174 Deduction, Foreign Research Expenses, April 2022 


Companies with foreign research expenses must account for section 174 changes soon. Beginning in tax years that begin after December 31, 2021, companies with foreign research will have to capitalize and amortize all foreign research over 15 years. This will increase taxable income, so companies need to plan for this change, especially the software industry. But companies can reduce the impact of these 174 changes, by asking foreign research vendors to break out development and maintenance expenses.   

Be Aware – Taxable income will rise and soon. 

It is amazing that the Tax Cuts and Jobs Act (TCJA) passed in 2017, will have a major impact upon companies with foreign research. Starting in tax year 2022, the TCJA requires all companies with research expenses to now capitalize and amortize all 174 deductions. For domestic research expenses, the amortization period is five years. But for foreign research expenses the amortization period is 15 years, triple the domestic timeframe. 

Congress has introduced a bill to modify and delay the implementation of these changes to Sec. 174, with the most recent being included in the “Build Back Better” bill.  Yet this bill has stalled in Congress and there is no certainty in a change being passed. Companies must be ready to not only incorporate these changes into tax policy but find ways to ensure maximum benefit.  

Be Ready – Mitigate the rise in income by breaking out Foreign Expenses  

There is a way companies can help mitigate the increase in taxable income from foreign research expenses. Companies should only amortize foreign expenses that are related to actual development. If a foreign vendor performs both development and maintenance work, a company can remove the maintenance expenses from the 174 deductions and amortize. This distinction provides an opportunity to make sure only the correct amount is amortized.  

To ensure only development work is deducted and amortized under 174, companies should work with foreign research vendors to itemize their expenses, especially those related to development and maintenance work. This might take some planning with foreign vendors, but it could considerably help lower taxable income.   

Companies with foreign research need to take a proactive approach and prepare for an increase in taxable income related to the TCJA 174 changes.  One such way to prepare is for companies to work with foreign research vendors to itemize expense between development and maintenance work, thereby to helping to mitigate the amount of increase in a company’s taxable income by carving out the maintenance work for immediate expensing and reducing the amount of foreign design work to be amortized under 174. 

CFO Services Can Help With Your Research Credit & Tax Incentive Needs 

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