside the U.S., the R&D write-off period is now 15 years, making it a no-brainer for companies to lay off foreign employees first. In addition, companies must treat software development costs as R&D expenditures.
Fixing the problem is on Congress’ tax writers’ radar
Tech industry watchers expected Congress to defer the new requirement to capitalize R&D expenses, but a deal fell apart at the end of December 2022. Now the chief GOP and Democrat tax writers are rushing to reinstate the full R&D write-off provisions.
A deal between Democrat Senator Ron Wyden of Oregon and Republican Representative Jason Smith of Missouri to give companies tax relief may face an uphill battle in both chambers. To pay for the roughly $80 billion in tax breaks, Wyden and Smith propose to eliminate the controversial and fraud-ridden employee retention credit.
If and until Congress revises the tax code, companies in biotech, software and contract manufacturing will continue to receive tax bills tens to hundreds of thousands of dollars higher than before. Startups and small- to mid-sized organizations coming off down years are laying off software engineers and programmers to pay their taxes. Some will try taking out loans to pay the IRS and others may opt to declare bankruptcy.
Many large companies, such as Amazon and Northrop Grumman, warned about the coming tax bills and urged Congress to revise the law more than a year ago. Many tech entrepreneurs worry the changes to Section 174 will stymie the industry, particularly biotech.
The IRS released guidance on amortization related to tax returns for 2022 and later. Section 174 provides tax relief for labor costs (including full- and part-time employees and contractors), materials and supplies, cost recovery, patent costs, overhead costs and travel expenses.