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What happens when a new law passes that changes how your company can account for R&D expenses? Instead of jumping for joy, many companies freeze up. First, they need to determine whether the new law will affect their taxes and, if so, how. Next, they must figure out how to implement the changes to their accounting practices. If a company qualifies for the R&D tax credit, the changes can create a significant tax liability that can cause unexpected problems if the new amortization routines are not implemented properly. This blog post will help you understand R&D tax credit amortization, what it means for your business, and how to transition to the new rules.
If you're still uncertain about the upcoming changes to the R&D tax credit, Haven can help. Our accounting services for small businesses can help you sort through the details to understand the impact of the changes on your business and get you on the right track to implement any necessary alterations to your accounting practices.
Table of Contents
What is R&D Tax Credit Amortization?
R&D Tax Credit Amortization refers to a significant tax law change that came into effect on January 1, 2022, as part of the 2017 Tax Cuts and Jobs Act (TCJA). This shift is governed by Section 174 of the Internal Revenue Code, and it applies regardless of whether a company claims the R&D tax credit.
Under this change, businesses are no longer allowed to immediately deduct research and development (R&D) expenses in the year they are incurred. Instead, they must capitalize and amortize these costs over several years. Specifically, companies must now amortize:
Domestic R&D expenses over five years
Foreign R&D expenses over fifteen years
In other words, even if you're not applying for the R&D tax credit, you are still required to amortize your R&D expenses under the new law.
R&D Amortization Hits Startups Hard
This change has caused a considerable stir in the business community. Before 2022, companies could fully deduct eligible R&D costs in the year they were incurred, reducing their taxable income significantly. Now, with amortization spreading those deductions over time, many businesses, particularly startups and high-growth tech companies, are facing larger upfront tax bills.
Growing Push to Repeal R&D Amortization
The backlash has been strong and bipartisan. Many lawmakers and business groups are advocating for a repeal of the amortization rule to restore the ability to expense R&D costs in the year they’re incurred. While legislative proposals have been introduced to reverse this provision, no repeal has been enacted yet, though support continues to grow.
In short, R&D tax credit amortization is not about how the credit itself is claimed. Still, how R&D spending is treated for tax purposes affects nearly every company engaged in research, regardless of profitability or credit eligibility.
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How Does Amortization Impact Your Startup?
Amortization of R&D expenses significantly impacts startups by delaying the timing of tax deductions, which in turn increases taxable income in the short term and tightens cash flow. Here’s how this works in practice, with examples and comparisons:
Immediate Expensing (Pre-2022) vs. Amortized Deductions (2022–2024)
Before 2022, startups could fully deduct their R&D expenses in the year they were incurred. For example, if a startup spent $500,000 on R&D in 2021, it could deduct the entire amount from its taxable income that year, reducing its tax bill immediately. This immediate expensing provided a crucial cash flow benefit, allowing startups to reinvest savings back into innovation and growth.
R&D Amortization Reduces First-Year Deductions
Starting in 2022, under the Tax Cuts and Jobs Act (TCJA), startups must amortize domestic R&D expenses over five years. Using the same $500,000 example, instead of deducting the full amount in one year, the startup would deduct $100,000 each year for five years.
This spreads out the tax benefit, increasing taxable income by $400,000 in the first year compared to the previous system, which means a higher tax bill upfront and less cash available for reinvestment.
Impact on Taxable Income and Cash Flow
Because amortization delays deductions, taxable income is higher in the early years following the incurring of R&D expenses. For startups, which often operate with tight budgets and limited revenue, this can create significant cash flow challenges. Higher tax liabilities mean less working capital to fund ongoing development, hire staff, or cover operational costs.
For instance, a software startup that heavily invests in R&D early on may face a tax bill thousands of dollars higher in the first year under amortization rules. This can force startups to delay projects, seek additional financing, or reduce hiring, slowing growth and innovation.
Why This Matters for Startups
Cash Flow Constraints: Startups rely on immediate tax relief to manage cash flow. Amortization reduces this benefit, making it harder to sustain early-stage innovation.
Increased Short-Term Tax Burden: Higher taxable income due to amortization means paying more tax upfront, which can be a barrier to reinvestment.
Planning Complexity: Startups must now forecast tax liabilities over multiple years and adjust their budgets accordingly, which complicates financial planning.
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The 2025 Legislative Changes and What They Mean
The proposed 2025 tax bill aims to repeal the mandatory amortization requirement for domestic research and development (R&D) expenses, effective January 1, 2025. This legislation, introduced as the American Innovation and R&D Competitiveness Act of 2025, seeks to restore the immediate expensing of research and experimental (R&E) costs that was standard before 2022, reversing the five-year amortization rule imposed by the 2017 Tax Cuts and Jobs Act (TCJA).
New R&D Bill Offers Flexibility for Domestic Expenses
Under the new draft law, taxpayers will have the option either to deduct domestic R&D expenses in the year incurred immediately or to amortize these costs over five or ten years. This flexibility enables businesses to select the approach that best aligns with their cash flow and tax planning strategies.
Foreign R&D expenses remain excluded from this repeal and must continue to be amortized over 15 years, maintaining the more extended deduction period for offshore research activities.
No Retroactive Relief in 2025 R&D Bill
Importantly, the bill does not provide retroactive relief for R&D expenses incurred during the 2022–2024 tax years. Companies that amortized their R&D costs during this period will not be able to amend prior returns to recapture those deductions or generate refunds. This lack of retroactivity means businesses must continue to manage the cash flow and tax impacts from those years as they stand.
In short, the 2025 legislative changes restore immediate expensing for domestic R&D starting in 2025, offer optional amortization periods, exclude foreign R&D from repeal, and do not retroactively adjust prior years’ amortization. This shift is expected to enhance cash flow and encourage innovation among U.S. companies that invest in domestic research.
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Strategic Considerations for Startups and Innovators
For startups and innovation-driven companies, understanding how R&D tax rules impact your financial strategy is essential, especially now that amortization of R&D expenses is required under Section 174. While the law currently mandates spreading deductions over time, your approach to tax planning can make a real difference in managing cash flow and preserving capital for growth.
Work With a Tax Advisor to Navigate R&D Changes
One of the most important steps you can take is to work with a knowledgeable tax advisor. If efforts to repeal the amortization rule are successful, businesses may have the option to return to the immediate expensing of R&D costs.
In that case, having a clear picture of your R&D expenditures and how they’re treated will help you decide whether to stick with amortization or opt for immediate deductions, each of which comes with different cash flow implications depending on your stage of growth and profitability.
R&D Tax Credits Still Matter Amid Amortization Rules
Even under the current rules, R&D tax credits remain a critical tool. They can help offset some of the additional tax burden caused by amortization. While you can’t expense all your R&D upfront, the tax credit still provides immediate value based on your Qualified Research Expenses (QREs), helping to soften the financial impact.
Ultimately, it’s crucial to monitor legislative developments closely. The tax code is in flux, particularly around innovation incentives such as R&D. Startups that remain informed and agile in response to these changes will be better positioned to make strategic decisions that support long-term growth and financial stability.
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The new R&D tax credit amortization rules can feel overwhelming, but you don’t have to handle them alone. The team at Haven is here to help. We specialize in finding and maximizing R&D tax credits to help innovative businesses lower their tax bills and get the cash they need to grow. Furthermore, we can help you navigate the new amortization rules and ensure your business complies with all IRS regulations while maximizing your tax savings. Book a call with our team today to learn how we can help your business.