The landscape of tax regulations for research and experimental development (R&D) expenditures underwent significant changes with the 2017 Tax Cuts & Jobs Act, marking the most comprehensive overhaul in more than three decades. Among the many provisions, Section 174 emerged as a critical focal point, reshaping how businesses can value and deduct R&D expenses for tax purposes. In 2022, the updates to Section 174 came into effect, bringing about crucial modifications that companies engaging in R&D must be aware of to remain in compliance.

Inclusive Applicability Across Entities

The impact of Section 174 is far-reaching and applies to a diverse array of entities irrespective of industry or size. Corporations, small businesses, startups, sole proprietorships, partnerships, LLCs, and pass-through entities, including S-corporations, all fall under the purview of Section 174 if they incur qualifying R&D costs.

Qualifying Expenses Under Section 174

Section 174 capitalization covers a spectrum of expenses associated with R&D activities. Salaries and wages, supplies and materials, patent costs, overhead expenses, and contract research expenses are among the qualifying costs that must be capitalized, rather than expensed when incurred.

State-Level Conformity to Section 174

The impact of Section 174 is not uniform across states. When planning, companies need to be mindful of the varying levels of conformity adopted by individual states. Some states conform on a rolling basis, automatically adopting changes to the federal tax code, while others adhere to a static basis, incorporating federal tax code as of a specific date. In addition, some states practice selective conformity, adopting specific portions of the Internal Revenue Code. Understanding state-level conformity is essential for businesses operating across different jurisdictions.

As companies engage in R&D activities, staying informed about the recent changes to Section 174 is paramount. A clear understanding of what constitutes a qualifying expenses and state-level conformity will aid businesses in strategically navigating the evolving tax landscape.