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Congress is Running Out of Time to Fix a Critical R&D Tax Issue in 2023

Before the end of this year, lawmakers have the chance to pass bipartisan tax legislation, with the key parts of an agreement likely centering on an expansion to the Child Tax Credit (CTC) and a change in the tax treatment of research and development (R&D) expenses for American businesses.

BPC breaks down the current tax treatment of R&D (called amortization) versus its historical treatment before 2022 (called full expensing). While returning to R&D expensing would incur fiscal costs, the benefits that full expensing provides to U.S. businesses both large and small would catalyze job creation and economic growth in the years ahead.

How Does the Tax Code Treat R&D?

From 1954 through 2021, businesses could deduct the full amount of an R&D investment from their taxable income in the year they made the investment. For example, if a business invested $100 in R&D in 2021, it could deduct $100 from taxable income, reducing its taxes by $21 in this simple example ($100 multiplied by the 21% statutory corporate income tax rate). This is called full expensing.

Under a provision in the 2017 tax law, businesses were required to amortize, or spread out, their deductions over five years starting in 2022. For example, if the business above invested $100 in R&D in 2022, it could only deduct $20 from taxable income over each of the next five years (2022-2026), reducing its taxes by just $4.20 per year.

Under R&D Full Expensing Under R&D Amortization
Amount of R&D Investment $100 $100
Deduction in Year of Investment $100 $20
Tax Reduction in Year of Investment $21 ($100 * 21%) $4.20 ($20 * 21%)

Dozens of lawmakers in both parties are supporting legislation to restore full expensing for R&D and end the five-year amortization requirement.

The Case for Full Expensing

Full R&D expensing can grow the economy. The nonpartisan Joint Committee on Taxation (JCT) wrote in July that restoring R&D expensing will decrease the cost of R&D, thereby incentivizing businesses to expand their investments. The Tax Foundation estimated that permanent R&D expensing would increase both gross domestic product and wages.

R&D expensing can also incentivize private investment, especially among businesses that might otherwise be reluctant to invest in R&D. While R&D can be risky for businesses, such investments are vital to America’s global competitiveness. The pharmaceutical sector is one example, where even drugs that reach the clinical trial phase (after years of costly R&D) only get approved and reach the market around 10% of the time.

R&D expensing is no less legitimate than other business expenses such as salaries, office rent, and materials that are fully and immediately deductible.

What’s the Proper Tax Treatment of R&D?

Congress should restore full expensing. This policy would grow the economy, treat R&D like the legitimate business expense it is, and restore the tax treatment that R&D received for decades.

Both Senate Finance Chair Ron Wyden (D-OR) and House Ways and Means Committee Chair Jason Smith (R-MO) have expressed a willingness to negotiate a year-end tax deal on R&D expensing and a CTC expansion. Should such a deal materialize, it could increase deficits by tens of billions of dollars, emphasizing the need for lawmakers to find offsets for any temporary or permanent tax cuts, so as to not make the nation’s unsustainable fiscal trajectory even worse.

It’s critical to note though that current negotiations may only lead to a temporary fix through 2025, when other major parts of tax law expire. While this patch would likely distort business decision-making in the absence of certainty that permanent tax law provides, a temporary return to R&D expensing is welcome over a continuation of the five-year amortization policy that might be the death knell for some small businesses.

BPC sees a year-end tax deal that supports families through the CTC and grows the economy through R&D expensing as both possible and worthy of Congress’ time and effort.

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