Published
March 29, 2024
The U.S. Senate must act quickly on the Tax Relief for American Families and Workers Act of 2024 (H.R. 7024), which would provide critical, long-awaited support and certainty to American small and midsize businesses.
Since 1954, American businesses have been allowed to deduct their research and development (R&D) expenses in the year incurred, just like their other ordinary and necessary business expenses.
Firmly rooted in the Internal Revenue Code, R&D expensing has been an uninterrupted U.S. tax policy for nearly 70 years and empowered American businesses to invest in innovative new products and services. However, since January 2022, businesses have been required to amortize (deduct ratably) their domestic R&D expenses over five years.
Unlike R&D expensing, R&D amortization reduces economic growth, penalizes investments by companies in R&D-intensive industries—which has a disproportionate effect on smaller manufacturing and technology companies—and puts American businesses at a competitive disadvantage.
Retroactive Legislation
If R&D expensing is not restored retroactively, R&D amortization will likely result in irreversible harm to U.S. innovation and competitiveness.
H.R. 7024 would seamlessly restore R&D expensing from its lapse in 2022 through the end of 2025, with special provisions designed to ease the administrative burden on affected businesses. While not a permanent solution, the bill’s retroactive restoration of R&D expensing is largely consistent with the approach supported by members of Congress on both sides of the aisle.
Delaying action any further risks the permanent loss of R&D spending and penalizes investment in R&D-intensive industries.
Impact on Small Businesses
Small businesses have been negatively impacted the most by R&D amortization.
Small businesses spend a much higher percentage of their sales on R&D than larger ones. Unlike some large corporations, small and midsize businesses usually do not have easy access to extra cash or the flexibility to move their R&D operations outside the United States (where R&D expensing is widely available).
Furthermore, since mandatory R&D amortization went into effect, many small businesses have suffered cash flow and liquidity issues, compounded by higher taxes on the same income. Small and midsize research-intensive companies have been especially hard hit, with some forced to take out high-interest loans, raise prices, and stop hiring just to survive and pay their taxes.
What Small Businesses Are Saying
Natalie Kaddas runs a second-generation, family-owned thermoplastic manufacturing business that has operated in Utah for 50 years. Last year, Kaddas explained the harsh impacts of R&D amortization to her small business, including an increased tax burden of 35% for 2022.
John Adams, CFO of Kaddas Enterprises, recently told the U.S. Chamber that these negative impacts only intensified in 2023 and will likely persist until Congress acts to restore R&D expensing. Like other innovative small businesses, approximately 15%–20% of Kaddas Enterprises’ total wages typically support domestic R&D investments. And if Congress fails to retroactively restore R&D expensing, Adams estimates the company will endure an increased tax burden of up to 35% for 2023. This is real money that would otherwise be reinvested into the business to grow its workforce, make capital purchases, and innovate.
Manufacturing accounts for approximately 58% of private-sector R&D in the United States. Small and midsize U.S. manufacturers are typically unable to move their R&D activities to more pro-growth tax environments outside the United States. It is American small businesses like Kaddas Enterprises, therefore, that tend to bear the greatest burden of mandatory R&D amortization, putting them at a material competitive disadvantage.
Adams explained that although the company had managed to maintain its operations at or around status quo over the last two years under mandatory R&D amortization, Kaddas Enterprises would soon need to “pivot” its business operations to sustain its competitiveness.
Restoring R&D expensing, albeit temporarily, would help American small businesses immensely, especially those in the manufacturing and information technology sectors like Kaddas Enterprises.
Bottom Line
Congress must seize this opportunity to enact H.R. 7024 and retroactively restore R&D expensing for American small businesses. This pro-growth legislation is vital to the survival of many of America’s most innovative small and midsize businesses. Its enactment would help resolve their cash-flow and liquidity issues while reinvigorating domestic capital investment. It would also represent an important step toward permanently restoring R&D expensing as a cornerstone of U.S. tax policy.
