Senate Shuts Down Research or Experimental Expenditures Tax Fix in Major Blow to Manufacturers

The Tax Relief for American Families and Workers Act of 2024 (H.R. 7024) was touted as a bipartisan tax bill aimed at helping American families and businesses in the United States. First announced by the House Ways and Means Committee on January 16, 2024, the bill quickly gained momentum. Just three days later, it passed through the Committee with a decisive 40 to 3 vote. Then, on January 31, 2024, the House overwhelmingly supported the bill, passing it with a wide margin vote of 357 to 70.

However, after months of delays and political negotiations, the Senate rejected the bill in August 2024 with a 48 to 44 vote. This outcome dealt a significant blow to the manufacturing sector, which had been one of the primary beneficiaries of the proposed tax relief.

The Tax Problem for Manufacturers

The Tax Cuts and Jobs Act (TCJA), signed into law on December 22, 2017, introduced significant changes to corporate and individual tax laws. Among these changes was a delayed provision, effective for tax years beginning after December 31, 2021, where businesses are required to capitalize and amortize their research or experimental costs, commonly referred to as research and development (R&D) expenses, as opposed to being able to deduct these costs directly as in previous tax years.

Effective for 2022 and future tax years, businesses no longer have the option to deduct R&D expenditures in the year incurred. Rather, Section 174 of the Internal Revenue Code mandates all businesses to capitalize and amortize these costs. The revised Section 174 rules require businesses to recover the capitalized expenditures over a five-year period, beginning in the taxable year the expenditures are paid or incurred. If the expenditures are attributable to foreign research, the five-year recovery period is extended to a fifteen-year period for the foreign research costs.

To put this problem into perspective, consider a manufacturer with a net income (before applying Section 174 rules) of $500,000 for 2023. Included in this net income was $1,000,000 in R&D expenditures. As a result, rather than paying tax on a net income of $500,000, the company would instead pay tax on a net income of $1,400,000, as follows:

Net Income (before Section 174)                        $500,000

Add: Section 174 Expenditures                        $1,000,000

Less: Section 174 Amortization (5 years)        ($100,000)

Taxable Income                                                 $1,400,000

Looking Forward for a Solution

It is without question that manufacturers are facing a larger tax burden, with many arguing that the Section 174 rules harm American businesses by disincentivizing innovation and R&D activities due to the additional tax burden. While the tax increases under Section 174 are considered “temporary” in nature, as the capitalized costs will eventually be recovered over the amortization period, manufacturers will feel pressure through added strain in cash flow. This is especially challenging in times of high inflation and rising costs.

Senate leaders have indicated that the bill may be brought to the Senate floor for a revote. Alternatively, others believe the issue will only be resolved through future negotiations and a likely new or revised tax bill after the election.

Until Congress reaches a consensus and passes a solution, manufacturers will continue to be subject to additional tax. However, with proper tax planning, the impacts of Section 174 can be minimized. We encourage you to work with a Dannible & McKee tax specialist to ensure your company is properly applying Section 174 rules while maximizing the available credits for the related R&D activities.

Contributing author: Brian J. Potter, CPA, CDA, is a tax partner at Dannible & McKee, LLP. Brian has over 18 years of experience providing tax and consulting services to a wide range of clients. He is responsible for overseeing tax engagements for a variety of the firm’s clientele with a focus on manufacturing firms, construction firms, multi-state corporations, and high net worth individuals. Brian has extensive experience in individual and corporate tax planning, financial planning, multi-state taxation, research and development tax credits, New York State income tax credits and ownership transition advisory.