Changes in amortization of research and development


Starting next year, companies will have to amortize their research and development (R&D) expenses over five years rather than immediately deducting them from taxable income, a policy change designed to increase federal tax revenues in the short term. As policymakers decide the future of this planned tax change, one option would be to delay amortization of R&D spending by four years until 2026. Within the ten-year budget window, a four-year delay would cost about $ 100 billion less than writing off outright depreciation, but that wouldn’t increase long-term economic growth.

The outright reversal of R&D depreciation would reduce federal revenues by about $ 131 billion between 2022 and 2031, while increasing long-term GDP and U.S. revenues by 0.1%. Delaying depreciation until 2026, on the other hand, would cost about $ 33.6 billion, or $ 100 billion less than write-off, over those ten years and would not increase GDP in the long run.

Effect on revenues of the deferral of R&D amortization until 2026
2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2022-2031
Conventional – $ 40.6 – $ 26.0 – $ 16.3 -10.6 $ – $ 5.2 $ 29.9 $ 17.5 $ 10.0 $ 5.8 $ 1.8 – $ 33.6

Source: General equilibrium model of the Tax Foundation, July 2021

Although deferring depreciation would cost less during the budget period, it would not increase GDP in the long run because temporary changes in tax policy do not affect long-term incentives. Temporary tax policy can change the timing of investment decisions, but not the long-term after-tax return on investment, which means that the long-term size of the economy is not affected.

There is also a risk that R&D expense will become a permanent “tax extender”, creating uncertainty about the tax treatment of R&D when companies make investment decisions.

While it may be better to extend the full deduction of R&D expenses until 2026 rather than allowing depreciation in 2022, a superior option for economic growth and the stability of the tax code would be to permanently cancel the tax code. future amortization of R&D expenses.

Modeling the timing of R&D deductions and impact on federal revenues

The move from full support for R&D costs to depreciation over five years temporarily limits the amount of deductions that companies can take. This increases the amount of basic income, and this income is one of the reasons R&D depreciation was included in the Tax Cuts and Jobs Act (TCJA). Delaying the switch to depreciation delays these higher incomes and has a somewhat counterintuitive interaction with the baseline of the current law.

As part of the deferral, between 2022 and 2026, companies would continue to take immediate deductions instead of amortizing them over five years. This would reduce corporate taxable income and tax liability during those years, which would reduce federal revenues. Between 2027 and 2031, businesses would begin to write off deductions, which would increase the taxable income and tax liability of businesses, thereby increasing federal revenues.

The table below illustrates the temporal difference of the delay compared to the reference base of the current law.

Imagine a company making $ 100 in R&D investments every year. The cost of this investment is fully deductible in 2021. Under current law, as of 2022, only one-fifth of the investment, or $ 20, is deductible each year. As a new investment is made each year, one-fifth is deductible, meaning that by 2023 the business would benefit from a total of $ 40 in deductions (reflecting one-fifth of the 2022 investment plus one-fifth of the ‘2023 investment). The trend continues until deductions for the 2022 investment are completed in 2026, when the total allowable deductions each year would stabilize. The total deductions each year would reflect one fifth of the total investment for the current year and the previous four years.

We can compare the deductions allowed each year under the current law baseline to the deductions allowed each year if depreciation is delayed to see how the schedule of deductions would change in the latter scenario.

If depreciation were delayed, more deductions would be allowed earlier in the budget window, reducing federal revenues from 2022 to 2026, as shown in Table 1. For example, in 2023, deductions would total $ 40 under the current law, but $ 100 if depreciation was delayed. After depreciation begins in 2026, the same phased-in deductions occur over five years, increasing federal revenues. For example, in 2028, deductions would have already increased to $ 100 under current law, but would only be $ 60 with the late option.

In the long run, however, both options have the same effect on annual revenue – from a federal budget perspective, this is simply a short-term change in the timing of deductions.

Illustrating how tax deductions for R&D change under current law and delay depreciation by 4 years
2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Total annual investment in R&D $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100
Total annual deductions under current law (amortization over 5 years from 2022) $ 20 40 $ $ 60 $ 80 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100
Total annual deductions when 5-year amortization is deferred until 2026 $ 100 $ 100 $ 100 $ 100 $ 20 40 $ $ 60 $ 80 $ 100 $ 100
Difference in value of R&D deductions for the amortization period $ 80 $ 60 40 $ $ 20 -80 $ -60 $ -40 $ -20 $ $ 0 $ 0

Source: author’s calculations. Note: The face value of the R&D investment and the deductions are not adjusted for inflation.

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